unit iv: imperfect competition · market • the firm is the industry. 2. unique good with no close...
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Unit 4: Imperfect
Competition
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Monopoly
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Characteristics of Monopolies
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5 Characteristics of a Monopoly1. Single Seller• One Firm controls the vast majority of a
market• The Firm IS the Industry2. Unique good with no close substitutes3. “Price Maker”The firm can manipulate the price by changing
the quantity it produces (ie. shifting the supply curve to the left).
Ex: California electric companies4
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5. Some “Nonprice” Competition
4. High Barriers to Entry
• No immediate competitors
• Despite having no close competitors, monopolies still advertise their products in an effort to increase demand.
5 Characteristics of a Monopoly
• New firms CANNOT enter market
• Firm can make profit in the long-run
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Examples of Monopolies
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Four Origins of Monopolies1. Geography is the Barrier to EntryEx: Nowhere gas stations, De Beers Diamonds, San Diego
Chargers, Cable TV, Qualcomm Hot Dogs…-Location or control of resources limits competition and leads to one supplier.
2. The Government is the Barrier to EntryEx: Water Company, Firefighters, The Army,
Pharmaceutical drugs, rubix cubes… -Government allows monopoly for public benefits or
to stimulate innovation. -The government issues patents to protect inventors
and forbids others from using their invention. (They last 20 years)
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Four Origins of Monopolies3. Technology or Common Use is the Barrier to EntryEx: Microsoft, Intel, Frisbee, Band-Aide…-Patents and widespread availability of certain products
lead to only one major firm controlling a market.
4. Mass Production and Low Costs are Barriers to EntryEx: Electric Companies (SDGE)
• If there were three competing electric companies they would have higher costs.
• Having only one electric company keeps prices low-Economies of scale make it impractical to have
smaller firms. Natural Monopoly- It is NATURAL for only one firm to
produce because they can produce at the lowest cost.8
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Drawing Monopolies
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Good news…1.Only one graph because the
firm IS the industry.2.The cost curves are the same3.The MR= MC rule still applies4.Shut down rule still applies
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The Main Difference• Monopolies (and all Imperfectly
competitive firms) have downward sloping demand curve.
• Which means, to sell more a firm must lower its price.
• This changes MR…
THE MARGINAL REVENUE DOESN’T EQUAL THE PRICE!
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P Qd TR MR$11 0 0 -
Why is MR less than Demand?
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$10
P Qd TR MR$11 0 0 -$10 1 10 10
Why is MR less than Demand?
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$10
P Qd TR MR$11 0 0 -$10 1 10 10$9 2 18 8
Why is MR less than Demand?
$9 $9
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$10
P Qd TR MR$11 0 0 -$10 1 10 10$9 2 18 8$8 3 24 6
Why is MR less than Demand?
$9 $9
$8 $8 $8
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$10
P Qd TR MR$11 0 0 -$10 1 10 10$9 2 18 8$8 3 24 6$7 4 28 4
Why is MR less than Demand?
$9 $9
$8 $8 $8
$7 $7 $7 $7
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$10
P Qd TR MR$11 0 0 -$10 1 10 10$9 2 18 8$8 3 24 6$7 4 28 4$6 5 30 2
Why is MR less than Demand?
$9 $9
$8 $8 $8
$7 $7 $7
$6 $6 $6 $6
$7
$6
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$10
P Qd TR MR$11 0 0 -$10 1 10 10$9 2 18 8$8 3 24 6$7 4 28 4$6 5 30 2$5 6 30 0
Why is MR less than Demand?
$9 $9
$8 $8 $8
$7 $7 $7
$6 $6 $6 $6
$7
$6
$5$5 $5 $5 $5 $5
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$10
P Qd TR MR$11 0 0 -$10 1 10 10$9 2 18 8$8 3 24 6$7 4 28 4$6 5 30 2$5 6 30 0$4 7 28 -2
Why is MR less than Demand?
