Download Perfect Competition - Agricultural & Applied Economics

Market
Equilibrium and
Market Demand:
Imperfect Competition
Chapter 9
Market Structure Characteristics
We characterize an
industry by
The number of firms and
their size distribution
Product differentiation
Barriers to entry
The picture to the right
concerned with two
markets:
2
 No. 2 yellow corn: many
producers/sellers (Perfect
Competition)
 Farm equipment: few
manufacturers/sellers
(Oligopoly)
Pages 145-148
Perfect Competition
Up to now we have been assuming the firm
and market reflect conditions of perfect
competition
 Not a bad assumption for many agricultural
subsectors
A large number of small firms:
2 million
farms
A homogeneous product: No. 2 yellow corn
Freely mobile resources: No barriers to entry
caused by patents, etc. or barriers to exit (???)
Perfect knowledge of market conditions:
Quality outlook information from government,
university and private sources
3
Imperfect Competition
Many markets in which farmers buy
inputs and sell their products however do
not reflect perfect competition conditions
Chapter 9 focuses on specific types of
imperfect competitors in the farm input
market
These firms are capable of setting prices
farmers must pay for specific inputs
4
Imperfect Competition
in Selling
5
Topics for Nov
rd
3
 Monopolistic Competition
 Definition
 Production and Pricing Decisions
 Oligopolies
 Definition/Examples
 Production and Pricing Decisions
 Monopolies
 Definition/Examples
 Production and Pricing Decisions
 Comparison of Market Structures
6
Pages 106-107
Imperfect Competition in Selling
Unlike perfect competitors who face a
perfectly elastic (horizontal) demand
curve
Imperfect competitors selling a
differentiated product have a downward
sloping demand curve
$ Firm’s demand curve
A
under P.C.
A
7
$
Firm’s demand curve under
imperfect competition
B
Q
B
Q
Price
8
Table 9-1 Imperfect
Quantity Total Rev. Avg. Revenue Marginal Revenue Competition
15
0
0
--------
-----
14
2
28
14
14
13
4
52
13
12
12
6 2
72 20
12
10
11
8
88
11
8
10
10
100
10
6
9
12
108
9
4
8
14
112
8
2
7
16
112
7
0
6
18
108
6
-2
5
20
100
5
-4
4
22
88
4
-6
3
24
72
3
-8
2
26
52
2
-10
1
28
28
1
-12
0
30
0
-----
-14
Firm faces a
downward sloping
demand curve →
MR ≤ AR
Marginal Revenue
(MR) : Change in
revenue from the
sale of the last
unit of output
(ΔTR÷ΔQ)
Average Revenue
(AR): Total
Revenue/Total
output (TR÷Q)
Note: Price =
Average Revenue
Page 149
Imperfect Competition in Selling
Marginal Revenue: Change in revenue
from the sale of the last unit of output
9
Page 150
Imperfect Competition in Selling
Maximum Total Revenue
 Marginal revenue in this instance is also
downward sloping
 MR=0 at the point where TR is at a maximum
10
Page 150
Types of Imperfect Competitors
in Input Markets
 Monopolistic Competition
 Oligopoly
 Monopoly
Let’s start here…
11
Monopolistic Competitors
Many sellers
 Each firm has relatively small market
share
 Power to set prices somewhat like a
monopoly
 Face competition like perfect
competition
 Collusion is not possible given
number of firms in the industry
No barriers to entry or exit
12
Page 148-151
Monopolistic Competitors
Product Differentiation:
Each firm makes a
product that is slightly different from the
products of competing firms
 Close substitutes but no perfect substitutes
 An attempt to ↑ price will normally results in a ↓ in
volume sold
Competition on Quality, Price, Marketing
13
 Quality is design, reliability, service provided to
buyer and ease of access to product
 The firm faces a downward sloping demand curve
 Firm must market intensively: promotions,
distribution, packaging, etc.
