imperfect competitions

8/8/2019 Imperfect Competitions

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IMPERFECTCOMPETITION

Dr.R.JAYARAJ, M.A., Ph.D.


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MONOPOLY

Definition

The term monopoly is from Greek monos , alone or single +polein , to

sell.

In Economics, a monopoly(or "Pure oligopoly") exists when a specificindividual or enterprise has sufficient control over a particular productor service to determine significantly the terms on which other

individuals shall have access to it.Monopolies are thus characterizedby a lack of economic competition for the good or service that theyprovide and a lack of viable substitute goods.


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A monopoly should be distinguished from monopsony, inwhich there is only one buyerof a product or service; a

monopoly may also have monopsony control of a sectorof a market. Likewise, a monopoly should bedistinguished from a cartel (a form ofoligopoly), in whichseveral providers act together to coordinate services,prices or sale of goods.

A government-granted monopoly or legal monopoly issanctioned by the state, often to provide an incentive toinvest in a risky venture or enrich a domesticconstituency. The government may also reserve theventure for itself, thus forming a

government monopoly.


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No close substitutes: A monopoly is not merelythe state of having control over a product; it alsomeans that there is no real alternative to the

monopolised product. A price maker: Because a single firm controlsthe total supply in a pure monopoly, it is able toexert a significant degree of control over the

price by changing the quantity supplied.


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Why Monopolies Arise

The main cause of monopolies is barriersto entry other firms cannot enter the market.Three sources of barriers to entry:

1. A single firm owns a key resource. E.g., DeBeers owns most of the worlds

diamond mines

2. The govt gives a single firm the exclusiveright to produce the good.

E.g., patents, copyright laws


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Why Monopolies Arise

Natural monopoly: a single firm can produce the entire market Qat lowerATCthan could several firms.

Q

Cost

ATC

1000

$50

Example: 1000 homes

need electricity.Electricity

Economies ofscale due to

huge FC

ATCis lower ifone firm servicesall 1000 homesthan if two firms

each service500 homes.

500

$80


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Monopoly vs. Competition: Demand Curves

A monopolist is the onlyseller, so it faces themarket demand curve.

To sell a largerQ,the firm must reduce P.

Thus, MR P.

D

P

Q

A monopolistsdemand curve


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A monopolys revenueA monopolys revenue

We consider, BSNListhe only seller of 3Gconnection in town.

The table shows themarket demand for3G.

Fill in the missing

spaces of the table.What is the relationbetween PandAR?Between Pand MR?

9

Q P TR AR MR

0 $4.50

1 4.00

2 3.50

3 3.00

4 2.50

5 2.00

6 1.50

n.a.


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AnswersAnswers

Here, P=AR,same as for acompetitive firm.

Here, MR< P,whereas MR= Pfor a competitivefirm.

10

1.506

2.005

2.504

3.003

3.502

1.50

2.00

2.50

3.00

3.50

$4.004.001

n.a.

9

10

10

9

7

4

$ 0$4.500

MRARTRPQ

1

0

1

2

3

$4


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BSNLs D and MR Curves

-3

-2

-1

0

12

3

4

5

0 1 2 3 4 5 6 7 Q

P, MR

Demand curve(P)

MR

$


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Understanding the Monopolists MR

Increasing Qhas two effects on revenue:

The output effect:More output is sold, which raises revenue

Theprice effect:The price falls, which lowers revenue

To sell a largerQ, the monopolist must reduce theprice on allthe units it sells.

Hence, MR< P

MRcould even be negative if the price effect

exceeds the output effect(e.g., when BSNL increases Qfrom 5 to 6).


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Profit-Maximization

Like a competitive firm, a monopolist maximizes profit byproducing the quantity where MR= MC.

Once the monopolist identifies this quantity,it sets the highest price consumers are willing to pay for

that quantity. It finds this price from the Dcurve.


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Profit-Maximization

1. The profit-maximizing Qis where

MR= MC.2. Find P from

the demandcurve at this Q.

Quantity

Costs andRevenue

MR

D

MC

Profit-maximizing output

P

Q


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The Monopolists Profit

As with a

competitive firm,the monopolistsprofit equals

(PATC) x Q

Quantity

Costs andRevenue

ATC

D

MR

MC

Q

P

ATC


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The Welfare Cost of Monopoly

Recall: In a competitive market equilibrium,P= MCand total surplus is maximized.

In the monopoly eqm, P> MR= MC The value to buyers of an additional unit (P)

exceeds the cost of the resources needed to produce that unit(MC).

