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IMPERFECTCOMPETITION
LookingbackonPerfectCompe;;on,wesawthatthereweremanyfirms
allproducinghomogeneousgoods.I.e.nochoice.InMonopoly,wesaw
thattherewasonlyonefirmintheindustryproducingonegood.Again,
theconsumerdoesn’tenjoyanychoice.Ifyoulookintoanyshop
nowadays,youwillseeavastarrayofdifferentproductsthatallperform
thesamefunc;on.Theseproductsaresubs;tutesforeachotherandas
suchtheconsumerenjoysagreatdealofchoice.
Also,weseethateachfirmtriestodis;nguishitsproductsfromthoseof
itscompe;tors.Thisgivesuscompe;;veadver;sing.Eachfirmistrying
toprovetotheconsumerthatitsproductsarebeHerthanthoseofits
compe;tors.Therefore,whatweseeintherealworldisnotaccurately
describedbyeitherPerfectCompe;;onorMonopoly.However,itis
accuratelydescribedbytheMarketStructureknownasImperfect
Compe;;ontowhichwenowturnouraHen;on.
Assump1ons
1) ManyFirmsintheIndustry:Eachfirmactsindependentlyandan
individualsellercaninfluencethequan;tysoldbythepriceitcharges
foritsoutput.
2) ManyBuyers:Eachbuyeractsindependently,andnoindividualbuyer,
byhisownac;ons,caninfluencethemarketpriceofthegoodsbeing
sold.
3) ProductDifferen1a1onExists:Theproductsbeingsoldbyeachfirm
areclose,butnotperfect,subs;tutes.Eachfirmistryingtoportrayits
productassuperiortotheproductsofitscompe;tors.Thisisusually
aHemptedthroughCompe;;veAdver;singandBrandNames.
4) ThereisReasonableKnowledgeofbothProfitsandCosts:Eachfirm
intheindustryhasreasonableknowledgeastotheprofitsmadeby
otherfirms.Also,consumershaveareasonableknowledgeofthe
pricesbeingchargedforthedifferentproductssoldbydifferentfirms.
5) Thereisfreedomofentryandexitintoandoutoftheindustry:Firms
alreadyintheindustrycannotpreventnewfirmsfromenteringthe
industry(nobarrierstoentry).Alsoitispossibleforexis;ngfirmsto
leavetheindustry.
6) Firmsareprofitmaximisers:Firmsproduceatthequan;tyofoutput
whereMC=MR(MarginalCost=MarginalRevenue)andMCisrising.
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NOTE:Aseachfirmistheonlyfirmen;tledtoproducetheirbrandwe
saythateachfirmhasaMonopolyintheirownbrandname.Forthis
reason,incollege,ImperfectCompe;;onisknownasMonopolis;c
Compe;;on.
Intheassump;onswesaidthatProductDifferen;a;onexists.
ProductDifferen1a1on:meansthattheproductssoldbycompe;ng
firmsaresimilarbuthavedifferences.Thereareclose(butnotperfect)
subs;tutesavailable.
ShortRunEquilibriumofaFirminImperfectCompe11on
Becausetherearemanygoods,whichareclosesubs;tutes,ifafirm
increasesitsprice,therewillbeareduc;onindemand,assome
consumerswillswitchtothegoodsproducedbycompe;tors,whichhave
becomerela;velycheaper.Ifafirmlowersitspriceitwillincreaseits
sales,assomeconsumersofothersubs;tutegoodswillswitchtothis
firm’sgoodbecauseitisrela;velycheaper.Fromthiswecandeducethat
anImperfectlyCompe;;vefirmfacesadownwardslopingdemandcurve
(ARCurve).Seegraphbelow.
Price
D/AR
Quan;ty
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Fromtherevenueandprofitshandout,iftheAverageRevenue(AR)
Curveisdownwardsloping(decreasing)thentheMarginalRevenue(MR)
Curveisalsodownwardsloping(decreasing).Therefore,theMarginal
RevenueCurveislessthanorlowerthantheAverageRevenueCurveand
theMarginalRevenueCurvedecreasesatafasterratethantheAverage
RevenueCurve.ThismeansthattheMarginalRevenueCurveisdrawn
belowtheAverageRevenueCurveandithasasteeperslope.