$9 $9
$8 $8 $8
$7 $7 $7
$6 $6 $6 $6
$7
$6
$5$5 $5 $5 $5 $5
$4 $4 $4 $4 $4 $4 $419
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$10
P Qd TR MR$11 0 - -$10 1 10 10$9 2 18 8$8 3 24 6$7 4 28 4$6 5 30 2$5 6 30 0$4 7 28 -2
Why is MR less than Demand?
$9 $9
$8 $8 $8
$7 $7 $7
$6 $6 $6 $6
$7
$6
$5$5 $5 $5 $5 $5
$4 $4 $4 $4 $4 $4 $420
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$10
P Qd TR MR$11 0 - -$10 1 10 10$9 2 18 8$8 3 24 6$7 4 28 4$6 5 30 2$5 6 30 0$4 7 28 -2
Why is MR less than Demand?
$9 $9
$8 $8 $8
$7 $7 $7
$6 $6 $6 $6
$7
$6
$5$5 $5 $5 $5 $5
$4 $4 $4 $4 $4 $4 $4
MR IS LESS THAN PRICE
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Calculating Marginal Revenue
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To sell more a firm must lower its price. What happens to Marginal Revenue?
Price QuantityDemanded
Total Revenue
Marginal Revenue
$6 0
$5 1
$4 2
$3 3
$2 4
$1 5
Does the Marginal Revenue equal the price?23
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To sell more a firm must lower its price. What happens to Marginal Revenue?
Price QuantityDemanded
Total Revenue
Marginal Revenue
$6 0 0
$5 1 5
$4 2 8
$3 3 9
$2 4 8
$1 5 5
Does the Marginal Revenue equal the price?24
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To sell more a firm must lower its price. What happens to Marginal Revenue?
Price QuantityDemanded
Total Revenue
Marginal Revenue
$6 0 0 -
$5 1 5 5
$4 2 8 3
$3 3 9 1
$2 4 8 -1
$1 5 5 -3
Draw Demand and Marginal Revenue Curves
MR DOESN’T EQUAL PRICE
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Plot the Demand, Marginal Revenue, and Total Revenue Curves
26Q
$15
10
5
$64
40
20
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18Q
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18
TR
P
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Q
$15
10
5
$64
40
20
TR
D1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18
Q
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18
MR
Demand and Marginal Revenue CurvesWhat happens to TR when MR hits zero?
Total Revenue is at it’s peak when
MR hits zero
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P
TR
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Elastic vs. Inelastic Range of Demand Curve
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Elastic and Inelastic Range
29Q
$15
10
5
$64
40
20
TR
D1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18
Q
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18
MR
P
TR
Total Revenue TestIf price falls and TR
increases then demand is elastic.
Elastic
Total Revenue TestIf price falls and
TR falls then demand is inelastic.
A monopoly will only
produce in the elastic
range
Inelastic
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Maximizing Profit
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D
MR
$98765432
MC ATC
311 2 3 4 5 6 7 8 9 10 Q
P
What output should this monopoly produce?MR = MC
How much is the TR, TC and Profit or Loss?
Profit =$6
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D
$98765432
Conclusion: A monopolists produces where MR=MC, buts charges the price consumer are willing to pay identified by the demand curve.
MC ATC
321 2 3 4 5 6 7 8 9 10 Q
P
MR
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D
MR
$109876543
MCATC
336 7 8 9 10 Q
P
TR= $90TC= $100Loss=$10
AVC
What if cost are higher? How much is the TR, TC, and Profit or Loss?
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D
MC
MR
TR=TC=
Profit/Loss=Profit/Loss per Unit=
Identify and Calculate: $70
$14$56
ATC
$2
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$10987654
1 2 3 4 5 6 7 8 9 10 Q
P
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Are Monopolies Efficient?
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Q
P
D
S = MC
Ppc
Qpc
CS
PS
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In perfect competition, CS and PS are
maximized.
Monopolies vs. Perfect Competition
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At MR=MC,A monopolist willproduce less and
charge a higher price
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Monopolies vs. Perfect Competition
Q
P
D
S = MC
Ppc
Qpc
MR
Pm
Qm
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Where is CS and PS for a monopoly?
