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SAYRE | MORRIS Seventh Edition Imperfect Competition CHAPTER 11 11-1 © 2012 McGraw-Hill Ryerson Limited Alanna Holowinsky, Red River College

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Page 1: SAYRE | MORRIS Seventh Edition Imperfect Competition CHAPTER 11 11-1© 2012 McGraw-Hill Ryerson Limited Alanna Holowinsky, Red River College

SAYRE | MORRIS Seventh Edition

Imperfect Competition

CHAPTER 11

11-1© 2012 McGraw-Hill Ryerson Limited

Alanna Holowinsky, Red River College

Page 2: SAYRE | MORRIS Seventh Edition Imperfect Competition CHAPTER 11 11-1© 2012 McGraw-Hill Ryerson Limited Alanna Holowinsky, Red River College

Imperfect Competition

Learning Objectives:

LO1: Understand the importance and effects of product differentiation, including advertising

LO2: Understand the differences between the two types of imperfect competition

LO3: Explain why monopolistically competitive firms tend to have excess capacity and are unlikely to earn long-run economic profits

CHAPTER 11

11-2© 2012 McGraw-Hill Ryerson Limited

Page 3: SAYRE | MORRIS Seventh Edition Imperfect Competition CHAPTER 11 11-1© 2012 McGraw-Hill Ryerson Limited Alanna Holowinsky, Red River College

Imperfect Competition

Learning Objectives:

LO4: understand the main characteristics of oligopoly markets

LO5: understand why large firms are often tempted to collude and form cartels

LO6: understand price leadership and why oligopolistic firms are reluctant to change prices very often

CHAPTER 11

11-3© 2012 McGraw-Hill Ryerson Limited

Page 4: SAYRE | MORRIS Seventh Edition Imperfect Competition CHAPTER 11 11-1© 2012 McGraw-Hill Ryerson Limited Alanna Holowinsky, Red River College

Imperfect Competition

• A market structure in which producers are identifiable and have some control over price

• Two forms:

1. Monopolistic Competition

2. Oligopoly

11-4© 2012 McGraw-Hill Ryerson Limited

LO1

Page 5: SAYRE | MORRIS Seventh Edition Imperfect Competition CHAPTER 11 11-1© 2012 McGraw-Hill Ryerson Limited Alanna Holowinsky, Red River College

Imperfect Competition

Product Differentiation • Attempt to distinguish a firm’s products from

those of its competitors

• Firms often compete on basis other than price

• Logos, symbols, brand names, location, service, product development

• Often involves extensive advertising

11-5© 2012 McGraw-Hill Ryerson Limited

LO1

Page 6: SAYRE | MORRIS Seventh Edition Imperfect Competition CHAPTER 11 11-1© 2012 McGraw-Hill Ryerson Limited Alanna Holowinsky, Red River College

Advertising

Benefits of Advertising • Provides the consumer with vital information

• Enhances competition between firms

• Lowers the prices of products

• Finances magazines and television shows

11-6© 2012 McGraw-Hill Ryerson Limited

LO1

Page 7: SAYRE | MORRIS Seventh Edition Imperfect Competition CHAPTER 11 11-1© 2012 McGraw-Hill Ryerson Limited Alanna Holowinsky, Red River College

Advertising

Criticisms of Advertising • Mostly not informative and wasteful

• Encourages concentration within industries

• Raises prices to the detriment of consumers

11-7© 2012 McGraw-Hill Ryerson Limited

LO1

Page 8: SAYRE | MORRIS Seventh Edition Imperfect Competition CHAPTER 11 11-1© 2012 McGraw-Hill Ryerson Limited Alanna Holowinsky, Red River College

Self-Test Assume that two firms dominate the running-shoes industry. One

of them hires a high-profile sports figure to endorse its product by appearing in its advertising.

a) What would you expect the other firm to do in response, and why?

b) After the second firm has reacted in the way you said it would above, what do you think the relative share of the market that each firm enjoyed would be?

c) Given your answer in b) above, what might these two firms be tempted to do?

11-8© 2012 McGraw-Hill Ryerson Limited

LO1

Page 9: SAYRE | MORRIS Seventh Edition Imperfect Competition CHAPTER 11 11-1© 2012 McGraw-Hill Ryerson Limited Alanna Holowinsky, Red River College

Self-Test Assume that two firms dominate the running-shoes industry. One

of them hires a high-profile sports figure to endorse its product by appearing in its advertising.

a) What would you expect the other firm to do in response, and why?

