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Imperfect Competition Shades of Gray between Perfect Competition and Monopoly Microeconomics - Dr. Dennis Foster The Spectrum of Competition Firms are primarily distinguished from each other by the degree of competition they face: Perfect Competition Monopoly Monopolistic Competition Contestable Markets Oligopoly Game Theory Cartels Contestable Markets There may be many firms … -- but, probably only a few. This market appears to be an oligopoly … -- but, there aren’t significant barriers to entry. In the long run, price must equal marginal cost … -- so, firms are allocatively efficient. In the long run, price must equal average cost … -- so, firms only earn a “normal” profit. Examples – Airlines, wine production … Monopolistic Competition Market structure when there are: many firms, no barriers to entry, each produces a “differentiated product.” Examples: Restaurants, Convenience stores, Barbers Differentiation may be by location! Substitutes are not perfect. Advertising may contribute. Monopolistic Competition Characteristics and Consequences Many sellers & easy entry - Can only earn economic profit in SR. - In LR, must earn only normal profit. Sells differentiated products - Faces a downward sloping demand. - Can raise price without losing all customers. Monopolistic Competition price MC P* ATC P** ATC* d d** MR** quantity q** q * MR While economic profits may be earned in the short run, the entry of new firms will compete them away. Monopolistic Competition & Efficiency Allocatively inefficient? - Yes, since demand slopes down, P>MC. Productively inefficient? - Yes!!! Must be. [Excess Capacity Theorem] Social waste of resources? - No, as there are no econ profits to protect. X-inefficiency? - Unlikely, due to competition. Oligopoly Market structure where: (i) there are a few dominant firms Price MC D2 (ii) there are high barriers to entry P* D1 quantity Q* MR OligOpOly … characteristics Few sellers - face downward sloping demand, - actions are interdependent. Homogeneous or differentiated products - steel, oil, concrete, diamonds - cigarettes, cereal, tires, soap Barriers to entry - can earn economic profit in long run. OligOpOly … barriers to entry Control of resource Scale economies Brand proliferation Legal barriers Deterrence strategies - price wars - switching costs - game theory OligOpOly … models of behavior Graphical analyses Kinked Demand Price Leader Cartel Model Entry-limit Pricing Contestable Markets Game Theory Descriptive analyses Oligopoly – Kinked Demand Price MC D2 P* D1 Presumes excess capacity quantity Q* MR - Others follow price reduction. - Nobody follows price increase. Price rigidity in the face of changing costs Oligopoly – Other Models Price Leader - One firm sets the price; others follow. - To be enforceable, this firm should dominate the market (Saudi Arabia). - Sometimes it is just by convention (Ford). Entry-limit pricing - Firms set price so any new entrant will force price down below ATC. - This is a barrier to entry. Contestable Markets Oligopoly - Efficiency Allocatively inefficient? - Yes, since demand slopes down, P>MC. Productively inefficient? - It is not certain, but likely. Social waste of resources? - Yes, as there are likely to be economic profits to protect. X-inefficiency? - Yes, especially if the market is regulated. Oligopoly – Cartel Model Price P** MC ATC P* demand MR Firms collude Q** Q* quantity - Try to act as if it were a monopoly. - Must increase excess capacity – incentive to cheat. BOAPW – Be the only one not to join! Oligopoly – Cartel Model Free rider problem. - Non members get advantage of higher price without having to control output. Raising profits encourages entry! - OPEC and . . . Mexico/North Sea/Alaska There must be few substitutes. - A cartel for coffee? Must be able to deter cheating by members. - Libya and oil; Iran & Iraq and oil. - Diamonds (DeBeers) and distribution/stocks Game Theory Models of oligopoly behavior based on the characteristic of Read Chapter 24 for more on Game Theory. interdependence. Cooperative vs. Noncooperative Dominant strategy Sequential games Games with Nash equilibrium Game Theory First-mover game Last-mover game Chicken game Prisoner’s Dilemma Game Theory The Prisoners’ Dilemma Should Bud and Miller advertise during the Super Bowl? Bud Advertise Don't Advertise Miller Advertise $100 Don't Advertise $50 $100 $200 $200 $50 $150 $150 The best outcome (for them) is . . . But, each has the same “best” strategy . . . How can these firms overcome the PD? The Spectrum of Competition Firms are primarily distinguished from each other by the degree of competition they face: Perfect Competition Monopoly Monopolistic Competition Contestable Markets Oligopoly Game Theory Cartels Imperfect Competition Shades of Gray between Perfect Competition and Monopoly Microeconomics - Dr. Dennis Foster