38
Monopolies vs. Perfect Competition
Q
P
D
S = MC
MR
Pm
Qm
CS
PS
Total surplus falls. Now there is
DEADWEIGHT LOSS
Monopolies underproduce and over charge, decreasing CS and increasing PS.
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Are Monopolies Productively Efficient?Does Price = Min ATC? No. They are not
producing at the lowest cost (min ATC)
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D
$98765432
MC ATC
1 2 3 4 5 6 7 8 9 10 Q
P
MR
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Are Monopolies Allocatively Efficiency?Does Price = MC? No. Price is greater.
The monopoly is under producing.
40
D
$98765432
MC ATC
1 2 3 4 5 6 7 8 9 10 Q
P
MR
Monopolies are NOT efficient!
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Monopolies are inefficient because they…1. Charge a higher price2. Don’t produce enough
• Not allocatively efficiency3. Produce at higher costs
• Not productively efficiency4. Have little incentive to innovate
Why?Because there is little external pressure to
be efficient41
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QDMR
MCATC
P
Natural Monopoly
42Qsocially optimal
One firm can produce the socially optimal quantity at the lowest cost due to economies scale.
It is better to have only one firm because ATC is
falling at socially optimal quantity
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Lump Sum vs. Per Unit Taxes and Subsidies
43
ACDC Econ Video
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2007 FRQ #1
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Are Monopolies Efficient?
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Monopolies are inefficient because they…1. Charge a higher price2. Don’t produce enough
• Not allocatively efficiency3. Produce at higher costs
• Not productively efficiency4. Have little incentive to innovate
Why?Because there is little external pressure to
be efficient46
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Where is CS and PS for a monopoly?
47
Monopolies vs. Perfect Competition
Q
P
D
S = MC
MR
Pm
Qm
CS
PS
Total surplus falls. Now there is
DEADWEIGHT LOSS
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Regulating Monopolies
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How do they regulate?•Use Price controls: Price Ceilings•Why don’t taxes work?
•Taxes limit supply and that’s the problem
Why Regulate?Why would the government regulate
an monopoly? 1. To keep prices low 2. To make monopolies efficient
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1.Socially Optimal PriceP = MC (Allocative Efficiency)
Where should the government place the price ceiling?
2. Fair-Return Price (Break–Even)P = ATC (Normal Profit)
OR
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D
MR
MC
ATC
51Q
P
Regulating MonopoliesWhere does the firm produce if it is
unregulated?
Pm
Qm
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D
MR
MC
ATC
52Q
P
Regulating MonopoliesPrice Ceiling at Socially Optimal
Pm
Qm
Pso
Qso
Socially Optimal = Allocative Efficiency
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D
MR
MC
ATC
53Q
P
Regulating MonopoliesPrice Ceiling at Fair Return
Pm
Qm
Pso
Qso
Fair Return means no economic profit
Pfr
Qfr
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D
MR
MC
ATC
54Q
P
Regulating Monopolies
Pm
Qm
Pso
Qso
Unregulated
Pfr
Qfr
Socially Optimal
Fair Return
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QDMR
MCATC
P
Regulating a Natural Monopoly
55Qsocially optimal
What happens if the government sets a price ceiling to get the socially optimal quantity?
