Imperfect Competition Shades of Gray between Perfect Competition and Monopoly

1. Imperfect CompetitionShades of Gray between Perfect Competitionand Monopoly Microeconomics - Dr. Dennis Foster

2. Monopolistic Competition Contestable Markets Cartels Oligopoly Game Theory The Spectrum of Competition Firms are primarily distinguished from each other by the degree of competition they face: Perfect Competition Monopoly

3. Contestable Markets • There may be many firms … -- but, probably only a few. • This market appears to be an oligopoly …-- but, there aren’t significant barriers to entry. • In the long run, price must equal marginal cost … -- so, firms are allocatively efficient. • In the long run, price must equal average cost … -- so, firms only earn a “normal” profit. • Examples – Airlines, wine production …

4. Monopolistic Competition Market structure when there are: • many firms, • no barriers to entry, • each produces a “differentiated product.” Examples: Restaurants, Convenience stores, Barbers • Differentiation may be by location! • Substitutes are not perfect. • Advertising may contribute.

5. Monopolistic Competition Characteristics and Consequences • Many sellers & easy entry - Can only earn economic profit in SR.- In LR, must earn only normal profit. • Sells differentiated products - Faces a downward sloping demand.- Can raise price without losing all customers.

6. price MC P* ATC P** ATC * d d** MR** quantity q * q** MR Monopolistic Competition While economic profits may be earned in the short run,the entry of new firms will compete them away.

7. P** d** MR** q** Monopolistic Competition price MC ATC quantity While economic profits may be earned in the short run,the entry of new firms will compete them away.

8. Monopolistic Competition & Efficiency • Allocatively inefficient?- Yes, since demand slopes down, P>MC. • Productively inefficient?- Yes!!! Must be. [Excess Capacity Theorem] • Social waste of resources?- No, as there are no econ profits to protect. • X-inefficiency?- Unlikely, due to competition.

9. Oligopoly Market structure where: (i)there are a few dominant firms (ii)there are high barriers to entry

10. Few sellers - face downward sloping demand, - actions are interdependent. • Homogeneous or differentiated products - steel, oil, concrete, diamonds - cigarettes, cereal, tires, soap • Barriers to entry - can earn economic profit in long run. Oligopoly … characteristics

11. Oligopoly … barriers to entry • Control of resource • Scale economies • Brand proliferation • Legal barriers • Deterrence strategies - price wars- switching costs- game theory

12. Descriptiveanalyses Graphicalanalyses Oligopoly … models of behavior • Kinked Demand • Price Leader • Cartel Model • Entry-limit Pricing • Contestable Markets • Game Theory

13. Price MC D2 P* D1 quantity Q* MR Oligopoly– Kinked Demand Presumes excess capacity- Others follow price reduction. - Nobody follows price increase. Price rigidity in the face of changing costs

14. Oligopoly– Other Models Price Leader- One firm sets the price; others follow. - To be enforceable, this firm should dominate the market (Saudi Arabia). - Sometimes it is just by convention (Ford). Entry-limit pricing- Firms set price so any new entrant will force price down below ATC. - This is a barrier to entry. Contestable Markets

15. Oligopoly - Efficiency - Yes, since demand slopes down, P>MC. - It is not certain, but likely. Allocatively inefficient? Productively inefficient? Social waste of resources? X-inefficiency? - Yes, as there are likely to be economic profits to protect. - Yes, especially if the market is regulated.

16. Price P** MC ATC P* demand MR quantity Q* Q** Oligopoly – Cartel Model Firms collude- Try to act as if it were a monopoly. - Must increase excess capacity – incentive to cheat. BOAPW – Be the only one not to join!

17. Oligopoly– Cartel Model Free rider problem.- Non members get advantage of higher price without having to control output. Raising profits encourages entry!- OPEC and . . . Mexico/North Sea/Alaska There must be few substitutes.- A cartel for coffee? Must be able to deter cheating by members. - Libya and oil; Iran & Iraq and oil. - Diamonds (DeBeers) and distribution/stocks

18. Game Theory Read Chapter 24 for more on Game Theory. • Cooperative vs. Noncooperative • Dominant strategy • Sequential games • Games with Nash equilibrium Models of oligopoly behavior based on the characteristic of interdependence.

19. Game Theory First-mover game Last-mover game Chicken game Prisoner’s Dilemma

20. $100 $50 $100 $200 $200 $150 $50 $150 Game Theory The Prisoners’ Dilemma Should Bud and Miller advertise during the Super Bowl? • The best outcome (for them) is . . . • But, each has the same “best” strategy . . . • How can these firms overcome the PD?

21. Monopolistic Competition Contestable Markets Cartels Oligopoly Game Theory The Spectrum of Competition Firms are primarily distinguished from each other by the degree of competition they face: Perfect Competition Monopoly

22. Imperfect CompetitionShades of Gray between Perfect Competitionand Monopoly Microeconomics - Dr. Dennis Foster