Download Forms of Market Competition

AAEC 2305
Fundamentals of Ag Economics
Chapter 7 - continued
Firms in an Imperfect Market
 Consider the following hypothetical case of
a tractor division of a farm machinery
manufacturer operating in an imperfectly
competitive environment.
• Assumptions of this example:
– There are no competitors
– The firm manufactures & sells 7100 to 9000
tractors per year at $44,000 to $52,000 per
tractor
(continue)
Price Charged
(Py)
Tractors Sold
(Y)
$52,000
7100
$50,000
7800
$48,000
8500
$46,000
9200
$44,000
9900
(continued)
Py
52000
AR
Add
TR
Tractors
(millions) Tractors (millions)
Sold
Sold
369.2
7100
MR
($)
50000
7800
390.0
700
20.8
29,714
48000
8500
408.0
700
18.0
25,714
46000
9200
423.2
700
15.2
21,714
44000
9900
435.6
700
12.4
17,714
(continued)
 The equilibrium price per tractor is the price
where MR and MC curves intersect (MR=MC)
 Under perfect competition, the MR and AR
curves where equal and represented by a
horizontal line, which also depicted the price
line
 In Imperfect Competition, however, the MR and
AR curves are two distinct curves (MR does not
equal AR)
(continued)
 Under Imperfect Competition, the AR curve
depicts the demand curve. Additionally, the
MR curve has a slope exactly twice the AR
and Demand curves.
 Furthermore, the MR curve intersects the
horizonatl axis at exactly the same point as
the AR curve. However, the MR curve
intersects the horizontal axis at exactly the
halfway point of the AR curve.
Determination of Output
 As in perfect competition, the output of the
imperfectly competitive firm is determined
at the point where MR = MC
 The price that the imperfectly competitive
firm will charge, however, will be the price
associated with the market demand curve
for the profit maximizing quantity.
(continued)
 To determine profitability, the firm will
need to compare TR and TC or AR and ATC.
Imperfect Competition
Among Sellers
 There are 3 categories of imperfect
competition among sellers (refer to Table
7.1, page 161.
• 1) Monopolistic Competition
• 2) Oligopoly
• 3) Monopoly
 Remember we are going to use Perfect
Competition as the baseline for
comparisons.
Monopolistic Competition
 Monopolistic Competition differs from
Perfect Competition in the following ways:
• 1) Differentiated Products (main
difference from pure competition.
– Real differences in products
– Perception of differences in Consumers
Minds
– Competition among firms exist on attributes
other than prices
(continued)
 2) Many firms, but fewer than under perfect
competition
• Food processing & marketing firms
 3) Limited control over prices
• A firm cannot increase prices significantly
without losing customers to competitors.
(continued)
 4) Limited or restricted entry
• Entry is more difficult than in a perfectly
competitive market
• Firms are fairly large, and capital requirements
are substantial
• Advertising dollars alone can create a barrier
to entry
• Emphasis on brand names associated with
higher quality
Oligopolies
 Oligopoly means “few sellers”
 The most distinguishing characteristic is
their interdependence in pricing and
marketing policies.
 Among oligopolistic industries are:
• Major farm machinery companies
• Farm chemical companies
• Major meat packers
(continued)
 Oligopolistic industries can result from:
• More extreme product differentiation
• Higher entry costs
• Greater dependence on costly & long-term
research & development efforts
• Easier access to major financial markets
• Aggressive merger & acquisition strategies
(continued)
Characteristics of Oligopolies are:
 1) Few Sellers - (ex. auto manufactures, oil
industries, etc.)
 2) Some control over prices
• Control over prices is limited due to
interdependence with other firms
• Have sticky prices to try to avoid price wars
– Farmers complain that prices for their crops
do not increase even when consumer prices
rise.

(continued)
– Farmer complain that prices for machinery
and farm chemicals are inflexible
– Consumers complain that retail prices
remain high even when farm prices fall
• Oligopolies provide benefits that perfectly
competitive markets do not:
– International competitiveness
– Access to funds for research and
development
– High barriers to entry
Pricing behavior in Oligopoly
 Mutual interdependence in oligopoly
requires strategic behavior & interactions
 Strategic behavior is actions by firms
trying to plan for and react to the actions of
other firms
 Strategic decision-making is called Game
Theory.