The firm would make a loss and would require a
subsidy
Pso
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Price Discrimination
56
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Price DiscriminationDefinition:Practice of selling the same products to different buyers at different prices
•Airline Tickets (vacation vs. business)•Movie Theaters (child vs. adult) •All Coupons (spenders vs. savers) •SPHS football games (students vs. parents)
Examples:
57
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PRICE DISCRIMINATION•Price discrimination 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
Requires the following conditions:1. Must have monopoly power2. Must be able to segregate the market 3. Consumers must NOT be able to resell
product58
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P Qd TR MR$11 0 0 -
59
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$10
P Qd TR MR$11 0 0 -$10 1 10 10
Results of Price Discrimination
60
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$10
P Qd TR MR$11 0 0 -$10 1 10 10$9 2 19 9
$10 $9
Results of Price Discrimination
61
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$10
P Qd TR MR$11 0 0 -$10 1 10 10$9 2 19 9$8 3 27 8$10 $9
$10 $9 $8
Results of Price Discrimination
62
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$10
P Qd TR MR$11 0 0 -$10 1 10 10$9 2 19 9$8 3 27 8$7 4 34 7
$10 $9
$10 $9 $8
$10 $9 $8 $7
Results of Price Discrimination
63
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$10
P Qd TR MR$11 0 0 -$10 1 10 10$9 2 19 $9$8 3 27 $8$7 4 34 $7$6 5 40 $6$5 6 45 $5$4 7 49 $4
Results of Price Discrimination
$10 $9
$10 $9 $8
$10 $9 $8
$10 $9 $8 $7
$7
$6
$5$10 $9 $8 $7 $6
$10 $9 $8 $7 $6 $5 $464
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$10
P Qd TR MR$11 0 0 -$10 1 10 10$9 2 19 $9$8 3 27 $8$7 4 34 $7$6 5 40 $6$5 6 45 $5$4 7 49 $4
$10 $9
$10 $9 $8
$10 $9 $8
$10 $9 $8 $7
$7
$6
$5$10 $9 $8 $7 $6
$10 $9 $8 $7 $6 $5 $4
WHEN PRICE DISCIMINATING
MR = D
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Regular Monopoly vs. Price Discriminating Monopoly
66
D
MR
MC
ATC
Q
P
Pm
Qm
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A perfectly discriminating can charge each person differently so the Marginal Revenue = Demand
67
D
MR
MC
ATC
Q
P
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68
D=MR
MC
ATC
Q
P
Qnm
Identify the Price, Profit, CS, and DWL
A perfectly discriminating can charge each person differently so the Marginal Revenue = Demand
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69
D=MR
MC
ATC
Q
P
Qnm
Identify the Price, Profit, CS, and DWL
A perfectly discriminating can charge each person differently so the Marginal Revenue = Demand
Price Discrimination results in several prices, more profit, no CS, and a higher
socially optimal quantity
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Monopolistic Competition
70
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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)
71
PerfectCompetition
PureMonopoly
MonopolisticCompetition Oligopoly
PureMonopoly
MonopolisticCompetition Oligopoly
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Monopolistic Qualities• Control over price of own good due
to differentiated product• D greater than MR • Plenty of Advertising• Not efficient
“Monopoly” + ”Competition”
Perfect Competition Qualities• Large number of smaller firms• Relatively easy entry and exit• Zero Economic Profit in Long-Run
since firms can enter72
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• 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. Examples of NON-PRICE Competition
• Brand Names and Packaging• Product Attributes • Service• Location• Advertising (Two Goals)
1. Increase Demand2. Make demand more INELASTIC 73
Differentiated Products
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Drawing Monopolistic Competition
74
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D
MR
MC ATC
75Q
Monopolistic Competition is made up of prices makers so MR is less than Demand
In the short-run, it is the same graph as a monopoly making profit
In the long-run, new firms will enter, driving down the DEMAND for firms
already in the market.
P
Q1
P1
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D
MR
MC
76Q
P
Firms enter so demand falls until there is no economic profit
ATC
Q1
P1
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D
MR
MC
77Q
P
Firms enter so demand falls until there is no economic profit
ATC
QLR
PLR
Price and quantity falls and TR=TC
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D
MR
MC
78Q
P
LONG-RUN EQUILIBRIUM
ATC
QLR
PLR
Quantity where MR =MC up to Price = ATC
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Why does DEMAND shift?When short-run profits are made…
– New firms enter.– New firms mean more close substitutes and
less market shares for each existing firm.– Demand for each firm falls.
When short-run losses are made…– Firms exit. – Result is less substitutes and more market
shares for remaining firms.– Demand for each firm rises.
79
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D
MR
MCATC
80Q
What happens when there is a loss?
In the long-run, firms will leave, driving up the DEMAND for firms already in the
market.