The monopoly Qis too low could increase total surplus with a largerQ.

Thus, monopoly results in a deadweight loss.


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The Welfare Cost of Monopoly

Competitive eqm: quantity = QE P= MC total surplus is

maximizedMonopoly eqm:

quantity = QM

P> MC deadweight loss

P= MC

Deadweight

loss

P

MC

Quantity

Price

D

MR

MC

QM QE

Socially efficientquantity is foundwhere MC and Dcurve intersect


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Public Policy Toward Monopolies

Public ownership Example: U.S. Postal Service

Problem: Public ownership is usually less efficient since noprofit motive to minimize costs

Doing nothing The foregoing policies all have drawbacks,

so the best policy may be no policy.


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Price Discrimination

Discrimination is the practice of treating people differentlybased on some characteristic, such as race or gender.

Price discriminationis the business practice of sellingthe same good at different prices to different buyers.

The characteristic used in price discriminationis willingness to pay (WTP):

A firm can increase profit by charging a higher price to buyerswith higher WTP.


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Single Price Monopoly

Here, the monopolistcharges the sameprice (PM) to all

buyers.

A deadweight lossresults.

Consumersurplus

Deadweight

loss

Monopolyprofit

MC

Quantity

Price

D

MR

P

M

QM


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Perfect Price Discrimination

Here, the monopolist

produces thecompetitive quantity,but charges eachbuyer his or her WTP.

This is called perfectprice discrimination.

The monopolistcaptures all CS

as profit.But theres no DWL.

Monopolyprofit

MC

Quantity

Price

D

MR

Q


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Price Discrimination in the Real World

In the real world, perfect price discrimination is notpossible:

no firm knows every buyers WTP

buyers do not announce it to sellers

So, firms divide customers into groupsbased on some observable traitthat is likely related to WTP, such as age.


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Examples of Price Discrimination

Movie tickets

Discounts for seniors, students, and people who canattend during weekday afternoons. They are all morelikely to have lower WTP than people who pay full price

on Friday night.

Airline prices

Discounts for Saturday-night stayovers help distinguish

business travelers, who usually have higher WTP, frommore price-sensitive leisure travelers.


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Discount coupons

People who have time to clip and organize coupons aremore likely to have lower income and lower WTP than

others.Need-based financial aid

Low income families have lower WTP for their childrens

college education. Schools price-discriminate by offeringneed-based aid to low income families.


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Quantity discounts

A buyers WTP often declines with additional units, sofirms charge less per unit for large quantities than smallones. Example: A movie theater charges $4 for

a small popcorn and $5 for a large one thats twice asbig.


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CONCLUSION: The Prevalence of Monopoly

In the real world, pure monopoly is rare. Yet, many firms have market power, due to

selling a unique variety of a product

having a large market share and few significant competitors

In many such cases, most of the results from this chapterapply, including

markup of price over marginal cost

deadweight loss


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SUMMARY

A monopoly firm is the sole seller in its market.Monopolies arise due to barriers to entry,including: government-granted monopolies, thecontrol of a key resource, or economies of scaleover the entire range of output.

A monopoly firm faces a downward-sloping demandcurve for its product. As a result, it must reduceprice to sell a larger quantity, which causes

marginal revenue to fall below price.


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SUMMARY

Monopoly firms maximize profits by producing thequantity where marginal revenue equals marginalcost. But since marginal revenue is less thanprice, the monopoly price will be greater thanmarginal cost, leading to a deadweight loss.

Policymakers may respond by regulatingmonopolies, using antitrust laws to promotecompetition, or by taking over the monopoly and

running it. Due to problems with each of theseoptions, the best option may be to take no action.


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SUMMARY

Monopoly firms (and others with market power) tryto raise their profits by charging higher prices toconsumers with higher willingness to pay. Thispractice is called price discrimination.


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Monopolistic competition

A market structure in which many firms sell products thatare similar but not identical.

Assumptions:

Many Sellers, Product Differentiation, Free Entry-Exit.

Examples: apartments books bottled water clothing fast food night clubs

0
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Another important dimension of product differentiation, is location. Petrol seems likean undifferentiated product, assume different petrol stations charge differentprices.

How can some Petrol stations get away with charging 50 or even 62.50 Rsmore per litter? The answer isproduct differentiation by location.

Imagine youre driving in rush-hour traffic from home. The Petrol indicator shows yourvehicle needs petrol. After uttering a few choice expletives, you notice on the rightside, there is a petrol station near by the place where you are driving and there isa mechanic shop owner at an upcoming intersection, who sells petrol. But, hecharges 12.50 Rs more than the one near by road. One near by road would require aheavy traffic and go via a U turn to go into the station. It makes you to spend 5 Rsworth of petrol.

