Unit 8

More Economics of Competition

and Competitive Strategies

Key Topics

1. Alternative market structuresa. Perfect competitionb. Imperfect competition

2. Barriers to entry3. Revenue concepts for a price-taking firm

(review)a. P = ARb. MRc. TR

Key Topics (cont’d)

4. Operating decisions for a price-setting firma. TR max ($ sales max)

b. Π max

c. Rent-seeking actions

d. Price discrimination

5. Revenue concepts and operating decisions for a P-setting firm

6. Monopolies and roles of governmenta. Restrict market power

b. Grant & regulate ‘natural’ monopolies

Characteristics of ‘perfectly’ competitive markets

1. Many firms each relatively small compared to the size of the entire market or industry.

2. Firms produce ‘homogeneous’ products.3. Relative ease of firm entry in to or exit out of the

market.4. Information about prices and production costs widely

available.5. Firms have no control over prices and are price

‘takers’.6. In long run, product price = minimum average cost =

marginal cost (i.e. no excess profits or losses).

Perfect Competition

D

S

0Units of output, Q

P*=5

Pric

e pe

r un

it ($

)

P*=5

0 Units of output, q

P=MR

The industry A representative firm

Characteristics of ‘imperfectly’ competitive markets

1. Limited number of firms so each has a relatively significant share of total output for the industry or market.

2. Firms produce ‘heterogeneous’ products.3. Relative difficulty of firm entry in to or out of the

market.4. Information about prices and production costs NOT

widely available.5. Firms have some control over prices charged for their

products and are price ‘setters’.6. In long run, product price > average cost and price >

marginal cost.

General types of imperfectly competitive markets

1. Monopolistic competitionMany firms selling slightly differentiated products

2. OligopolyFew firms selling products with varying degrees of

differentiation

3. MonopolyONE firm selling product that has no (or few) close

substitutes

Barriers to entry

1. Government franchises = exclusive licenses to sell product/servicesWhy? - Economies of scale (i.e. greater efficiency lower

production costs)- Greater governmental control (e.g. alcohol)

2. Patents = exclusive right to sell a product or use a process to the inventor (for 20 years)Why?- To promote research, scientific progress

Barriers to entry (cont’d)

3. High capital costs (e.g. production, marketing)

4. Ownership of scarce factor of production

Prices charged by imperfectly competitive firms

1. They are a choice decision, not given (or taken)

2. They are constrained by consumer demand for the firm’s product (i.e. can set either P or Q, but NOT both).

Demand Curve ‘Constraint’

P

Pa

qa

q

a

Not possible

D curve facing P-setting firm(shows max P & Q combinations)

Recall, P = MR for P-taking (competitive firm)

However, MR < P for P-setting firm

q

P = MR = AR

$

MR for P-setting firm of lowering P to sell 1 more Q (graph)

P

q

-$

+$

P1

P2

ΔP {

q1 (q1+1)

Δq = 1

{

Marginal Revenue Example, Imperfect Competition

Quantity Price Total Revenue Marginal Revenue

0 $11 0 --

1 10 $10 $10

2 9 18 8

3 8 24 6

4 7 28 4

5 6 30 2

6 5 30 0

7 4 28 -2

8 3 24 -4

MR and TR max vs π max

MR = slope of TR

TR max= $ sales max MR = 0

(= D curve mid point)

Π max MR = MC

TR max vs π max (graph)

q

$

TR

TCMR=0 TR maxMR=MC

π max

More Monopoly Questions, Issues

Can you show with a graph:1. A monopolist maximizing its profits,

yet still losing money?2. The consumer surplus impacts of monopoly

(vs competition)?3. The impact on a monopolist’s profit of

offering a price discount on large quantity purchases?

Monopoly (vs Perfect Competition)

Profits can persist LR (entry blocked)

Output less & price higher ( loss of consumer surplus)

May act to preserve profits (= rent-seeking behavior) (e.g. lobbying, advertising, build entry barriers)

Price Discrimination

= charging different prices to different groups of buyers (i.e. different markets)

Examples:

Airlines, movie theatres, golf courses, restaurants, telephone companies, utility companies

Price Discrimination (graph)

q A*

$ $

Mkt A Mkt B

q q

Pa

MRa

dA

PB

MC = ATC

dBMRB

q B*

Monopolies and the Roles of Government

1. Promote competition/restrict market power antitrust laws

- Sherman Antitrust Act, 1890 (restraint of trade illegal)

- Clayton Act, 1914 (anticompetitive mergers and tying

contracts illegal)- Federal Trade Commission Act, 1914

(established FTC as regulatory agency and made ‘unfair methods of competition illegal)

Other legality issues: rule of reason vs. per se; conduct vs structure; remedies = consent decrees, treble damages, etc.

Monopolies and the Roles of Government

2.Grant monopolies (natural) and regulate so consumers benefit from economies of scale

Monopoly Regulation Alternatives

1. Require P = MC not practical as P < ATC

2. Require P = ATC (or P = ATC+)- Little incentive to minimize costs

3. Incentive pricing - set prices for number of yrs into future & allow firms to keep profits