P
Q1
P1
In the short-run, the graph is the same as a monopoly making a loss
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D
MR
MCATC
81Q
Firms leave so demand increases until there is no economic profit
P
Q1
P1
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D
MR
MCATC
82Q
Firms leave so demand increases until there is no economic profit
P
QLR
PLR
Price and quantity increase and TR=TC
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Are Monopolistically Competitive Firms
Efficient?
83
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D
MR
MC
84Q
P
LONG-RUN EQUILIBRIUM
ATC
QLR
PLR
Not Allocatively Efficient because P ≠ MC Not Productively Efficient because not producing
at Minimum ATC
QSocially Optimal
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D
MR
MC
85Q
P
LONG-RUN EQUILIBRIUM
ATC
QLR
PLR
This firm also has EXCESS CAPACITY
QSocially Optimal
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• Given current resources, the firm can produce at the lowest costs (minimum ATC) but they decide not to.
• The gap between the minimum ATC output and the profit maximizing output.
• Not the amount underproduced86
Excess Capacity
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D
MR
MC
87Q
P
LONG-RUN EQUILIBRIUM
ATC
QLR
PLR
The firm can produce at a lower cost but it holds back production to maximize profit
QProd Efficient
Excess Capacity
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Practice Question
88
Assume there is a monopolistically competitive firm in long-run equilibrium. If this firm were to realize productive efficiency, it would: A) have more economic profit. B) have a loss.
C) also achieve allocative efficiency.D) be under producing. E) be in long-run equilibrium.
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• Large number of firms and product variation meets societies needs.
• Nonprice Competition (product differentiation and advertising) may result in sustained profits for some firms.
Ex: Nike might continue to make above normal profit because they are a well known brand.
Advantages ofMONOPOLISTIC COMPETITION
89
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Oligopoly
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FOUR MARKET MODELS
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
•Firms use Strategic PricingExamples: OPEC, Cereal Companies,
Car Producers
PerfectCompetition
PureMonopoly
MonopolisticCompetition Oligopoly
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Oligopolies occur when only a few large firms start to control an industry.
High barriers to entry keep others from entering.
Types of Barriers to Entry1. Economies of Scale
•Ex: The car industry is difficult to enter because only large firms can make cars at the lowest cost
2. High Start-up Costs3. Ownership of Raw Materials
HOW DO OLIGOPOLIES OCCUR?
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Game Theory
An understanding of game theory helps firms in an oligopoly maximize profit.
The study of how people behave in strategic situations
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Game theory helps predict human behavior
THE ICE CREAM MAN SIMULATION1. You are a ice cream salesmen at the beach2. You have identical prices as another salesmen.3. Beachgoers will purchase from the closest
salesmen4. People are evenly distributed along the beach.5. Each morning the two firms pick locations on
the beach
Where is the best location?
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Why learn about game theory?•Oligopolies are interdependent since they compete with only a few other firms.• Their pricing and output decisions must be strategic as to avoid economic losses. •Game theory helps us analyze their strategies.
SIMULATION!
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Game Theory MatrixYou and your partner are competing firms. You
have one of two choices: Price High or Price Low.
Firm 2
Firm 1
Both High = $20 Each
Both Low= $10 each
High Low
High
LowHigh = 0
Low = $30
Low = $30High = 0
Without talking, write down your choice
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Game Theory Matrix
Notice that you have an incentive to collude but also an incentive to cheat on your agreement
Firm 2
Firm 1
Both High = $20 Each
Both Low= $10 each
High Low
High
LowHigh = 0
Low = $30
Low = $30High = 0
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Dominant StrategyThe Dominant Strategy is the best move to make
regardless of what your opponent doesWhat is each firm’s dominate strategy?
Firm 2
Firm 1
$100, $50
High Low
High
Low
$50, $90
$80, $40 $20, $10
No Dominant Strategy
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Video: Split or Steal
Firm 2
Firm 1
Half, Half
Split Steal
Split
Steal
None, All
All, None None, None
What is each player’s dominate strategy?