And how much would you save? If you buy 2 litters, youd save only 5 Rs.

Alternatively, imagine you run a petrol station located in a highly residential area, inwhich there are few other businesses including gas stations. If people want gas,they can buy it from you, or they can drive 10 minutes to a more commercial areawith lots of gas stations. Your location allows you to charge a higher price.

Business people have long understood that location is a critical dimension of product

differentiation. Hence the saying location, location, location.

Role of Location
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A Monopolistically Competitive Firm Earning Profits in theShort Run

The firm faces adownward-slopingD curve.

At each Q, MR< P.

To maximize profit,firm produces Qwhere MR= MC.

The firm uses theD curve to set P.

profit

ATC

P

Quantity

Price

ATC

D

MR

MC

Q

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A Monopolistically Competitive FirmWith Losses in the Short Run

For this firm,P


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Monopolistic Competition and Monopoly

Short run: Under monopolistic competition,

firm behavior is very similar to monopoly. Long run: In monopolistic competition,

entry and exit drive economic profit to zero. If profits in the short run:

New firms enter market, taking some demand away from existing

firms, prices and profits fall. If losses in the short run:

Some firms exit the market, remaining firms enjoy higher demandand prices.

0

The level of output that minimizes ATC is greater than the output that maximizes th


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A Monopolistic Competitor in the Long Run

Entry and exit

occurs untilP=ATCand profit= zero.

Notice that thefirm charges amarkup of priceover marginalcost, and does

not produce atminimumATC.

Quantity

Price

ATC

DMR

Q

MC

MC

P = ATC

markup

0


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Why Monopolistic Competition IsLess Efficient than Perfect Competition1. Excess capacity

The monopolistic competitor operates on the downward-sloping part of itsATCcurve, produces less than the cost-minimizing output.

Under perfect competition, firms produce the quantity thatminimizesATC.

2. Markup over marginal cost Under monopolistic competition, P> MC.

Under perfect competition, P= MC.

0


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Monopolistic Competition and Welfare

Monopolistically competitive markets do nothave all the desirable welfare properties ofperfectly competitive markets.

Because P> MC, the market quantity is belowthe socially efficient quantity.

Yet, not easy for policymakers to fix this problem:Firms earn zero profits, so cannot require themto reduce prices.

0


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Monopolistic Competition and Welfare

Number of firms in the market may not be optimal,due to external effects from the entry of new firms:

the product-variety externality:surplus consumers get from the introduction of new products

the business-stealing externality:losses incurred by existing firms when new firms enter market

The inefficiencies of monopolistic competition aresubtle and hard to measure. No easy way forpolicymakers to improve the market outcome.

0


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Advertising

In monopolistically competitive industries, productdifferentiation and markup pricing lead naturally to theuse of advertising.

In general, the more differentiated the products,

the more advertising firms buy. Economists disagree about the social value of advertising.

0


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The Critique of Advertising

Critics of advertising believe: Society is wasting the resources it devotes to advertising.

Firms advertise to manipulate peoples tastes.

Advertising impedes competition

It creates the perception that products are more differentiatedthan they really are, allowing higher markups.

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The Defense of Advertising

Defenders of advertising believe: It provides useful information to buyers.

Informed buyers can more easily find and exploit pricedifferences.

Thus, advertising promotes competition and reduces marketpower.

Results of a prominent study:Eyeglasses were more expensive in states

that prohibited advertising by eyeglass makers

than in states that did not restrict suchadvertising.

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Advertising as a Signal of Quality

A firms willingness to spend huge amountson advertising may signal the quality of its productto consumers, regardless of the content of ads.

Ads may convince buyers to try a product once, but the product

must be of high quality for people to become repeat buyers. The most expensive ads are not worthwhile unless they lead to

repeat buyers.

When consumers see expensive ads, they think the productmust be good if the company is willing to spend so much on

advertising.

0

0


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Brand Names

In many markets, brand name products coexist withgeneric ones.

Firms with brand names usually spend more onadvertising, charge higher prices for the products.

As with advertising, there is disagreement aboutthe economics of brand names

0

0


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The Critique of Brand Names

Critics of brand names believe: Brand names cause consumers to perceive differences that

do not really exist.

Consumers willingness to pay more for brand names isirrational, fostered by advertising.

Eliminating govt protection of trademarks would reduceinfluence of brand names, result in lower prices.