11-9© 2012 McGraw-Hill Ryerson Limited

LO1

Game theory analysis suggests that the other firm would be forced to respond with a new advertising campaign possibly using another high profile sports figure.

Page 10: SAYRE | MORRIS Seventh Edition Imperfect Competition CHAPTER 11 11-1© 2012 McGraw-Hill Ryerson Limited Alanna Holowinsky, Red River College

Self-Test Assume that two firms dominate the running-shoes industry. One

of them hires a high-profile sports figure to endorse its product by appearing in its advertising.

b) After the second firm has reacted in the way you said it would above, what do you think the relative share of the market that each firm enjoyed would be?

11-10© 2012 McGraw-Hill Ryerson Limited

LO1

Relative market share between the two firms probably would not change much from what it was initially.

Page 11: SAYRE | MORRIS Seventh Edition Imperfect Competition CHAPTER 11 11-1© 2012 McGraw-Hill Ryerson Limited Alanna Holowinsky, Red River College

Self-Test Assume that two firms dominate the running-shoes industry. One

of them hires a high-profile sports figure to endorse its product by appearing in its advertising.

c) Given your answer in b) above, what might these two firms be tempted to do?

11-11© 2012 McGraw-Hill Ryerson Limited

LO1

The two firms would be tempted to come to an (illegal) agreement avoiding expensive adverting campaigns in the future.

Page 12: SAYRE | MORRIS Seventh Edition Imperfect Competition CHAPTER 11 11-1© 2012 McGraw-Hill Ryerson Limited Alanna Holowinsky, Red River College

Types of Imperfect Competition

Monopolistic Competition • a market in which many firms sell a

differentiated product and have some control over price

Oligopoly • a market dominated by a few large firms

11-12© 2012 McGraw-Hill Ryerson Limited

LO2

Page 13: SAYRE | MORRIS Seventh Edition Imperfect Competition CHAPTER 11 11-1© 2012 McGraw-Hill Ryerson Limited Alanna Holowinsky, Red River College

Measuring Industry Concentration

Concentration Ratio • The percentage of an industry’s total sales that

is controlled by the largest few firms

• 4-firm concentration ratio: % of sales revenue by 4 largest firms in industry

• If < 40% may be monopolistic competition

• If > 40% likely oligopoly

11-13© 2012 McGraw-Hill Ryerson Limited

LO2

Page 14: SAYRE | MORRIS Seventh Edition Imperfect Competition CHAPTER 11 11-1© 2012 McGraw-Hill Ryerson Limited Alanna Holowinsky, Red River College

4 Firm Concentration Ratios

11-14© 2012 McGraw-Hill Ryerson Limited

LO2

Page 15: SAYRE | MORRIS Seventh Edition Imperfect Competition CHAPTER 11 11-1© 2012 McGraw-Hill Ryerson Limited Alanna Holowinsky, Red River College

Self-Test The grummit industry consists of 10 companies.

Company Sales $m:

A $22

B $6

C $17

D $12

E $8

F $15

Next 4 (total) $12

11-15© 2012 McGraw-Hill Ryerson Limited

LO2

a) Calculate the 4-firm concentration ratio for this industry.

b) What type of market does this industry operate in?

Page 16: SAYRE | MORRIS Seventh Edition Imperfect Competition CHAPTER 11 11-1© 2012 McGraw-Hill Ryerson Limited Alanna Holowinsky, Red River College

Self-Test The grummit industry consists of 10 companies.

Company Sales $m:

A $22

B $6

C $17

D $12

E $8

F $15

Next 4 (total) $12

11-16© 2012 McGraw-Hill Ryerson Limited

LO2

a) Calculate the 4-firm concentration ratio for this industry.

b) What type of market does this industry operate in?

71.7% ($66/$92)

Oligopoly (it is higher than the 40%)

Page 17: SAYRE | MORRIS Seventh Edition Imperfect Competition CHAPTER 11 11-1© 2012 McGraw-Hill Ryerson Limited Alanna Holowinsky, Red River College

Monopolistic Competition

Characteristics • Many small firms acting independently

• Freedom of entry

• Products are differentiated

• Each firm has some control over price

11-17© 2012 McGraw-Hill Ryerson Limited

LO3

Page 18: SAYRE | MORRIS Seventh Edition Imperfect Competition CHAPTER 11 11-1© 2012 McGraw-Hill Ryerson Limited Alanna Holowinsky, Red River College

Monopolistic Competition

• May have economic profit in the short run

• In the long run, the representative firm in a monopolistically competitive market makes only normal profits