Page 148-151
Monopolistic Competitors
Product differentiation does not necessarily
mean there are any physical differences among
products
 They might all be the same, but how they are sold
may make all the difference
14
Page 148-151
Monopolistic Competitors
The monopolistic competitor tries to set
his/her product apart from the competition
 Main method is via advertising
 When this is done successfully, the demand curve
becomes more vertical or inelastic
 Buyers are willing to pay more because they believe it is
much better than their other choices
Basis for product differentiation
 Physical differences
 Ambience
 Appeals to vanity
15
Convenience
Reputations
Snob appea
Page 148-151
Monopolistic Competitors
Typical Monopolistic Competitor
Tries to set firm apart from competition
 New Product Development and Innovation
 Advertising
o Create consumer perception of product differentiation
– real or imagined
o Attempt to keep demand as inelastic as possible
Selling costs can be extremely high
16
Page 148-151
Monopolistic Competitors
Short run profits can exist but long
run profits are reduced to 0 with
industry entrants
Fast food industry is a good example
 All services basically the same
 Extensive use of marketing to
differentiate products/services across
firms
 Striving to produce more products
and services
17
Page 148-151
Monopolistic Competitors
Production Decision:
Determine output level where
MC=MR (Why does this make sense?)
Pricing Decision:
Determine where above quantity
intersects the downward sloping
demand curve
18
Page 148-151
Monopolistic
Competition
Short run profits exist if:
PSR > ATCSR at QSR
Short run profits
 The firm produces QSR where MR=MC at E
 Prices its products at PSR by reading off the demand
19
curve at quantity QSR
 Represents consumer’s willingness to pay for QSR
Page 150
Monopolistic
Competition
Short run loss
 At QSR, PSR
20
< ATCSR
Page 150
In the Long Run (LR)
PLR = ATCLR
 Profits are bid away as more
firms enter the market
 Losses will no longer exist as
firms leave the market
At QLR the remaining firms
are just breaking even
Monopolistic
Competition
21
Page 151
Monopolistic Competitors
How much is the industry dominated or
not dominated by few suppliers
Geographical scope – national, regional,
global
 An industry can be almost perfectly competitive
on a national scope, but almost a monopoly
locally e.g. Feed Retailing
Barriers to entry and exit: industries may
appear concentrated but few barriers exist
to prevent entry
22
Page 148-151
Monopolistic Competitors
Quantitative measures of competition
Concentration Ratio (CR): 2,4, 8, 20, etc
 % of the value of total market revenue accounted
for by 2, 4, 8, 20, etc. largest firms in the industry
 Low CR values→ a high degree of competition
 High CR values → an absence of competition
23
Page 148-151
Monopolistic Competitors
Quantitative measures of competition
Herfindahl-Hirschman Index (HHI): The
square of the % market share of each firm
summed over the largest 50 firms in an
industry or all firms if < 50 in industry
 Perfect competition, HHI is small
 Only 1 firm, HHI is 10,000 = (1002)
 U.S. Justice Department
o HHI < 1,000 competitive markets
o HHI > 1,800 could be considered concentrated
industry worthy of Justice Dept. examination of any
purchases
24
Page 148-151
Oligopolies
A few number of sellers
 Each can impact market price & quantities
Interdependent in their decision making
 Key component in marketing strategies and
pricing behavior
 Match price cuts but not price increases by
fellow oligopolists
 Do this to maintain market share
Non-price competition between
oligopolists to uniquely identify products
25
Pages 152-155
Oligopolies
Rival oligopolists will match price cuts but
not price increases in the short run because
they want to capture a larger market share
If there are differences in prices they are the
result of successful product differentiation
Tend to have stable prices
 Changes in production and other costs not easily
passed on and may have to be absorbed
26
Pages 152-155
Oligopolies
Price leadership strategy
 A particular firm dominates the market
 Controls the largest share of the market
 Other industry firms more efficient in operation,
marketing, etc.
 The dominant firm first sets its price to
maximize profit
 Remaining firms set their prices based on the
dominant firms pricing
 The price set by the oligopolist seller is
higher under perfect competition
27
 Quantity produced is lower then perfect comp.
Pages 152-155
Oligopolies
The dominant firm may be efficient
enough to set a lower price
 Eventually drive the other firms out of
the market
28
Pages 152-155
Oligopolies
Examples of Oligopolies
 Auto manufacturers
 1997 CR4 value of 97.4
 Aircraft manufacturing
 Farm machinery and equipment
 John Deere, J.I.Case and New Holland
 80% of 2-wheel drive tractors
 close to 90% of combines sold in the U.S.