0

0


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The Defense of Brand Names

Defenders of brand names believe: Brand names provide information about quality to consumers.

Companies with brand names have incentive to maintainquality, to protect the reputation of their brand names.

0

0


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Comparing Perfect & Monop. Competition

yesnone, price-takerfirm has market power?

downward-sloping

horizontalD curve facing firm

differentiatedidenticalthe products firms sell

zerozerolong-run econ. profitsyesyesfree entry/exit

manymanynumber of sellers

monopolisticcompetitionperfectcompetition

0


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0


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Comparing Oligopoly & Monop. Competition

highlowlikelihood of fiercecompetition

lowhighimportance of strategicinteractions betweenfirms

manyfewnumber of sellers

monopolisticcompetition

oligopoly

0

0


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CONCLUSION

Differentiated products are everywhere; examples ofmonopolistic competition abound.

The theory of monopolistic competition describes manymarkets in the economy,

yet offers little guidance to policymakers looking toimprove the markets allocation of resources.

0

0


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SUMMARY

A monopolistically competitive market hasmany firms, differentiated products, and free entry.

Each firm in a monopolistically competitive market

has excess capacity produces less than thequantity that minimizesATC. Each firm charges aprice above marginal cost.

0

0


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SUMMARY

Monopolistic competition does not have all of thedesirable welfare properties of perfectcompetition. There is a deadweight loss causedby the markup of price over marginal cost. Also,the number of firms (and thus varieties) can be toolarge or too small. There is no clear way forpolicymakers to improve the market outcome.

0

0


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SUMMARY

Product differentiation and markup pricing lead tothe use of advertising and brand names. Critics ofadvertising and brand names argue that firms usethem to reduce competition and take advantage ofconsumer irrationality. Defenders argue that firmsuse them to inform consumers and to competemore vigorously on price and product quality.

0


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OLIGOPOLY


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BETWEEN MONOPOLY AND PERFECT COMPETITION

Oligopoly

Only a few sellers, each offering asimilar or identical product to theothers.


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MARKETS WITH ONLY A FEW SELLERS Characteristics of an Oligopoly Market

Few sellers offering similar or identical products Interdependent firms Best off cooperating and acting like a monopolist by producing a

small quantity of output and charging a price above marginal cost

MARKETS WITH ONLY A FEW SELLERSBecause of the few sellers, the key feature of oligopoly is the tension betweencooperation and self-interest.

A Duopoly ExampleA duopoly is an oligopoly with only two members.

It is the simplest type of oligopoly.


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Competition, Monopolies, and Cartels

The duopolists may agree on a monopoly outcome. Collusion

An agreement among firms in a market about quantities to produceor prices to charge.

Cartel

A group of firms acting in unison.


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Competition, Monopolies, and Cartels

Although oligopolists would like to form cartels and earnmonopoly profits, often that is not possible.

Antitrust laws prohibit explicit agreements amongoligopolists.


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The Equilibrium for an Oligopoly

When each firm in an oligopoly chooses its ownproduction to maximize its own profit, taking the otherfirms outputs as given, they collectively produce

more than the level produced by a monopolyand

less than the level produced in perfect competition.


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Therefore, the oligopoly price is less than the monopoly price but

greater than the competitive price (which equals marginal cost).


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Equilibrium for an Oligopoly:

Joint output is greater than the monopoly quantity but lessthan the competitive industry quantity.

Market prices are lower than monopoly price but greaterthan competitive price.

Total profits are less than the monopoly profit.


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How the Size of an Oligopoly Affects the MarketOutcome

As the number of firms in the oligopoly increases, theprice effect becomes weaker.

As a result, the output effect determines firms behavior:firms feel encouraged to boost production as long as P>

MC.


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How the Size of an Oligopoly Affects the MarketOutcome

As the number of sellers in an oligopoly grows larger, anoligopolistic market looks more and more like acompetitive market.

The price approaches marginal cost, and the quantity

produced approaches the socially efficient level.

T bl 1 Th D d S h d l f W t


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Table 1 The Demand Schedule for Water

Perfect Competition

Monopoly

Duopoly/Oligopoly

Assumption: Marginal

Cost of producingwater is zero: MC= 0.


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Defining a game

Formally, a game is a set of 4 elements: a set of players (can even be infinite)

a set of rules (allowable actions and sequencing ofactions by each player)

a payoff function (which assigns payoffs for eachplayer as a function of strategies chosen)

informational structure (what players know at eachpoint in the game)


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More on Common Knowledge

As we know, there are known knowns. Theseare things we know we know.

