Chapter 11: [ 9 Questions on the Final] Imperfect Competition
Ø Know the key terms (except for Cournot duopoly model)
The chapter is titled “Imperfect Competition”, but the term “imperfect competition” can be misleading. Think in terms of the market power of the firm, that power defined as the ability of the firm to influence the market price of the product.
In pure/perfect competition there are so many firms supplying the identical good that each firm simply has to take the overall market price as given and seek profit maximization given that price (i.e., firm faces a horizontal demand curve – Chapter 9).
Under monopoly there is only one firm facing the demand curve so the firm can select a (P,Q) – on that demand curve – as it seeks to maxinize profits (Chapter 10).
In “imperfect competition” there are two ranges of market power between the extremes of pure competition and monopoly.
Ø Close to pure competition, with no market power, one finds monopolistic competition where firms have a small amount of market power as a result of some modest product differentiation. This gives them a slightly price sensitive individual firm demand curve (slightly downward sloping curve).
Ø Close to monopoly, with maximum market power, one finds oligopoly where there are very few firms supplying a similar product, but they are very much aware of the presence of their competitors.
Ø NOTE: The book devotes a section (11.5) to Duopoly and Cournot Games/Solutions. This is the special case of an oligopoly where there are only two players, and each has to plan a production/market strategy fully aware that the other firm is watching and planning a production/market strategy as well. We will skip this special case
Why do Market Structures Differ?
Ø When there is ease of entry, low upfront capital costs, and consumers see products as perfect substitutes markets tend toward pure competition.
Ø When there are obstacles to entry (capital costs, patented products, and economies of scale) markets tend toward monopolies.
Ø When there are conditions that tend toward pure competition, but there is scope for individual firms to engage in modest product differentiation (features, elite properties, etc.) markets tend toward monopolistic competition.
Ø When there are economies of scale, as well as large start up costs, markets tend toward oligopolies (e.g. automobile production).
A key factor determining how many firms will operate within a market, and hence determine the market structure is the minimum efficient scale relative to the size of the total market. (think about that and get it clear in your head).
Empirical Measurement of Market Structures
It is not good enough to simply county the number of firms in a given product market to determine what the market structure is for that product. If there is only one firm, it is easy to declare that the firm is a monopoly. If there are a few firms with similar products one can conclude that the market structure is probably an oligopoly. If there are dozens and dozens of firms with ease of entry and exit, one can conclude that the market structure is probably nearly purely competitive, or exhibits monopolistic competition.
But what if there are 15, 30, 60 or even 120 firms and they are not all approximately the same size (in terms of production for the market). Then we need some measure of the degree of concentration in the market. Is it dominated by a few firms, or is market power widely distributed.
To measure the degree of market power within the market economists make use of concentration ratios. The n-firm concentration ratio (where n = 4) is one approach. It asks what percentage of the total market the 4 largest firms control. Table 11.2 (1984 data) demonstrates that brewing was highly concentrated with 98% of the market controlled by the four largest firms. At the other end, for Table 11.2 data, in women’s clothing the four largest firms accounted for only 9% of the market, suggesting a highly competitive market.
Monopolistic Competition
Remember that the cost curves for the firm already include a competitive rate of return on the capital provided by the shareholders, and a competitive return to the labour of the entrepreneur. Therefore, when the price is above ATC the profits earned are called “supernormal profits” or – by economists- also called “pure economic profits”. These supernormal/pure economic profits act as a signal for other firms to compete on the profitable firms market territory.
Therefore, although the monopolistic competition firm can act like a weak monopoly in setting MC = MR (Figure 11.2), in the long run market entry by competitors will push the firm’s demand curve “back” (to the left) and this process of entry and competition will continue until there are no more supernormal/pure economic profits ( PE,QE in Figure 11.2)
Compare this solution ( PE,QE in Figure 11.2) with a monopoly solution. P > MC = MR so some of the inefficiency associated with monopoly is present here, although to a lesser degree. There is some output that the firm could produce where MC < P, i.e. from QE to QO , that the profit maximizing monopolistic competition firm decides not to produce – in its pursuit of profit maximization.
Oligopoly, Interdependence and Game Theory <= Not on Final Exam - Alas, I like the topic!
The challenge for an oligopoly firm is to second guess how its competitors will respond to its moves, and how it should respond to their moves, all in the name of the pursuit of profits.
The textbook stresses two strategies for oligopolistic competitors. One is to be quick to offer something the competitors don’t offer, things such as “roll up the rim” to sell coffee, and “No PST/GST, or no payments for 18 months” to sell furniture and appliances. The other is continuous innovation, to capture and hold customers. This is particularly important in the area of information and communication technology products and services.
It is difficult to model the various strategies open to Oligopolistic firms in the way we have modeled pure competition, monopoly and monopolistic competition.
We will not cover Game Theory on the exam
One approach is to treat oligopolistic profit maximizing as a game of strategies, much like poker (the card game). A famous two-person two-option game (two separated prisoners who can either confess or not confess) is called “the prisoner’s dilemma”. If there is time we will work though the original prisoner’s dilemma in our resumed course meeting. If not, look up prisoner’s dilemma online (e.g. via Google).
Such “strategic game” approaches focus on games where there is a dominant strategy for each player and a Nash equilibrium where each player has a single best strategy. [NOTE: John Nash, the author of the “Nash equilibrium” is the Noble Prize wining economist whose life was portrayed in the film “A Beautiful Mind” staring Russell Crowe.]
One interesting outcome of the prisoner’s dilemma game is that the competitive solution (where the players do not cooperate) leave both worse off than if they has cooperated. This is the point being made in the game depicted in Table 11.3. Understand how the strategy outcome is arrived at. Don’t worry much about the meaning of “commitment” and “credible threat”.
11.5 Duopoly and Cournot Games (Skip this section)
11.6 Entry and Potential Competition
The threat of entry and potential competition can serve to curb/discipline the behaviour of a firm already in the market. Two important factors are (a) the ease of entry, and (b) the ease of exit. Ease of entry means that the up front (fixed) cost allows new entrants to easily move into the market. Ease of exit means that one can liquidate the business without incurring major loses. Think of a business where everything is on short-term lease – easy entry and easy exit. If there is ease of entry/exit the market is called “contestable” and that may temper the degree to which existing firms pursue supernormal profits. So, a small number of firms may not be able to act like an oligopoly, since ease of entry keeps their behaviour in check.
Information and communication technologies (ICTs) are extending the degree to which a global corporation can engage in production and marketing command and control. This means that the contestability of a market increasingly includes the threat from foreign global firms.
Given the time to do so, we will discuss strategic entry barriers.
Comments (0)
You don't have permission to comment on this page.