 Cattle slaughtering
 CR4 value increased from 39% to 67% over
the 1985-1995 period
29
Pages 152-155
 Demand curve DD
 All oligopolists move prices
together and share market
6
 Demand curve dd
A single firm changes
its price
Curve DD is more
inelastic
Below point 1, firms
match price cut
This leads to a kinked
demand curve d1D
Leads to a
discontinuous
marginal revenue
curve, d256
Remember oligopolists account for the reaction of
other firms so there is no single demand curve
30
Page 154
Meeting demand
along the lower
segment of the
kinked demand
curve → the firm is
maintaining its
market share
31
Page 154
Shifting MC curves
reflecting
technological
advances will not
affect PE and QE
It does impact
profits as MC drops
from pt 3 to pt 4
32
Page 154
Monopolies
 One seller in the market
 Entry of other firms restricted by
patents, etc. (i.e., barrier to entry)
 Firm has absolute power over
setting market price
 Produces a unique product
 It can have economic profits in the
long run because it can set price
without competition
33
Page 155-156
Monopolies
$/unit
 Total revenue = area
MC
ATC
AVC
C
PE
B
M
A
0PECQE
 Monopolist
produces
quantity where
MC=MR (pt A),
QE
 Uses the
demand curve
(pt C) when
setting price PE
N
Demand= AR
TVC
MR
Quantity
0
34
QE
Page 155-156
Monopolies
$/unit
MC
A
N
Demand= AR
TVC
MR
Quantity
0
35
for the monopolist is
equal to area
0NAQE, (green box)
=AVC x QE
= 0N x QE
B
M
AVC
Total variable costs
C
PE
ATC
QE
Page 155-156
Monopolies
$/unit
MC
AVC
C
PE
 Total fixed costs equals
B
M
NMBA (orange box)
=(ATC-AVC) x QE
TFC
N
ATC
A
Demand= AR
MR
Quantity
0
36
QE
Page 155-156
Monopolies
$/unit
MC
0MBQE (green box
+ orange box)
 = area ONAQE
+ area NMBA
B
M
TFC
N
A
Demand= AR
TVC
MR
Quantity
0
37
AVC
 Total cost is area
C
PE
ATC
QE
Page 155-156
Monopolies
$/unit
Economic
Profit
MC
area MPECB
 = Total Revenue (yellow
box) – Total Costs (green
box + orange box)
B
M
TFC
A
N
Demand= AR
TVC
MR
Quantity
0
38
AVC
 Monopoly economic profit =
C
PE
ATC
QE
Page 155-156
Monopolies
$/unit
MC
AVC
C
PE
Economic
M Profit
 Total fixed costs equals
B
NMBA (orange box)
=(ATC-AVC) x QE
TFC
A
N
Demand= AR
TVC
MR
Quantity
0
39
ATC
QE
Page 155-156
Comparison of Structure Results
Lets compare the results we have
obtained from the alternative
market structures
40
Perfect Competition Case
Consumer surplus =
sum of areas
1, 4, 5, 8 and 9 (blue
triangle)
41
Page 157
Perfect Competition Case
Producer surplus = to
the sum of areas 2, 3,
6 and 7 (green
triangle)
Page 157
42
Perfect Competition Case
Total economic surplus
= sum of blue and green
triangles
=sum of areas 1 – 9
Page 157
43
CS = sum of areas 8 and
Monopoly Case
9, (new blue triangle)
Compared to P.C.,
consumers would be
economically worse-off
by areas 1, 4 and 5
Paying a higher
price, PM
Purchasing a smaller
quantity, QM
44
Page 157
PS = to sum of
Monopoly Case
areas 3, 4, 5, 6 and
7 (green area)
Compared to P.C.
producers lose area
2 but gain areas 4
+5
Economically
better-off than
P.C.