We also know, there are known unknowns.That is to say we know there are some things

we do not know. But there are also unknown unknowns, the

ones we don't know we don't know. D.H. Rumsfeld, Feb. 12, 2002, Department of

Defense news briefing Common knowledge means that there are no

unknown unknowns.


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History of Game Theory

Cournot (1838) - quantity-setting duopoly model Bertrand (1883) price-setting duopoly model Zermelo (1913) the game of chessvon Neumann & Morgenstern (1944) definedgames, min-max solution for 0-sum games

Nash (1950) defined a the equilibrium and thesolution to a cooperative bargaining problem


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Nobel prize winners for Game

Theory (Economics) 1994 John Nash, John Harsanyi, Reinhard Selten

1996 James Mirrlees, William Vickrey

2005 Robert Aumann, Thomas Shelling

Prisoners Dilemma


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Prisoners Dilemma

Two criminals-Bonnie and Clyde-minor crime of carryingunregistered gun- police suspect that two criminals havecommitted a Bank robbery together-but due to the lack ofevidence police convict them of their major crimes-Police question them-deal-choices

1.Lock up for 1 yr.2.If u confess to the bank robbery and implicate your partner,

you will be free. Your partner will be in jail for 20 yrs.3.But if u both confess to the crime, you will get an immediate

sentence up to 8 yrs.

What do u expect them to do?


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Bonnies Decision

Confess Remain Silent

Confes

s

Remain

Silent

Bonniegets 8 yrs

Clyde gets8 yrs

Bonniegets 20 yrs

Clydegoes free

Bonniegoes free

Clyde gets20 yrs

Bonniegets 1 yr

Clyde gets1 yr

Clydes

Decision

What do u expect them to do?Would they confess or remain silent?

Figure shows choices. Each prisoner has 2 strategies: confess or remain silent. The sentencedepend of their strategy he choose and strategy chosen by the partner.

1.Bonnies decision: If Clyde remains silent, I will confess, since then I will gofree rather than spending time in jail. If he confess, I too will confess, since


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p g j , ,then I will spend 8 yrs in jail rather than 20 yrs.

Dominant strategy (for bonnie). If it is the best strategy for a

player to follow regardless of strategies pursued by other players.

2. Clydes Decision: He faces exactly same choices as Bonnie, and he reasonsin much the same way. (Dominant Strategy)

3.In the end, both Bonnie and Clyde confess, and both spend 8 yrs in jail. Ifthey had both remain silent, both of them would have been better off,

spending 1 yr in Jail on the gun charge.4. Therefore, Cooperation between the 2 prisoners is difficult to maintain

because, cooperation is individually irrational.


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A Nash equilibrium is a situation in which economic actorsinteracting with one another each choose their beststrategy given the strategies that all the others havechosen.


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Nash EquilibriumJohn Nash equilibrium is a situation in which economic participantsinteracting with one another each choose their best strategy given thestrategies the others have chosen.

For Example, Jill is producing 40 gallons of water, the best strategy for Jackis to produce 40 gallons. Similarly, given that Jack is producing 40 gallons of

water, the best strategy for Jill is to produce 40 gallons. Once they reach thisNash equilibrium, neither Jack nor Jill has an incentive to make a differentdecision.Summery: When firm in an oligopoly individually choose production tomaximize profit, they produce a quantity of output greater than thelevel produced by monopoly and less than the level produced by

competition. The oligopoly price is less than the competitive price .


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Normal Form Games

Simple games without timing, i.e. where players make decisionssimultaneously. Dynamic games can be reduced into a normalform.

The set of strategies is simply the set of possible choices for eachplayer.

Normal (Strategic) Form Game consists of the followingelements:

- N={1,.., n} the finite set of players

- S={S1,.., Sn} the set of strategies, including a (possibly infinite)set for each player

- U(s1,.., sn) the vector of payoff functions, where si

Si for eachplayer If the set of strategies is small and countable (typically 2-5), then

we can use a game matrix to represent a normal-form game


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Game Matrix

Example 1: Advertising game

N={1, 2}

S={S1, S2} and S1 = S2 = {A, N}

U(s1, s2) = { u1(s1, s2); u2(s1, s2)}

u1(A, A) = 40; u1(A, N) = 60; u1(N, A) = 30; u1(N, N) = 50 u2(A, A) = 40; u2(A, N) = 30; u2(N, A) = 60; u2(N, N) = 50

Player 2

A N

Player1

A 40, 40 60, 30

N 30, 60 50, 50


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Thank You

imperfect competitions

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