Theories of Imperfect Competition

• Major Contributors:– Piero Sraffa (1898-1983)– Joan Robinson (1903-1983)– Edward Chamberlin (1899-1967)

• Sraffa’s 1926 article on the laws of return

• Criticism of Marshall’s external economies as a way of reconciling falling supply prices with competition

• Need to focus on monopoly

Joan Robinson and Imperfect Competition

• The Economics of Imperfect Competition (1933)

• Introduction of marginal revenue curves

• Deals with an individual firm assuming the firm has its own market and faces a downward sloping demand curve

• In the absence of new entry, the analysis is as for a monopoly

Monopoly Equilibrium

• A monopoly faces the market demand curve

• For a single price monopoly the D curve is the AR curve

• MR will lie below AR curve

• Monopoly profit max equilibrium where MC=MR

• Second order condition is that the MC cuts the MR from below

Monopoly Equilibrium

MC

D=ARMR

P

Q

MC

D=AR

MR

a

b

P

Q

Point a is not an equilibrium

Monopoly Equilibrium

• Firm will have excess profits if P > ATC

• If no new entry of other firms selling substitute goods excess profit can remain

• Idea of “full equilibrium” where other firms come in and all firms are where MC =MR and

P = ATC but each firm still facing a downward sloping demand curve

Price Discrimination• Perfect price discrimination

– D curve becomes the MR curve – No restriction of output

D=MR

MC

Q

P

Q

Totalrevenue

Price Discrimination

• Market segmentation– Profit max output where the

aggregate MR=MC– Allocate output between markets

so as to equalize MR

MR1+MR2

MC

Total Q

MR

$

Q

Price Discrimination

D1

MR1

D2

MR2

q1

p1

q2

p2MR

Price discrimination of this type may or may not increase total output as compared with a single price monopolist depending on exact shapes of the demand curves. In the case of linear demand curves total output will be the same

Imperfect Factor Markets

• Effects of monopoly in output market on the factor market– Firms will hire where W=MRP– But MRP<VMP– Monopoly exploitation of labour

D comp

D monop

S

Wage

L

w

l

Imperfect Factor Markets

• Effects of monopsony in the factor market– Single buyer in the labour market– Faces upward sloping supply

curve for the factor– Marginal cost of the factor lies

above the supply curve– Firm equates MRP with MC of

the factor– Wage below VMP– Monopsony exploitation of labour

Monopsony Exploitation

W

L

S

MC of labour

D=MRP

l

w

mrp

Difference between mrp and w is monopsonyexploitation of labour

Edward Chamberlin: Monopolistic Competition

• Theory of Monopolistic Competition 1933

• Very different starting point from Robinson

• Not an issue with Marshall’s laws of return, but a response to the existence of advertising and product differentiation

• Firms have monopoly over their own brands but there are many close substitutes

Monopolistic Competition: Demand

• Firms face two demand curves

• one showing the demand with the prices of other brands given (dd curve)

• the other is a share of the market curve which is drawn for this brand assuming all brands have the same price (DD curve)

• Chamberlin assumes symmetry between firms

Monopolistic Competition

Demand curves facing the firm

d

d

D

D

p

q

P

Q

Monopolistic Competition

• Monopolistic competition

• Large group and small group models

• Large group: like perfect competition but for product differentiation

• Small group: oligopoly, barriers to entry: like monopoly but an issue of firms being aware of their interdependence

Monopolistic Competition: Large

Group• Equilibrium for the individual firm

is where mr (derived from the dd curve) = MC

• For this to be consistent with equilibrium for the group the firm must also be on its share of the market demand curve

• In the long run all firms must just be making normal profits due to free entry condition

• Long run equilibrium will be to the lest of min LRACT

Large Group Equilibrium

Short Run

d

d

mr

MC

p

q Q

PD

D

Long run

LRATC

D

Dd

d

mr

MC

p

q Q

P

Small Group Model

• Small number of firms

• Barriers to entry

• If all firms charge the same price then each firm only faces the DD demand curve

• Similar to monopoly equilibrium

D

DMR

MCp

q Q

P

Kinked Demand Curve Model

• But will all firms charge the same price? What happens if one firm changes price?

• That firm might believe that other firms will follow price cuts but will not follow price rises

• Paul Sweezy and the kinked demand curve model (1939)

• Discontinuity in MR curve• Price inflexibility thesis

Kinked Demand Curve Model

d

d

D

D

P

Q

p

q

D

MR

MC’

MC”

P

Q

P

General Problem of Oligopoly Analysis

• Problem of interdependence

• Cournot model of duopoly

• Stackelberg and price leadership models

• More recent game theory approaches– oligopoly as a prisoners’ dilemma game

• Cournot-Nash equilibrium

• One shot and repeated games

• Evolutionary game theory and evolutionary stable strategies