45
Page 157
Society as a whole
Monopoly Case
46
would be economically
worse-off by areas 1+2
 Known as the dead
weight loss
 Reflects the fact that
less of available
resources in this
market are used to
provide products to
consumers
Page 157
Summary of Imperfect Competitors
from a Selling Perspective
47
Page 157
Imperfect Competition
From the Buying Perspective
48
Types of Imperfect Competitors
on the Buying Side
 Monopsonistic competition
 Oligopsony
 Monopsony
Let’s start here…
49
Monopsonies
 Single buyer in the input market
 Focus is on the marginal input cost
of purchasing an addition unit of
resources
 Will purchase input until Marginal
Value Product (MVP)=Marginal
Input Cost (MIC)
As long as MVP>MIC, the
monopsonist makes a profit
50
Page 158-160
Monopsonies
 Under perfect competition, the firm
views the input supply curve as a
horizontal line
Firm can purchase as much as desired as the
going price
Firm’s purchase does not impact inputs cost
 Monopsonist is the only input buyer
→Faces an upward sloping input supply
curve
Buying decisions impact input prices
51
Page 158-160
Monopsonies
 Monopsonist must consider the marginal
input cost (MIC) when purchasing inputs
MIC defined as the change in the cost of an
input as more of the input is used
Lets look at a simple example
 Monopsonist must pay higher prices per
unit if he/she wants to purchase greater
amounts of the input
→MIC curve is above the input supply
curve
52
Page 158-160
Marginal Input Cost
53
Units of
Variable Input
1
2
3
Price/Unit
($)
3.00
3.50
4.00
Total Input
Cost
3.00
7.00
12.00
Marginal
Input Cost
----4.00
5.00
4
4.50
18.00
6.00
5
6
7
5.00
5.50
6.00
25.00
33.00
42.00
7.00
8.00
9.00
8
9
10
6.50
7.00
7.5
52.00
63.00
75.00
10.00
11.00
12.00
Page 158-160
Marginal Input Cost
Marginal Input Cost
12
11
10
9
$/Unit
8
Input Supply Curve
7
6
5
4
Data obtained from
previous table
3
2
1
1
54
2
3
4
5
6 7
8
9 10
Quantity/unit of time
Page 158-160
Monopsonies
 Profit maximizing monopsonist
55
Use variable input to the point where
Marginal Input Cost (MIC) =Marginal
Revenue Product (MRP)
MRP = addition to total revenue attributed
to the addition of one unit of variable input
= Marginal revenue x MPP
So long as MRP>MIC, profits will increase
with increased input use
If MRP<MIC, profits will ↑ by reducing the
amount of input used (Why?)
Page 158-160
Buying Decisions by Perfect Competitors
 MRP = MVP under
perfect competition
 MVP=PPC x MPP
56
Page 160
Monopsonist makes
Buying Decisions by a Monopsonist
decisions along
MRP curve
Differs from MVP
MRP=MIC at A
Purchase QM inputs
57
Page 160
Resource use
Buying Decisions by a Monopsonist
58
 Higher Price paid
under P.C., PPC
 Utilization higher
under P.C., QPC
 Price difference
referred to as
monopsonistic
exploitation
(i.e., PPC – PM)
Page 160
Imperfect Competition on Both Sides
Product Selling Input Purchasing
Perspective
Perspective
Perfect
Perfect
Competition
Competition
Monopolistic
Monopsonistic
Competition
Competition
Oligopoly
Oligopsony
Monopoly
Monopsony
Can have any combination of the above for a
particular firm
59
 Lets look at profit maximization under specific cases
Page 160
 Case #1: Monopsonist in input purchasing and
Monopolist seller of product
 Equilibrium: MRP=MIC at Point A.
 Pricing off input supply curve gives QMM and PMM
60
Page 161
Case #2: Perfect Competition in input purchasing
and Monopoly seller
 Equilibrium is where MRP=Supply at C
 No Marginal InputCost curve → QPCM and PPCM
61
Page 161
Case #3: Monopsony in input purchasing and
Perfectly Competitive seller
Equilibrium: MVP=MIC at Point E
Pricing off supply curve → QMPC and PMPC
62
Page 161
Case #4: Perfect Competition in both input
purchasing and product sales
Equilibrium: MVP=Supply at Point F
→ QPC and PPC
63
Page 161
Monopsonistic Competitors
Many firms buying resources
Ability to differentiate services to
producers
Differentiated services includes
distribution convenience and location of
facilities, willingness to provide credit or
technical assistance
P and Q determined same as
monopsonist
64
Page 161
Oligopsonies
A few number of buyers of a resource
Profit earned will depend on elasticity
of supply for resource (less elastic than
monopsonistic competition)
Each oligopsonist knows fellow
oligopsonists will respond to changes in
price or quantity it might initiate
P and Q determined same as
monopsonist
65
Page 161
Various segments of the livestock industry
Exhibit several forms of imperfect competition.