Price
MR
D/AR
Quan;ty
IfwesuperimposetheMarginalandAveragecostcurvesontothegraph
abovewegettheShortRunequilibriumposi;onoftheImperfectly
Compe;;vefirm.Seegraphoverleaf.
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ShortRunEquilibriumPosi1onofanImperfectlyCompe11veFirm
Price
AC
MC
!
P1
C1
!
SNP
X
D/AR
MR
Q1
Explana1onofShortRunEquilibrium
1) Equilibrium/ProfitMaximisa1on:occursatpointXwhereMC=MR
(MCisrisingandcutsMRfrombelow).
2) PriceandQuan1ty:ThelevelofoutputproducedisQ1andtheprice
thefirmsellsthisoutputatisP1.
3) Costs:Theaveragecostofproduc;onisshownatthecostC1.Wecan
seefromthecurvethatthefirmisnotproducingatthelowestpoint
oftheACcurveandassuchiswastefulofresource.
4) Profit:ThisfirmisearningSuperNormalProfitsbecauseattheprice
P1,AR>AC.
5) TheShortRunEquilibriumposi;onofanImperfectlyCompe;;vefirm
iswhereMC=MRandAR>AC.
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Quan;ty
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IfwelookatthediagramoverleafweseethattheShortRunequilibrium
posi;onofanImperfectlyCompe;;vefirmisalmostexactlythesameas
theEquilibriumposi;on(bothShortRunandLongRun)ofaMonopolist.
TheonlydifferenceisthatthedemandcurveforaMonopolistismore
inelas;c(steepersloped)thantherela;velyelas;c(flaHersloped)
demandcurvefacingtheImperfectlyCompe;;vefirm.
ThisisduetothefactthatthedemandcurvefacedbytheMonopolistis
rela;velyinelas;castherearenosubs;tutesavailable.TheDemand
CurvefacedbyanImperfectlyCompe;;vefirmisrela;velyelas;cas
therearemanyclose,butnotperfect,subs;tutesavailable.
LongRunEquilibriumPosi1onofanImperfectlyCompe11veFirm
Fromtheassump;ons,weknowthatthereisfreedomofentryandexit
intoandoutoftheindustry,andthereisreasonableknowledgeofprofits
andcosts.Asaresultoftheseassump;onstheImperfectlyCompe;;ve
firmcannotcon;nuetoearnSNPintheLongrun.Thisisbecausethere
arenobarrierstoentry,unlikeMonopoly.
Price
InordertocapturesomeofthisSuperNormalProfit(SNP),newfirms
entertheindustry,resul;nginincreasedindustrysupplycausinga
reduc;oninthelevelofdemandforeachindividualfirm.Seegraph
below.
D1
D2
Quan;ty
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Thereduc;oninAverageRevenuecausestheSNPbeingearnedbyeach
firmtodiminish.Duetotheassump;onof“FreeEntry”,theSNPearned
byeachfirmwillcon;nuetofallun;leachfirmintheindustryisearning
NormalProfits.Thatis,theSNPwilleventuallyfalltozero.Seegraph
below.
Price
!
AC
!
P1
MC
B
MR
D/AR
E
Q1
Quan;ty
1) Fromtheassump;ons,weknowthatImperfectlyCompe;;vefirms
areProfitsMaximisersandassuchproducethequan;tyofoutput
whereMC=MRandMCisrising.PointE.
2) Therefore,thefirmproducesquan;tyQ1andchargespriceP1.
3) Atthisquan;ty,theAverageRevenueCurveequalstheAverageCost
Curve(AR=AC)andassuch,thefirmisearningNormalProfits.
PointB.
IfwelookcloseratwheretheAverageRevenueCurvemeetstheAverage
CostCurve,weseethattheAverageRevenueCurveisatangenttothe
AverageCostCurve.Whendescribingthissitua;onwesaythatthe
AverageRevenueCurveistangen;altotheAverageCostCurve.
