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Imperfect Competition Chapter 9

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Imperfect Competition Chapter 9 LIPSEY & CHRYSTAL ECONOMICS 12e Learning Outcomes Concentration of production varies between industries, but firms in all intermediate ... – PowerPoint PPT presentation

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Title: Imperfect Competition Chapter 9


1
Imperfect CompetitionChapter 9
  • LIPSEY CHRYSTAL
  • ECONOMICS 12e

2
Learning Outcomes
  • Concentration of production varies between
    industries, but firms in all intermediate
    industry types have some power to influence
    price.
  • In industries where there are many producers but
    of different products, free entry will tend to
    eliminate profits in the long run.

3
Learning Outcomes
  • Where there is a small group of dominant
    producers (oligopoly), strategic interaction is
    important because the market form of one is
    affected by what its rivals do.
  • Insights into the choices available and the
    nature of outcomes can be achieved using game
    theory.
  • Oligopoly can be associated with pure profits in
    the long run if there are barriers to entry.

4
INTRODUCTION - IMPERFECT COMPETITION
  • Imperfectly Competitive Market Structures
  • Firms in market structures other than perfect
    competition face negatively sloped demand curves
    and must administer their prices.

5
INTRODUCTION - IMPERFECT COMPETITION
  • Monopolistic Competition
  • In the theory of large-group monopolistic
    competition, many firms compete to sell
    differentiated products.
  • Each may make pure profits in the short run. In
    the long run, freedom of entry shifts its demand
    curve until it is tangent to the ATC curve,
    leading to excess capacity and production at
    average costs above the minimum possible level.

6
INTRODUCTION - IMPERFECT COMPETITION
  • Oligopoly
  • Competitive behaviour among oligopolists may lead
    to a non-cooperative equilibrium.
  • It is self-policing in the sense that no one has
    an incentive to depart from it unilaterally.
  • The prisoners dilemma game is a case in point.

7
INTRODUCTION - IMPERFECT COMPETITION
  • Oligopoly
  • Oligopolistic profits can persist only if there
    are entry barriers.
  • Natural barriers include economies of large-scale
    production and large fixed costs of entering the
    market.
  • Artificial barriers include brand proliferation
    and high levels of advertising.

8
INTRODUCTION - IMPERFECT COMPETITION
  • Oligopoly as a Game
  • Small-group interaction can be analysed using a
    game theory framework, which sets out the
    available actions and the payoffs under various
    actions.
  • In a Nash equilibrium each firm is doing the best
    it can, given the choices that other firms have
    made.
  • A co-operative solution is likely to be the one
    that maximizes joint profits, but each firm will
    typically have an incentive to cheat, and
    explicit co-operation between firms may be
    proscribed by competition law.

9
INTRODUCTION - IMPERFECT COMPETITION
  • Dynamics of Oligopoly Industries
  • In qualitative terms the workings of the
    allocative system under oligopoly are similar
    but not identical to what they are under
    perfect competition.
  • Oligopolistic industries appear to have
    contributed much more to the technological
    changes that underlie the long-run growth of
    productivity than have perfectly competitive
    industries.

10
i Equilibrium of a Typical Firm in Monopolistic
Competition
MC
per unit
ATC
Es
ps
D
MR
qs
Output
I. Short-run equilibrium
11
(i) Short run equilibrium for a firm in
monopolistic competition
  • A typical monopolistically competitive firm is
    shown in short-run equilibrium is at point ES.
  • Output is qs, where MC MR, price is ps.
  • Profits are the blue area.

12
ii Equilibrium of a Typical Firm in
Monopolistic Competition
MC
per unit
ATC
EL
pL
pc
D
MR
qL
qc
Output
ii. Long-run equilibrium
13
(ii) Long run equilibrium of a firm in
monopolistic competition
  • Here the firm is in long-run equilibrium at point
    EL.
  • Entry of new firms has pushed the existing firms
    demand curve to the left until the curve is
    tangent to the firms ATC curve at output qL.
  • Price is pL, and total costs are just being
    covered. Excess capacity is qC-qL.
  • If the firm did produce at capacity, its costs
    would fall from pL per unit of output to pC.

14
The Oligopolists Dilemma to Co-operate or to
Compete
As output
One-half monopoly output
Two-thirds monopoly output
One-half monopoly output
20
20
15
22
Bs output
Two-thirds monopoly output
17
22
15
17
15
The Oligopolists Dilemma to Co-operate or to
Compete
  • The figure gives a payoff matrix for a two-firm
    duopoly game.
  • As production is indicated across the top. Its
    profits (in millions of pounds) are shown in the
    yellow circles within each square.
  • Bs production is indicated down the left side.
  • Its profits (in millions of pounds) are shown in
    the green circles within each square.
  • For example, the top right square tells us that
    if B produces one-half, while A produces
    two-thirds, of the output that a monopolist would
    produce
  • As profits will be 22 million
  • while Bs will be 15 million

16
The Oligopolists Dilemma to Cooperate or to
Compete
  • If A and B co-operate, each produces one-half the
    monopoly output, and earns profits of 20 million
    as shown in the upper left box.
  • In this co-operative solution, either firm can
    raise its profits by producing two-thirds of the
    monopoly output, provided that the other firm
    does not do the same.
  • Now let A and B behave non-cooperatively.
  • A reasons that whether B produces either one-half
    or two-thirds of the monopoly output, As best
    output is two-thirds.
  • B reasons similarly.
  • As a result, they reach the non-cooperative
    equilibrium.
  • Here each produces two-thirds of the monopoly
    output, and each makes less than it would if the
    two firms co-operated.

17
The Prisoners Dilemma
Johns plea
Innocent
Guilty
J no sentence W severe sentence
J light sentence W light sentence
Innocent
Williams plea
J severe sentence W no sentence
J medium sentence W medium sentence
Guilty
18
The Prisoners Dilemma
  • Two prisoners are interrogated separately.
  • They are told
  • if they both plead innocent, they will get a
    light sentence.
  • If one pleads innocent while the other pleads
    guilty, the one who claims innocence will get a
    heavy sentence while the other will be let off.
  • If both plead guilty, they will both get a medium
    sentence.
  • The pay off matrix shows these conditions.

19
The Prisoners Dilemma
  • Both prisoners reason as follows
  • (1) if the other pleads innocent I am better off
    to plead guilty and get off.
  • (2) if the other pleads guilty I am better off to
    plead guilty and get only a medium sentence.
  • So the optimal non-cooperative strategy for both
    is to plead guilty
  • This gives them a medium sentence rather than the
    light sentence that they would get if they were
    allowed to consult and agree that both would
    plead innocent.
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