Unit 4: Imperfect Competition

Characteristics of Oligopolies

- A Few Large Producers (Less than 10) - Identical or Differentiated Products - High Barriers to Entry - Control Over Price (Price Maker) - Mutual Interdependence

Production process

- A single firm can produce output at a lower cost than can a larger number of producers (economies of scale) - Create a natural monopoly

Examples of Price Discrimination

- Airline Tickets (vacation vs. business) - Movie Theaters (child vs. adult) - All Coupons (spenders vs. savers) - Football games (students vs. parents)

Dominant Strategy

- Best move to make regardless of what your opponent does - What firms make informed decisions based on

Examples of Non-Price Competition

- Brand Names and Packaging - Product Attributes - Service - Location - Advertising

Price Wars

- Breakdown in Price Leadership - Occurs when other firms don't follow price increases of dominant firm - Each firm tries to undercut each other

Price Leadership

- Collusion is illegal - Firms cannot set prices - Price leadership is a strategy used by firms to coordinate prices without outright collusion

Monopolistic qualities of monopolistic competition

- Control over price of own good due to differentiated product - D greater than MR - Not efficient

Copyright/patent

- Copyright granted for life of owner - Patent granted ownership of idea for years

Differentiated Products

- Goods are not identical - Firms seek to capture a piece of the market by making unique goods - Since these products have substitutes, firms use non price competition

Fair return (break even) price

- Government sets price where P or D=ATC - Normal Profit - Not all units demanded by consumers get produced

Socially optimal price

- Government sets price where P or D=MC - Allocative Efficiency - If ATC > P monopoly will suffer losses and need to subsidize

Regulations for Monopoly Pricing

- Govt does not consider MR=MC - Govt sets fair return or socially optimal price

Total Revenue Test

- If price falls and TR increases then demand is elastic - If price falls and TR falls then demand is inelastic

Natural Monopoly

- Industries that provide a good or service at a lower cost than many small firms - Governments tend to regulate these monopolies rather than break them up

Perfect Competition Qualities of monopolistic competition

- Large number of smaller firms - Relatively easy entry and exit - Zero Economic Profit in Long-Run since firms can enter

Barriers to Entry

- Large start up costs - Limited access to resources - Copyright/patent - Production process

elastic range

where a monopoly will only produce

Match price

If one firm cuts its prices, then the other firms follow suit causing inelastic demand

Ignore change

If one firm raises prices, others maintain same price causing elastic demand

Where does a monopoly produce?

where MR=MC

Dominant Strategy Equilibrium

- When each player chooses their own dominant strategy

Why do monopolies behave in their inefficient ways?

Because there is little external pressure to be efficient

Game Theory

The study of how people behave in strategic situations

4 market models (in order)

perfect competition, monopolistic competition, oligopoly, pure monopoly

Importance of Game Theory

- Oligopolies are interdependent - Must strategize about pricing and output to avoid economic losses - Game theory helps us analyze their strategies

Characteristics of Monopoly

- One supplier - No close substitutes - Price maker/searcher - Barriers to entry

Regulation of Minimum Output Requirements

- Order monopoly to produce more - Forced output can reduce profit which is okay as long as losses don't bankrupt monopoly

Regulation of Subsidizing Monopoly

- Per unit subsidy shifts MC curve down vertically - MC and MR meet at a higher level of output - Not popular with voters

Price Discrimination

- Practice of selling the same products to different buyers at different prices - Seeks to charge each consumer what they are willing to pay in an effort to increase profits - Those with inelastic demand are charged more than those with elastic - MR = D

Elastic portion of the demand curve

- Price increases = TR decreases - Price decreases = TR increases - Quantity effect stronger

Inelastic portion of the demand curve

- Price increases = TR increases - Price decreases = TR decreases - Price effect stronger

Regulating Natural Monopolies

- Regulate monopoly pricing - Subsidize a monopoly to increase output - Imposing minimum output requirements

Characteristics of Monopolistic Competition

- Relatively Large Number of Sellers - Differentiated Products - Some control over price - Easy Entry and Exit (Low Barriers) - A lot of non-price competition (Advertising)

Questions game theory raises to help us analyze strategies of oligopolies

- Should the firm enter the market? - Raise prices? - Best location? - Type of product?

Elastic and Inelastic Range

- left of dotted line is elastic - right of dotted line is inelastic

Oligopoly summary

- must use strategic pricing - have a tendency to collude to gain profit

If a firm with a kinked demand curve increases its price

- other firms will ignore it and keep prices the same - it will be the only firm with high prices meaning that quantity demanded will decrease a lot

If a firm with a kinked demand curve decreases its price

- other firms will match it and lower their prices - since all firms have lower prices, quantity demanded for this firm will increase only a little

Colluding Oligopolies

- same thing as Cartel - firms within them act as a monopoly and share the profit

Price Discrimination results in

- several prices - more profit - no consumer surplus - higher socially optimal quantity

Collusion

- the act of cooperating with rivals in order to "rig" a situation - results in the incentive to cheat

Nash Equilibrium

- the optimal outcome of a game is one where no player has an incentive to deviate from their chosen strategy - This is even after considering an opponent's choice - Every dominant strategy equilibrium is a Nash Equilibrium, but NOT every Nash Equilibrium is a dominant strategy equilibrium

How do oligopolies occur?

- when only a few large firms start to control an industry - high barriers to entry keep others from entering

Monopolies are inefficient because they...

1. Charge a higher price 2. Don't produce enough (not allocatively efficient) 3. Produce at higher costs (not productively efficient) 4. Have little incentive to innovate

General Process of Price Leadership

1. Dominant firm initiates a price change 2. Other firms follow the leader

Types of Barriers to Entry in Oligopolies

1. Economies of Scale 2. High Start-up Costs 3. Ownership of Raw Materials

Examples of Monopolistic Competition

1. Fast food restaurants 2. Furniture companies 3. Jewelry stores 4. Clothing manufacturers 5. Candy companies

Two Goals of Advertising

1. Increase Demand 2. Make demand more inelastic

Non-Colluding Oligopolies reaction to competitor's pricing

1. Match price 2. Ignore change

Requirements for price discrimination to occur

1. Must have monopoly power 2. Must be able to segregate the market 3. Product must not be able to be resold by consumers

Price-output models of oligopolies

1. Price Leadership (no graph) 2. Colluding Oligopoly 3. Non Colluding Oligopoly

Process of cartels

1. Set price and output at an agreed upon level 2. Firms require identical or highly similar demand and costs 3. Must have a way to punish cheaters 4. Together they act as a monopoly

Why would the government regulate an monopoly?

1. To keep prices low 2. To make monopolies efficient

Large start up costs

Discourage other firms from entering

Mutual Interdependence

Firms use Strategic Pricing

Regulation of Subsidizing Monopoly example

Gas, electric, phone

Limited access to resources

Key resource for production is owned by firm

Oligopoly examples

OPEC, Cereal Companies, Car Producers

Kinked Demand Curve Model on Oligopoly Graphs

Shows how non-collusive firms are interdependent

Why don't taxes work for the government to regulate monopolies?

Taxes limit supply and that's the problem

What happens if the government, when regulating a natural monopoly, sets a price ceiling to get the socially optimal quantity?

The firm would make a loss and would require a subsidy

Cartel

a group of producers that create an agreement to fix prices high

How does the government regulate monopolies using price controls?

price ceilings

Where is MR on a kinked demand curve?

it has a vertical gap at the kink

How does a monopoly charge price?

it is set by the demand curve

Regulation of Minimum Output Requirements example

phone company must provide basic phone service, can't shut off heat in winter