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Chapter 7: Firms and How They Operate II 1. Comparison of the 4 Markets Type Perfect Competition Monopoly Monopolistic Competition Oligopoly Number of buyers / sellers

! Large ! No one buyer / seller

can influence price ! Firm price taker

! Only one firm ! Firm price setter

! Large ! FOP relatively mobile ! When firm makes

decisions, does not have to worry how its rivals will react

! Few large firms ! Interdependent

Barriers to entry

! None ! FOP perfectly mobile ! No transaction /

transportation costs ! Minimal sunk costs

! High ! Natural: huge sunk costs

(AFC falls over very large output AC falls continuously enjoys huge IEOS), exclusive ownership of essential raw materials

! Artificial: non-price competition, contrived barriers (cartel), legal protection: exclusive rights (patents, tariffs to block foreign firms)

! No / Low ! Firm lowers price

profits spread thinly over many rivals rivals suffer negligibly

! Retaliation unlikely ! No collusion keen

competition

! Substantial ! Natural ! Artificial: legislation,

collusion / mergers, non-price competition, advertising

Nature of products

! Homogeneous ! Buyers no preference

for any firm

! No close substitutes ! CED and PED very low

! Differentiated: quality, design, location, promotion

! Demand price elastic

! Homogeneous / differentiated

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Knowledge ! Perfect

! Seller knows rivals prices, market costs and available technology

! Buyers know all sellers prices, quality and availability of products will not purchase at a higher price than equilibrium price

! Imperfect ! Consumers not fully

aware of COP

! Imperfect ! Production methods and

prices ! Cost structures differ as

some firms enjoy more favourable locations / rentals

! Imperfect

Firms curve

! P = AR = MR

! P > MR ! Cannot increase both

output and price at the same time as curve is downward sloping

! P > MR ! Some degree of control

over own prices ! No single equilibrium

price in market no market demand curve

! P > MR ! Firm increases price

other firms will not ! Firm decreases price

other firms follow may lead to price war

! Price rigidity: menu costs, fear of harming firms image (fall in price fall in quality)

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Examples ! Stock market ! Forex market ! Agricultural products:

many farmers in LDCs

! Utilities ! Starhubs EPL coverage ! SMRT for NS and EW

lines

! Bubble tea ! UK brewery industry ! Taxi companies ! OPEC ! Mobile service

provision Firms SR equilibrium

! Supernormal, normal / subnormal profits ! MC = MR and MC must be rising

Firms LR equilibrium

! Normal profits ! New firms will enter

industry to erode supernormal profits

! Normal / supernormal profits

! Firm will shut down if subnormal profits

! Normal profits ! Normal / supernormal

LR equilibrium curve

Productive efficiency

! Efficient ! Firm produces at MES

! Inefficient unless by coincidence

! Inefficient ! Will settle at LRAC that

is not necessarily at MES

! Inefficient unless by coincidence

! Firms POV: all points on LRAC ! Societys POV: MES

Allocative efficiency

! Efficient ! P = MC

! Inefficient ! P > MC

! Could be seen as premium society pays for product differentiation

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2. Analysis of Imperfect Market Structures Type Monopoly Monopolistic Competition Oligopoly Economic efficiency

! Allocative inefficiency: P > MC, output below optimum

! Productive inefficiency ! X-inefficiency but increasingly

reduced due to globalisation, reduced customs duties and barriers to trade

! Dynamic efficiency: r+d

! Allocative inefficiency: P > MC ! Productive inefficiency: do not

utilise optimal plant capacity, do not exhaust potential for further EOS because all small firms

! Dynamic inefficiency: no r+d

! Allocative inefficiency: P > MC, output below optimum

! Productive inefficiency ! Dynamic efficiency: r+d

Variety of products

! Unique ! Possible innovation and new

products: BTE stimulus to the creativity required to destroy barriers monopoly profits stimulates new entrants producing new and competing products

! Large variety increase in consumer welfare

! Differentiated

R+d and new profits

! Profits lead to unequal income distribution: dollar votes + shift of consumer surplus to producer

! Supernormal profits plough into r+d better quality products + better methods of production lower AC but there is no guarantee that monopolies will do this

! More equity: no redistribution of income from consumers to shareholders

! Normal profits: no additional profits to plough into r+d

! Supernormal profits ploughed into r+d

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Theory vs empirical evidence

! MES high IEOS lower MC than PC industry lower P and higher o/p but monopolies charge high prices by restricting output

! Practise price discrimination [has

both costs and benefits] ! Natural monopolies ! Perfectly contestable markets:

costs of entry and exit by potential rivals are zero, and when such entries can be made very rapidly eg. deregulation of airline industry in 1978

! Hit and run competition: market contestable for certain seasons eg. parcels service during festivals

! Reduces wasteful competition (instead of extensive advertising, money can be spent to produce more goods)

! Wasteful competition ! Advertising provides better

consumer information which helps move market structure closer to PC model but loss of consumer sovereignty

! High price rigidity: price stability ! Wasteful competition: more likely

to engage in extensive advertising encourages price competition, with increased sales volume and reaping of EOS, price reduce further

! But possible monopoly power through collusion

! But multiple branding gives consumers misguided information in thinking products are from different firms

P/R/C

Q AR

MCm

MR

MCpc Pc Pm

0 Qc

Qm