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What did we learn?1. Oligopolies must use strategic
pricing (they have to worry about the other guy)
2. Oligopolies have a tendency to collude to gain profit.(Collusion is the act of cooperating with
rivals in order to “rig” a situation)3. Collusion results in the incentive to
cheat.4. Firms make informed decisions
based on their dominant strategies
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2007 FRQ #3Payoff matrix for two competing bus companies
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2009 FRQB #3Payoff matrix for two competing bus companies
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Oligopoly Graphs
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Because firms are interdependentThere are 3 types of Oligopolies1. Price Leadership (no graph)2. Colluding Oligopoly3. Non Colluding Oligopoly
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#1. Price Leadership
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Example: Small Town Gas StationsTo maximize profit what will they do?
OPEC does this with OIL
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PRICE LEADERSHIP MODEL
•Collusion is ILLEGAL.•Firms CANNOT set prices.•Price leadership is a strategy used by firms to coordinate prices without outright collusionGeneral Process: 1. “Dominant firm” initiates a price change2. Other firms follow the leader
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PRICE LEADERSHIP MODELBreakdowns in Price Leadership
• Temporary Price Wars may occur if other firms don’t follow price increases of dominant firm.
• Each firm tries to undercut each other.
Example: Employee Pricing for Ford
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#2. Colluding Oligopolies
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A cartel is a group of producers that create an agreement to fix prices high.
1. Cartels set price and output at an agreed upon level
2. Firms require identical or highly similar demand and costs
3. Cartel must have a way to punish cheaters
4. Together they act as a monopoly
Cartel = Colluding Oligopoly
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Firms in a colluding oligopoly act as a monopoly and share the profit
D
MC ATC
Q
P
MR
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#3. Non-Colluding
Oligopolies
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1. Match price-If one firm cuts it’s prices, then the other firms follow suit causing inelastic demand
2. Ignore change-If one firm raises prices, others maintain same price causing elastic demand
Kinked Demand Curve Model
If firms are NOT colluding they are likely to react to competitor’s pricing in two ways:
The kinked demand curve model shows how noncollusive firms are interdependent
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DQ
If this firm increases it’s price, other firms will ignore it and keep prices the same
P
Pe
Qe
As the only firm with high prices, Qd for this firm will decrease a lot
P1
Q1
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DQ
If this firm decreases it’s price, other firms will match it and lower their prices
P
Pe
Qe
Since all firms have lower prices, Qd for this firm will increase only a little
P2
Q2
P1
Q1
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DQ
Where is Marginal Revenue?
P
Pe
Q
MR has a vertical gap at the kink. The result is that MC can move and Qe won’t change. Price is sticky.
MC
MR
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Market Structures Venn Diagram
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Perfect Competition Monopolistic Competition
Oligopoly Monopoly
No Similarities
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Name the market structure(s) that it is associated with each concept1. Price Maker (Demand > MR)2. Collusion/Cartels3. Identical Products4. Price Taker (Demand = MR)5. Excess Capacity6. Low Barriers to Entry7. Game Theory8. Differentiated Products9. Long-run Profits 10.Efficiency11.Normal Profit12.Dead Weight Loss13.High Barriers to Entry14.Firm = Industry15. MR=MC Rule
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Perfect Competition Monopolistic Competition
Oligopoly Monopoly
No Similarities
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•Identical Products•No advantage•D=MR=AR=P•Both efficiencies•Price‐Taker•1000s
Perfect Competition Monopolistic Competition
Oligopoly Monopoly
No Similarities
•MR = MC•Shut‐Down Point•Cost Curves•Motivation for Profit
•Excess Advertising•Differentiated Products•Excess Capacity• More Elastic Demand than
Monopoly•100s
•Low barriers to entry•No Long‐Run Profit•Price = ATC
•Price Maker (D>MR)•Some Non‐Price Competition
•Inefficient
•Collusion•Strategic Pricing (Interdependence)•Game Theory•10 or less
•Unique Good•Price Discrimination•1
•Price Maker (D>MR)•High Barriers•Ability to Make LR Profit•Inefficient