6. Rivalry exists in oligopolistic industries due to mutual interdependence. Modeling this rivalry is verydifficult; industries tend to develop their own standards of behavior depending on the particular nature of theproduction and distribution process and on the demand for the product itself. Game theory is a method of analysis that is used in situations involving two or more decision makers who have conflicting objectives.
can help us to understand and even to predict, in some cases, the behavior of rivals in an industry.7. Price discrimination is a technique used by firms with monopoly power to extract additional consumer surplus. Price discrimination schemes occur when firms charge different consumers different prices for thesame product. Firms want to charge higher prices to consumers whose demand is more inelastic.
B. Innovation and Information
l. In large firms, ownership is often divorced from control. This means that the owners of the firm have givendecision-making authority over to a group of managers, who may or may not be operating in the best interest of the owners. Managers might be more interested in increasing their own salaries or improving their ownworking conditions than maximizing profits. Managers have less incentive to pay dividends; often it is in their own best interest to plow retained earnings back into the firm rather than to distribute them to owners.2. Because of the difficulty in assessing actual market demand and cost structures a priori, firms approximatethe profit-maximizing strategies that we have developed in theory by using
rules of thumb
. For example,
rules are strategies that set price at a percentage over estimated average production costs. Thismay land us exactly on the demand curve; the rules can be adjusted with experience to converge toward profit-maximizing pricing behavior in a world where managers do not operate with perfect information or certainty.3. The Schumpeterian hypothesis suggests that large firms support valuable research and development thatwould not otherwise be forthcoming. However, in recent years small businesses have forged ahead, increasingtheir share of R&D advances. The real issue involves incentives for firms to innovate and to take risks. If firmsbelieve that they will be unable to appropriate a significant portion of the benefits to R&D, they will beunwilling to make sufficient investments. Because information is costly to produce but cheap to reproduce,markets in information are subject to severe market failure. For example, markets for “bootlegged” computer programs exist in most countries around the world, making it more difficult for firms to justify largeinvestments in new software.
C. The Balance Sheet on Imperfect Competition
l. Imperfect competitors generally produce too little and charge prices in excess of marginal cost. Thewelfare cost of their approach can be measured in terms of diminished consumer surplus—the
lossthat results from their exploiting whatever market power is available. The notion that big business exploitsconsumers is pervasive and so governments and policy-makers in the United States are encouraged to supportcompetitive behavior.2. Intervention strategies are used by governments as they attempt to preserve competitive markets. Theseinclude antitrust laws, regulation, government ownership or nationalization, price controls, and taxation.Regardless of their form, these actions all indicate a desire on the part of governments to encourage theefficiencies brought about by competition.
V. HELPFUL HINTS
l. As you learned in Chapter 9, entry barriers are important to the emergence of imperfect competition.However, notice that these barriers evolve over time. For example, IBM had a near monopoly in the market for computers throughout the 1960s and 1970s. Their economic profits encouraged entry by competitors; “BigBlue” was able to hold them at bay for years due to the fact that it was heavily invested in research anddevelopment. This led to large numbers of patents on new products. However, with the emergence of thepersonal computer around 1980, rivals burst into the market with a passion. Economic profits were soon erodedby fierce competition among firms in the industry, and IBM now sees itself fighting for market share.2. Oligopoly behavior is very difficult to model, posing great challenges for economists. In oligopolisticindustries, firms must explicitly recognize and react to their competitors. This mutual interdependence is one of the factors that makes modeling difficult. If you think about big industries in the U.S. economy, you canimagine why. Domestic airlines have a system of pricing that is mystifying to even the most knowledgeabletravelers, auto producers use a complex and ever-changing system of rebates and financing incentives, andproducers of breakfast cereals have an endless variety of products on the grocery store shelves. All of theseindustries are dominated by domestic oligopolies, requiring that firms be aware of the responses of competitorsto changes in prices and output. Because of this mutual interdependence, economists have a wide class of models from which they can pick and choose when describing oligopoly behavior. There is no single modelthat can accurately generalize the actions and reactions of rivals.