66
Page 162
Governmental Regulation
Various approaches have been used to
counteract adverse effects of imperfect
competition in the marketplace
 Legislative acts passed by Congress, including
the Sherman Antitrust and Clayton Acts
 Price ceilings
 Lump-sum Tax
 Minimum price or floors
67
Page 162
Legislative Acts
Sherman Antitrust Act of 1890
 Prohibited monopoly and other restrictive
business practices
Packers and Stockyards Act of 1921
 Reinforced Anit-trust laws regarding
livestock marketing
Capper-Volstead Act of 1922
 Exempted cooperatives from anti-trust laws
Robinson-Patman Act
 Prohibited price discrimination practices
Agricultural Marketing Agreement Act
Established agricultural marketing orders
68
Page 163
Impacts of Price Ceilings
Regulatory agencies such as the Federal
Trade Commission can impact monopoly
effects by instituting a maximum (ceiling)
price
 FTC charged with investigating business
organizations and practices and carrying
out anti-trust provisions
How can we model the impact of price
ceilings?
69
Page 163
Impacts of Price Ceilings
Implications of a Price Ceiling
Without regulatory
involvement the
monopolist will
A′
70
D
Equate MR and MC
(point C)
Produce QM and
charge price PM
Earn a profit of
A′PMBD
Page 164
Impacts of Price Ceilings
Implications of a Price Ceiling
With gov’t imposed
price ceiling, PMAX
A′
D
 The demand curve
is given by PMAXED
 MR is PMAXEFG
 Mono. produces
more (Q1>QM) at a
lower price (PMAX <
PM)
71
Page 164
Impacts of Price Ceilings
Implications of a Price Ceiling
A′
Monopolist’s profit falls to
area IPMAXEH (turquoise box)
72
Page 164
Impacts of a Lump Sum Tax
A regulatory agencies can impact the
level of monopoly profits by assessing a
lump-sum tax
 May be a license fee or one-time charge
 Corresponds to a fixed tax regardless of
output level
How can we model the impact of a lump
sum tax?
73
Page 165
Impacts of A Lump Sum Tax
Implications of Lump-Sum Tax
The monopolist
equates
MC=MR (pt. F)
Produces QM
Charges PM
Profit of APMBC
Page 165
74
Impacts of A Lump Sum Tax
Implications of Lump-Sum Tax
Lump-sum tax
↑ firm’s ATC from
ATC1 to ATC2
↓ producer surplus
from APMBC to
EPMBT
Does not change
output level or
price
75
The loss in producer
surplus is area AETC
(blue box)
Page 165
Impacts of a Minimum Price
In a monopsony, the gov’t could regulate
the price of a resource by imposing a
minimum price that must be paid for that
resource
 Good example is the various minimum wage
laws
How can we model the impact of a
minimum price policy?
76
Page 165
Impacts of a Minimum Price
Implications of a Minimum Price
No minimum price
Monopsonist
determines where
MRP=MIC
Employ QM input units
Pays $PM/unit
77
Page 166
Impacts of a Minimum Price
Implications of a Minimum Price
Minimum price, PF,
imposed
 Monopsonist’s MIC
curve would be
PFDCB
 The firm would use
more input
78
Page 166
Summary
Unlike perfect competition, imperfect
competitors have ability to influence price
Monopolistic competitors try to differentiate
their product
Monopolists are the only seller in their
product market. Monopsonists are the only
buyer
Oligopolies are a few number of sellers while
oligopsonies are a few number of buyers.
What are the economic welfare implications
of imperfect competition?
79
Chapter 10 focuses on resource use
in agriculture and the environment
80