11-18© 2012 McGraw-Hill Ryerson Limited

LO3

Page 19: SAYRE | MORRIS Seventh Edition Imperfect Competition CHAPTER 11 11-1© 2012 McGraw-Hill Ryerson Limited Alanna Holowinsky, Red River College

Monopolistically Competitive Equilibrium (SR)

11-19© 2012 McGraw-Hill Ryerson Limited

LO2

Page 20: SAYRE | MORRIS Seventh Edition Imperfect Competition CHAPTER 11 11-1© 2012 McGraw-Hill Ryerson Limited Alanna Holowinsky, Red River College

Monopolistically Competitive Equilibrium (SR)

11-20© 2012 McGraw-Hill Ryerson Limited

LO2

Page 21: SAYRE | MORRIS Seventh Edition Imperfect Competition CHAPTER 11 11-1© 2012 McGraw-Hill Ryerson Limited Alanna Holowinsky, Red River College

Self-Test Assume that a representative firm in monopolistic

competition is experiencing economic losses. What series of events will occur to return this firm to its long-run equilibrium?

11-21© 2012 McGraw-Hill Ryerson Limited

LO2

Page 22: SAYRE | MORRIS Seventh Edition Imperfect Competition CHAPTER 11 11-1© 2012 McGraw-Hill Ryerson Limited Alanna Holowinsky, Red River College

Self-Test Assume that a representative firm in monopolistic

competition is experiencing economic losses. What series of events will occur to return this firm to its long-run equilibrium?

11-22© 2012 McGraw-Hill Ryerson Limited

LO2

Some firms within the industry will go out of business (exit). Graphically, this would shift the demand curve faced by each of the remaining firms to the right so that it once again became tangent to the average cost curve.

Page 23: SAYRE | MORRIS Seventh Edition Imperfect Competition CHAPTER 11 11-1© 2012 McGraw-Hill Ryerson Limited Alanna Holowinsky, Red River College

11-23© 2012 McGraw-Hill Ryerson Limited

LO2

Page 24: SAYRE | MORRIS Seventh Edition Imperfect Competition CHAPTER 11 11-1© 2012 McGraw-Hill Ryerson Limited Alanna Holowinsky, Red River College

Appraisal of Monopolistic Competition

• produces a lower output than a perfectly competitive firm

• does not achieve productive efficiency because the long-run equilibrium price does not equal minimum average total cost

• charges a higher price than a perfectly competitive firm

• does not achieve allocative efficiency because price exceeds marginal cost

11-24© 2012 McGraw-Hill Ryerson Limited

LO3

Page 25: SAYRE | MORRIS Seventh Edition Imperfect Competition CHAPTER 11 11-1© 2012 McGraw-Hill Ryerson Limited Alanna Holowinsky, Red River College

Self-Test a) What output will this firm produce?

b) How much excess capacity exists at this output level?

11-25© 2012 McGraw-Hill Ryerson Limited

LO3

Page 26: SAYRE | MORRIS Seventh Edition Imperfect Competition CHAPTER 11 11-1© 2012 McGraw-Hill Ryerson Limited Alanna Holowinsky, Red River College

Self-Test a) What output will this firm produce?

b) How much excess capacity exists at this output level?

11-26© 2012 McGraw-Hill Ryerson Limited

LO3

Q2. (where MC=MR.)

Excess capacity of Q4 – Q2

Page 27: SAYRE | MORRIS Seventh Edition Imperfect Competition CHAPTER 11 11-1© 2012 McGraw-Hill Ryerson Limited Alanna Holowinsky, Red River College

Oligopoly

Characteristics • It is dominated by a few large firms.• Entry by new firms is difficult.• Nonprice competition between firms is widely

practised.• Each firm has significant control over its price.• Mutual interdependence exists between firms.• Products can be either homogeneous or

differentiated.

11-27© 2012 McGraw-Hill Ryerson Limited

LO4

Page 28: SAYRE | MORRIS Seventh Edition Imperfect Competition CHAPTER 11 11-1© 2012 McGraw-Hill Ryerson Limited Alanna Holowinsky, Red River College

Oligopoly

Mutual interdependence • the condition in which a firm’s actions depend, in

part, on the reactions of rival firms

11-28© 2012 McGraw-Hill Ryerson Limited

LO4

Page 29: SAYRE | MORRIS Seventh Edition Imperfect Competition CHAPTER 11 11-1© 2012 McGraw-Hill Ryerson Limited Alanna Holowinsky, Red River College