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NOTE:Atangentisastraightlinethattouchesacurveatonepointonly
andnevercrossesthatcurve.Atthepointoftouch,thetangentandthe
curvehavetheexactsameslope.
Therefore,mathema;cally,bothcurveshavethesameslopeatthepoint
oftouch.AstheAverageRevenuecurveisanormaldownwardsloping
demandcurveanditistangen;altotheAverageCostcurve,theAverage
Costcurvemustbedownwardsloping,whichmeansthatanImperfectly
Compe;;vefirmcannotbeproducingattheminimumpointofthe
AverageCostCurve.Duetothisfact,ImperfectlyCompe;;vefirmsare
consideredtobeinefficientandwastefulofresources.
TheLongrunEquilibriumofanImperfectlyCompe1tveFirm
Price
AC
!
!
P1
MC
B
D/AR
E
Q1
Explana1onofLongRunEquilibrium
1) Equilibrium/ProfitMaximisa1on:occursatpointEwhereMC=MR
(MCisrisingandcutsMRfrombelow).
2) PriceandQuan1ty:ThelevelofoutputproducedisQ1andtheprice
thefirmsellsthisoutputatisP1.
3) Costs:Theaveragecostofproduc;onisshownatpointB.
4) Profit:ThisfirmisearningnormalprofitsbecauseAR=AC.
5) Efficiency:ThefirmisnotproducingatthelowestpointofACcurve
thisindicatesthatthefirmiswas;ngscarceresources.
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Quan;ty
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ReasonswhyImperfectlyCompe11veFirmsareconsideredwastefulof
Resources
1) ExcessCapacity:ImperfectlyCompe;;vefirmswillgenerallybe
producingatalevelofoutputtoosmalltocompletelyavailofallof
theadvantagesofEconomiesofScale.Thedifferencebetweenthe
actualoutputthatImperfectlyCompe;;vefirmsproduceandthe
outputrequiredtocompletelyavailofEconomiesofScaleisknownas
the“ExcessCapacity”ofthefirm.
2) Compe11veAdver1sing:Compe;;veAdver;singtriestopersuade
consumersthattheproductofonefirmisbeHerthanthoseofits
compe;tors.Itisknownasa“Non-Produc;onCost”,whichisusually
passedontotheconsumerintheformofhigherprices.Assuch,the
costsfacedbythefirmarehigherthanisneededfortheproduc;onof
theproduct.
TypesofAdver1sing
ThefollowingarethedifferentformsofAdver;singavailabletoanyfirm
inanyindustry.
1) GenericAdver1sing:Thisisadver;singthatpromotestheproductsof
anen;reindustryratherthantheproduceofanindividualfirm.Allor
mostofthefirmsintheindustrywouldsharethecostofthis
adver;singcampaign.Thistypeofadver;singwouldbeusedin
PerfectCompe;;on.
2) Compe11veAdver1sing:AHemptstoconvincetheconsumerthatthe
product’sofonefirmisbeHerthanthoseofitscompe;tors.
3) PersuasiveAdver1sing:IsverylikeCompe;;veAdver;singwith
subtledifferences.Noreferenceismadetotheproductsof
compe;tors,butyouaretoldthatyoureallyneedordesirethis
product.Thistypeofadver;singisusuallyseenintheadver;singof
expensivebrands.E.g.L’Oreál’smoHo“Becauseyou’reworthit”.
4) Informa1veAdver1sing:Thistypeofadver;singtriestoeducatethe
consumer.Iteither,tellstheconsumerabouttheexistenceofa
certaintypeofproductorexplainstoconsumersthedangers
associatedwithcertaintypesofproductsorac;ons.E.g.“Saywhat
youlike,SmokingKills”.
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AdvantagesofImperfectCompe11on
1) GreaterChoice:Goodsarenothomogenous,butareclosesubs;tutes,
thereforeconsumershaveagreaterchoiceofgoods/services.
2) NormalProfit:Inthelong-runconsumersarenotbeingexploitedas
thefirmisearningnormalprofits.
3) LowerPrices:Compe;;onbetweenfirmsintheindustrywillhelp
lowerpricesandmakethemmorecompe;;veforconsumers.Some
itemssuchasnewspapers,magazines,spor;ngandmusiceventsmay
becheaperduetotherevenuesearnedbythesupplierfrom
compe;;veadver;sing.
