Imperfect Competition Part I

1. Chapter 11 Imperfect Competition (Part I) © 2004 Thomson Learning/South-Western

2. Imperfect Competition • Pricing in these markets falls between perfect competition and monopoly. • Three topics considered: • Pricing of homogeneous goods in markets with few firms. • Product differentiation in these markets. • How entry and exit affect long-run outcomes in imperfectly competitive markets.

3. Pricing of Homogeneous Goods • In this market a relatively few firms produce a single homogeneous good. • Assume demanders are price takers. • Assume there are no transactions or informational costs. • These assumptions result in a single equilibrium price for the good. • Initially, assume a fixed, small number of identical firms.

4. Quasi-Competitive Model • A model of oligopoly pricing in which each firm acts as a price taker even though there may be few firms is a quasi-competitive model. • As a price taker, a firm will produce where price equals long-run marginal costs. • This equilibrium will resemble the perfectly competitive solution, even with few firms.

5. Quasi-Competitive Model • In Figure 11.1, the quasi-competitive equilibrium is PC (= MC), QC. • This equilibrium represents the highest quantity and lowest price that can prevail in the long run given the demand curve D. • A lower price would not be sustainable in the long run because it would not cover average costs.

6. FIGURE 11.1: Pricing under Imperfect Competition Price C P MC C D MR Q Quantity 0 C per week

7. Cartel Model • A model of pricing in which firms coordinate their decisions to act as a multiplant monopoly is the cartel model. • Assuming marginal costs are constant and equal across firms, the cartel output is point M (the monopoly output) in Figure 11.1. • The plan would require a certain output by each firm and how to share the monopoly profits.

8. FIGURE 11.1: Pricing under Imperfect Competition Price P M M P A A C P MC C D MR Q Q Q Quantity 0 M A C per week

9. Cartel Model • Maintaining this cartel solution poses three problems: • Cartel formations may be illegal, as it is in the U.S. by Section I of the Sherman Act of 1890. • It requires a considerable amount of costly information be available to the cartel. • The market demand function. • Each firm’s marginal cost function.

10. Cartel Model • The cartel solution may be fundamentally unstable. • Each member produces an output level for which price exceeds marginal cost. • Each member could increase its own profits by producing more output than allocated by the cartel. • If the cartel directors are not able to enforce their policies, the cartel my collapse.

11. APPLICATION 11.1: The De Beers Cartel • In the 1870s the discovery of the rich diamond fields in South Africa lead to major gem and industrial markets. • After a competitive start, the ownership of the richest mines became incorporated into the De Beers Consolidated Mines which continues to dominate the world diamond trade.

12. APPLICATION 11.1: The De Beers Cartel • Operation of the De Beers Cartel • Since the 1880s diamonds found outside of South Africa are usually sold to De Beers who markets the diamonds to the final consumers through its central selling organization (CSO) in London. • By controlling supply, the CSO maintains high prices which have been estimated to be as much as one thousand times marginal cost.

13. APPLICATION 11.1: The De Beers Cartel • Dealing with Threats to the Cartel • This large markup promotes threat of entry with any new diamond discovery. • De Beers has used its market power to control would-be-chiselers. • They drove down prices when the former Soviet Union and Zaire tried market entry in the 1980s. • New finds in Australia were sold to the CSO rather than try to fight the cartel.