Collusion

Collusion • an agreement among suppliers to set the price of a

product or the quantities each will produce

Game Theory • a method of analyzing firm behaviour that

highlights mutual interdependence among firms

11-29© 2012 McGraw-Hill Ryerson Limited

LO5

Page 30: SAYRE | MORRIS Seventh Edition Imperfect Competition CHAPTER 11 11-1© 2012 McGraw-Hill Ryerson Limited Alanna Holowinsky, Red River College

Game Theory

Nash Equilibrium • a situation where each rival chooses the best

actions given the (anticipated) actions of the other(s)

11-30© 2012 McGraw-Hill Ryerson Limited

LO5

Page 31: SAYRE | MORRIS Seventh Edition Imperfect Competition CHAPTER 11 11-1© 2012 McGraw-Hill Ryerson Limited Alanna Holowinsky, Red River College

Game Theory

11-31© 2012 McGraw-Hill Ryerson Limited

LO5

Page 32: SAYRE | MORRIS Seventh Edition Imperfect Competition CHAPTER 11 11-1© 2012 McGraw-Hill Ryerson Limited Alanna Holowinsky, Red River College

Collusive Oligopoly

Cartel • an association of sellers acting in unison

• for example, Organization of Petroleum Exporting Countries (OPEC)

• able to increase prices by restricting output

• cartels work to the advantage of their members only if there is no cheating among the participants

11-32© 2012 McGraw-Hill Ryerson Limited

LO5

Page 33: SAYRE | MORRIS Seventh Edition Imperfect Competition CHAPTER 11 11-1© 2012 McGraw-Hill Ryerson Limited Alanna Holowinsky, Red River College

Self-Test Suppose that Spartan Inc. and Trojan Ltd, the only two firms

in the industry, have entered into a collusive agreement to share the industry’s total profits of $50 million equally. However, if any one of them cheats, it will increase its profits by $10 million at a cost of $10 million to the other firm. If they both cheat, they will each reduce their profits by $5 million.

a) Construct a matrix showing the various options.

b) Which option will they likely chose?

11-33© 2012 McGraw-Hill Ryerson Limited

LO5

Page 34: SAYRE | MORRIS Seventh Edition Imperfect Competition CHAPTER 11 11-1© 2012 McGraw-Hill Ryerson Limited Alanna Holowinsky, Red River College

Self-Test a) Construct a matrix showing the various options.

b) Which option will they likely chose?

11-34© 2012 McGraw-Hill Ryerson Limited

LO5

Cell D. They will end up both cheating.Spartan Inc

stick to agreement cheat

Cell A Cell B

Cell C Cell D

stick to agreement

cheat

Trojan Ltd

$25

$25

$35

$15

$15

$35

$20

$20

Page 35: SAYRE | MORRIS Seventh Edition Imperfect Competition CHAPTER 11 11-1© 2012 McGraw-Hill Ryerson Limited Alanna Holowinsky, Red River College

Noncollusive Oligopoly

Price Leadership • When rival firms engage in what amounts to price

fixing without overt collusion

• A leader – usually the largest or most efficient firm – sets price, other firms follow

• Must balance the advantages of a price increase with the risks of creating an opening for new entrants

11-35© 2012 McGraw-Hill Ryerson Limited

LO6

Page 36: SAYRE | MORRIS Seventh Edition Imperfect Competition CHAPTER 11 11-1© 2012 McGraw-Hill Ryerson Limited Alanna Holowinsky, Red River College

© 2012 McGraw-Hill Ryerson Limited 11- 36

LO6

Page 37: SAYRE | MORRIS Seventh Edition Imperfect Competition CHAPTER 11 11-1© 2012 McGraw-Hill Ryerson Limited Alanna Holowinsky, Red River College

© 2012 McGraw-Hill Ryerson Limited 11- 37

LO6

Page 38: SAYRE | MORRIS Seventh Edition Imperfect Competition CHAPTER 11 11-1© 2012 McGraw-Hill Ryerson Limited Alanna Holowinsky, Red River College

Oligopoly

• Some believe that oligopolies are too powerful and produce inefficiently

• Others take the view that oligopolies are at the cutting edge of new technological development and, in the long run, push the average costs of production down

11-38© 2012 McGraw-Hill Ryerson Limited

LO6

Page 39: SAYRE | MORRIS Seventh Edition Imperfect Competition CHAPTER 11 11-1© 2012 McGraw-Hill Ryerson Limited Alanna Holowinsky, Red River College

Key Concepts to Remember:

• The importance of product differentiation

• The two types of imperfect competition – monopolistic competition and oligopoly

• Collusion and cartels

• Price leadership

CHAPTER 11 SUMMARY

11-39© 2012 McGraw-Hill Ryerson Limited