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LCEconomicswww.thebusinessguys.ie© 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. JonathanTraynor LCEconomicswww.thebusinessguys.ie© 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 JonathanTraynor2 LCEconomicswww.thebusinessguys.ie© 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. JonathanTraynor3 LCEconomicswww.thebusinessguys.ie© 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. JonathanTraynor4 Quan;ty LCEconomicswww.thebusinessguys.ie© 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 JonathanTraynor5 LCEconomicswww.thebusinessguys.ie© 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. JonathanTraynor6 LCEconomicswww.thebusinessguys.ie© 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. JonathanTraynor7 Quan;ty LCEconomicswww.thebusinessguys.ie© 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”. JonathanTraynor8 LCEconomicswww.thebusinessguys.ie© 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. JonathanTraynor9 LCEconomicswww.thebusinessguys.ie© 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. JonathanTraynor10 LCEconomicswww.thebusinessguys.ie© 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. JonathanTraynor11