Download Perfect Competition

Unit 8
More Economics
of Competition
and Competitive
Strategies
Key Topics
1.
Alternative market structures
a.
b.
2.
3.
Perfect competition
Imperfect competition
Barriers to entry
Revenue concepts for a price-taking firm
(review)
a.
b.
c.
P = AR
MR
TR
Key Topics (cont’d)
4. Operating decisions for a price-setting firm
a.
b.
c.
d.
TR max ($ sales max)
Π max
Rent-seeking actions
Price discrimination
5. Revenue concepts and operating decisions for a Psetting firm
6. Monopolies and roles of government
a.
b.
Restrict market power
Grant & regulate ‘natural’ monopolies
Characteristics of ‘perfectly’
competitive markets
1.
2.
3.
4.
5.
6.
Many firms each relatively small compared to the size
of the entire market or industry.
Firms produce ‘homogeneous’ products.
Relative ease of firm entry in to or exit out of the
market.
Information about prices and production costs widely
available.
Firms have no control over prices and are price
‘takers’.
In long run, product price = minimum average cost =
marginal cost (i.e. no excess profits or losses).
Perfect Competition
A representative firm
Price per unit ($)
The industry
S
P=MR
P*=5
P*=5
D
0
Units of output, Q
0
Units of output, q
Characteristics of ‘imperfectly’
competitive markets
1.
2.
3.
4.
5.
6.
Limited number of firms so each has a relatively
significant share of total output for the industry or
market.
Firms produce ‘heterogeneous’ products.
Relative difficulty of firm entry in to or out of the
market.
Information about prices and production costs NOT
widely available.
Firms have some control over prices charged for their
products and are price ‘setters’.
In long run, product price > average cost and price >
marginal cost.
General types of imperfectly
competitive markets
1.
Monopolistic competition
Many firms selling slightly differentiated products
2.
Oligopoly
Few firms selling products with varying degrees of
differentiation
3.
Monopoly
ONE firm selling product that has no (or few) close
substitutes
Barriers to entry
1.
Government franchises = exclusive licenses to
sell product/services
Why?
- Economies of scale (i.e. greater efficiency  lower
production costs)
- Greater governmental control (e.g. alcohol)
2.
Patents = exclusive right to sell a product or
use a process to the inventor (for 20 years)
Why?
- To promote research, scientific progress
Barriers to entry (cont’d)
3.
High capital costs (e.g. production,
marketing)
4.
Ownership of scarce factor of production
Prices charged by imperfectly
competitive firms
1.
They are a choice decision, not given (or
taken)
2.
They are constrained by consumer demand
for the firm’s product (i.e. can set either P or
Q, but NOT both).
Demand Curve ‘Constraint’
P
D curve facing P-setting firm
(shows max P & Q combinations)
a
Not possible
Pa
q
qa
Recall, P = MR for P-taking
(competitive firm)
$
P = MR = AR
q
However, MR < P for P-setting firm
MR for P-setting firm of lowering P to
sell 1 more Q (graph)
P
P1
{P
-$
2
+$
q1
(q1+1)
{
ΔP
Δq = 1
q
Marginal Revenue Example, Imperfect
Competition
Quantity
0
1
Price
$11
10
Total Revenue Marginal Revenue
0
-$10
$10
2
3
4
9
8
7
18
24
28
8
6
4
5
6
30
2
6
7
8
5
4
3
30
28
24
0
-2
-4
MR and TR max vs π max
MR
=
slope of TR
TR max
=
$ sales max  MR = 0
(= D curve mid point)
Π max

MR = MC
TR max vs π max (graph)
$
MR=MC
 π max
MR=0
 TR max
TC
TR
q
More Monopoly Questions, Issues

1.
2.
3.
Can you show with a graph:
A monopolist maximizing its profits, yet
still losing money?
The consumer surplus impacts of monopoly
(vs competition)?
The impact on a monopolist’s profit of
offering a price discount on large quantity
purchases?
Monopoly (vs Perfect Competition)

Profits can persist LR (entry blocked)

Output less & price higher ( loss of
consumer surplus)

May act to preserve profits (= rent-seeking
behavior) (e.g. lobbying, advertising, build
entry barriers)
Price Discrimination
= charging different prices to different groups of
buyers (i.e. different markets)
Examples:
Airlines, movie theatres, golf courses,
restaurants, telephone companies, utility
companies
Price Discrimination (graph)
$
$
PB
Pa
MC = ATC
MRa
dA
MRB
q
q *A
q
q
Mkt A
dB
*
B
Mkt B
Monopolies and the Roles of
Government
1.
Promote competition/restrict market power
 antitrust laws
- Sherman Antitrust Act, 1890 (restraint of trade illegal)
- Clayton Act, 1914 (anticompetitive mergers and tying
contracts illegal)
- Federal Trade Commission Act, 1914 (established
FTC as regulatory agency and made ‘unfair methods
of competition illegal)
Other legality issues: rule of reason vs. per se; conduct
vs structure; remedies = consent decrees, treble
damages, etc.
Monopolies and the Roles of
Government
2. Grant monopolies (natural) and regulate so
consumers benefit from economies of scale
Monopoly Regulation Alternatives
1.
2.
Require P = MC not practical as P < ATC
Require P = ATC (or P = ATC+)
- Little incentive to minimize costs
3.
Incentive pricing 
- set prices for number of yrs into future &
allow firms to keep profits