• Example - Prisoners Dilemma:
Prisoners Dilemma
 A crime is committed, and two suspects are
apprehended and questioned by the police
 The police do not have enough evidence to
convict the suspects of a major crime,
unless one of them confesses.
 The police separate the suspects and make
each one an offer that each one is aware of.
(continued)
 The offer is:
• If one suspect confesses to the crime and
turns state’s witness, the one who confesses
receives only a 2-year sentence, while the
other who does not confess will get 12 years.
• If both prisoners confess, each receives a 6year sentence.
• If neither confesses, both will receive a 1-year
sentence.
(continued)
 Refer to class discussions on the possible
outcomes.
 This process is called the minimax
strategy, meaning the players want to
minimize their maximum losses
 If both suspects had not confessed, each
would have been sentenced to 1 year, but
the temptation is too high.
(continued)
 This same scenario exists for oligopolistic
firms.
(continued)
 Now consider the following example for two
hypothetical meat packing firms.
 The two firms are trying to set prices, but
realize their decisions along with the
decision of their competitor affects their
profitability.
(continued)
 The choice is:
• If one firm charges a lower price and the other
firm charges a higher price, the firm that
charges the lower price will receive$125,000
profit and the firm charging the higher price
will receive $25,000.
• If both charge a high price, both receive
$100,000 profit.
• If both charge a low price, both receive
$50,000 profit.
(continued)
 Clearly, the choices of each firm make a
significant difference.
 The point of the example is that the firms
must anticipate the reaction of other firms
in their industry to their pricing strategies.
(continued)
 If one firm raises the price of its product,
other firms may not raise prices to the
same extent.
 As a result the firm raising its prices may
lose market share.
 But if the firm lowers its price, other firms
may likely lower their prices as well to
avoid losing market share.
Kinked Demand Curve
 The result is that each firm in an
oligopolistic industry faces a kinked
demand curve.
 The kink in the demand curve is at the
current price and quantity.
 Above the kink, the demand curve tends to
be more elastic.
 Below the kink, the demand curve tends to
be more inelastic.
4 Types of Pricing Behaviors in
Oligopolistic Markets
 1) Noncollusive Oligopoly
• A firm may increase prices if it determines that
its product is good enough, or the loyalty of the
customers is strong enough, for it to do so
without losing market share.
• Alternatively, a firm may cut prices in an
attempt to drive rivals out of the market or to
weaken them enough to make them good
targets for takeover.
• Ex. Airlines, farm machinery, pesticides, etc.
(continued)
 2) Collusive Oligopoly-
• If all firms in an industry reach an explicit or
tacit agreement to fix prices.
• Firms then compete on the basis of non-price
factors such as service or advertising.
• Thus, as in our packer example, there is a
significant incentive to collude & raise prices.
• Problems - incentive to cheat on the
agreement.
(continued)
 3) Price Leadership -
• In some industries, there is a recognized price
leader.
• Additionally, in some cases, there may be little
explanation why a firm is the price leader.
 4) Cost-Plus Pricing-
• It is common practice in some industries,
especially selling unique products to the
government, to sell products at cost plus a
given percentage mark-up
Monopoly
 Strictly speaking, a pure monopoly - a one
firm industry - is rare.
 Monopolies may arise because sometimes
because it is the most efficient way to
organize production and marketing
activities.
 However, instead of breaking up
monopolies in the US, it has been common
policy to regulate them.
Basic Characteristics
of Monopolies
 1) Single seller
 2) Unique Product
• i.e. there are no close substitutes
 3) Ability to Set Prices
• Monopolist is a price maker, although in some
cases they may be regulated by the gov’t.
• Discriminating monopolists charge different
prices to different classes of consumers
(continued)
 4) Barriers to Entry
• A monopoly must have an economic, legal or
technical barrier to entry to other firms.
 The gov’t has established many agencies to
protect consumers from the adverse
consequences of oligopolies & monopolies
• Interstate Commerce Commission - regulates
transportation
(continued)
 Federal Communication Commission -
regulates telephone rates, tv, radio, etc.
 State & Local Power Commissions regulate local utilities
 U.S. Sherman (antitrust) Act of 1890 and
Clayton Act of 1914
• First of several acts with goal of preventing
collusive pricing and restrictive trade
practices of oligopolies
(continued)
 However, these laws and more recent laws
have been enforced to a varying extent by
successive presidential administrations depending on the philosophy of each
administration.