4) Innova1veGoods/Services:Innova;onisencouragedasfirmswill
constantlystrivetogainacompe;;veedgeovertheirrivals,hence,
consumersgetthebenefitofmodernup-to-dategoods/services.
5) AccesstoInforma1on:Consumersmayhavemoreinforma;on
availabletothembecauseoftheextensivecompe;;veadver;sing
usedwithintheindustry.
DisadvantagesofImperfectCompe11on
1) ExcessCapacity:ImperfectlyCompe;;vefirmswillgenerallybe
producingatalevelofoutputtoosmalltocompletelyavailofallof
theadvantagesofEconomiesofScale.Thedifferencebetweenthe
actualoutputthatImperfectlyCompe;;vefirmsproduceandthe
outputrequiredtocompletelyavailofEconomiesofScaleisknownas
the“ExcessCapacity”ofthefirm.
2) Compe11veAdver1sing:Compe;;veAdver;singtriestopersuade
consumersthattheproductofonefirmisbeHerthanthoseofits
compe;tors.Itisknownasa“Non-Produc;onCost”,whichisusually
passedontotheconsumerintheformofhigherprices.Assuch,the
costsfacedbythefirmarehigherthanisneededfortheproduc;onof
theproduct.
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LongRunSimilari1esbetweenPerfectandImperfectCompe11on
1) NormalProfit:IntheLongrun,bothPerfectlyandImperfectly
Compe;;vefirmsearnnormalprofitastheyproducewhereAC=AR.
LongRunSimilari1esbetweenImperfectCompe11onandMonopoly
1) BothWastefulofResources:Afirmopera;ngineitherMonopolyor
ImperfectCompe;;ondoesnotproduceatthelowestpointof
AverageCostCurve
2) DownwardSlopingDemandCurve:AsfirmsinbothImperfect
Compe;;onandMonopolyfaceadownwardslopingdemandcurve
theymustlowertheirpriceinordertoincreasesales.
3) PriceisGreaterthanMarginalCost:Thepricethattheyarecharging
forthelastgoodisinexcessofwhatitcostthemtomakeit.Thisfact
indicatesthatmoreofthegoodcouldbeproduced
ProductDifferen1a1onRevisited
ProductDifferen1a1on:meansthattheproductssoldbycompe;ng
firmsaresimilarbuthavedifferences.Thereareclose(butnotperfect)
subs;tutesavailable.
ProductDifferen1a1oncanbeachievedby
1) Branding:Establishingdifferentanddis;nc;vebrandnamesforthe
products.E.g.Nike,Addidas,Reebok
2) Compe11veAdver1sing:Crea;ngdifferencesintheproductsinthe
mindsofconsumerse.g.throughpackagingwhichclearly
dis;nguishesoneproductfromanotherDazv.Surf,Kellog’sCornflakes
3) ProductInnova1on:Firmsdeveloptheirproductfurther(addvalue)
sothatitisbeHerormoreadvancedthanthatofcompe;tors.
Lyonspyramidteabags;
Avonmore–supermilk.
Fairydetergent–an;bacterialagents.
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EffectofProductDifferen1a1onontheARandMRcurves
AsaresultofProductDifferen;a;on:
1) Afirm’sARwillbedownwardslopingfromlestoright.Asproducts
areclosesubs;tutes.IfafirmlowerspriceitcanexpecttoaHract
somebutnotallcustomersfromotherfirms;ifthefirmincreases
pricesitmayexpecttolosesomebutnotallcustomers–sothefirm
willselllessathigherpricesandmoreatlowerprices.Consequently
thedemandcurve(ARcurve)facingthefirmisdownwardsloping.
2) IfARisfallingthenMRisalsofallingandliesbelowAR.Toencourage
morecustomersthefirmmustdroptheprice.TheARCurveisfalling.
Therevenuefromtheincreasedsaleswillbereducedbythefalling
revenueoneachunitpreviouslysoldatahigherpricebutnowata
reducedprice.
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