Download Perfect Competition Monopolistic Competition Oligopoly Monopoly

EC 102
Issues and expectations
Professor Scott
Spring, 2002
1
-----------------------------------------------------------------------------------------------------------The following is a list of issues that you should be fully familiar with before taking
the exam. By fully familiar I mean:
1. Know the definition in your own words
2. Know what the concept means
3. Know why the issue is important
4. Know an example
5. (if appropriate) Be able to deal with the issue on a graph
Chapter 8
TC, TFC, TVC, MC, AVC, AFC, ATC
Production function - how it relates to costs
Short run vs long run
Competitive equilibrium for the firm
With a profit
Breaking even
With losses
Shut-down point
Long run
Cost curves
Economies of scale
Diseconomies of scale
Constant returns to scale
Minimum efficient scale
Characteristics of Competitive market - how these characteristics affect behavior
and outcome in the market and for the firm (this crosses a number of chapter)
The continuum is as below:
Perfect Competition Monopolistic Competition Oligopoly
Monopoly
Many Small sellers
Many Small sellers
Many small buyers
Many small buyers
buyers
Homogeneous Product Differentiated Product
Free Entry and Exit
Free Entry and Exit
Perfect Information
Perfect Information
Information
One seller
Many small
Few sellers
Many small buyers
Differentiated Product “Unique” Product
Some Barriers Strong Barriers
Perfect Information
Perfect
Monopoly is one pole,
Perfect competition is the other pole.
Monopolistic competition is close to perfect competition, but with differentiated product. An example
would be the pain reliever or aspirin markets. There are many alternative brands, with slight variations and
known, easily replicated formulas. Entry is easy and exit is easy. The products are slightly differentiated
and heavily advertised.
EC 102
Issues and expectations
Professor Scott
Spring, 2002
2
-----------------------------------------------------------------------------------------------------------Oligopoly is close to monopoly. Interfirm rivalry is personal in nature. Policy is made taking the
competitors’ strategy in mind. Game theory is one way of understanding the dynamics of this type of
industry. “If I do this, he/she will do that…” An example of an oligopoly and a strategy based upon this,
Home Depot and Lowes and close competitor. One of the pricing strategies used by both is “We will
match and competitor’s advertised price.” This is a strategy which sounds like it is intense price
competition, but in reality it is a means of decreasing the profit from competitors trying to compete on
price.
BEHAVIOR:
Monopolistic Competition:
Firms are price makers in the sense that they know that they can raise and lower price and not have all-ornothing quantity. The demand for the firm is very elastic because there are good, although not perfect,
substitutes. Marginal revenue is not much below price because of the high price elasticity. This means that
marginal cost equals marginal revenue will bring marginal cost close to price. His is close to the
competitive situation. With free entry and exit, the firm will have zero profit in the long run (entry
dissipating profits, exit eliminating losses).
The main difference between monopolistic competition and perfect competition is in the long run
ATC=P>MR=MC. Notice that with MC<ATC this means that ATC is still decreasing—we are not at the
minimum of the ATC. In words differentiation means that we are not as cost efficient. The fact that you
have choices means that each firm cannot minimize their ATC.
OLIGOPOLY
In the case of oligopolies, the interpersonal dynamics of the individual managers comes into play. This
means that we have difficulty predicting behavior. This is why we spend so much time on Monopoly and
Perfect Competition. These polar cases show the transition which occurs and know where the industry is
placed in the continuum helps us understand the behavior. But when the interaction becomes personal, it
becomes less predictable. What we do in this situation is start making up models to describe various
behavior patterns. These are pretty good at describing the behavior in the specific situation, but may not be
generalizable to other situations.
Just to give you one example:
KINKED DEMAND CURVE MODEL:
The general assumption is that the market (or industry) has a small number of competitors who know each
other and watch each other’s responses.
Specific behavioral assumptions:
1. If I raise price, the assumption is that the competitors will not follow suit and will gladly accept my
customers. This makes the demand for my product very elastic.
2. If I drop price, the assumption is that the competitor will follow suit rather than accept the loss of
customers to me. This makes the demand elasticity comparable to the industry elasticity, as I will not be
able to attract customers from competitors, but only from outside the industry.
3. This causes a kink at the current price. This causes the marginal revenue to be fairly close to price for
price increases, and marginal revenue to be significantly lower for price decreases. This combination leads
to Marginal cost being likely to be below the MR for price increases, causing me not to raise price.
Marginal cost will likely be above the MR for price decreases, causing me to not want to decrease price.
EC 102
Issues and expectations
Professor Scott
Spring, 2002
3
-----------------------------------------------------------------------------------------------------------This model gives a theoretical justification for the observation of quite stable pricing in many situations
with a small number of competitors. For example, notice the stability of the gas prices at any given corner.
They typically move only in response to increases or decreases in the overall gasoline prices. And they will
establish a consistent relationship (Exxon higher than Crown by 1-2 cents per gallon…).
PRICE DISCRIMINATION (or MARKET SEGMENTATION)
The general issue here is to charge more to customers who are less price sensitive, and less to those who are
more price sensitive. The difficulty is identifying the specific customers in each group and separating them
so that they will not be able to transfer goods from the lower priced market to the higher one,
circumventing your separation.
Criterion needed to be successful:
1. differing elasticities.
2. separable market.
In the greater elasticity market, marginal revenue is higher than it is in the lower elasticity market. By
expanding in this market and contracting in the less elastic market, these marginal revenues can be drawn
together and equated to marginal cost.
Where do you want to sell a specific unit? Where MR is the greatest – the elastic market
If MR1>MR2, you can increase total revenue without affecting cost by moving a unit from market 2 to
market one. This movement will increase MR2 and decrease MR1. Keep doing this until you equalize the
MR’s across the markets.
Chapter 9
Entry/exit effect in a competitive market
Accounting profits
Economic profits
Normal profit
Long run supply curve
External diseconomies of scale
External economies of scale
Internal economies and diseconomies of scale