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Imperfect

Competition
Imperfect Competition

Monopolistic
Competition
MONOPOLISTIC COMPETITION

• Assumptions of monopolistic
competition
• Equilibrium of the firm
– short run
MR = MC
Short-run equilibrium of the firm
under monopolistic competition
£ MC

AC

Ps

ACs

AR = D

MR
O Qs Q
MONOPOLISTIC COMPETITION

• Assumptions of monopolistic
competition
• Equilibrium of the firm
– short run
MR = MC
– long run
MR = MC; AR = AC
Long-run equilibrium of the firm
under monopolistic competition
£

LRMC

LRAC

PL

ARL = DL

MRL
O QL Q
MONOPOLISTIC COMPETITION

• Assumptions of monopolistic
competition
• Equilibrium of the firm
– short run
MR = MC
– long run
MR = MC; AR = AC
– under-utilisation of capacity in long run
Under-utilisation of capacity in the long run
£

LRAC

DL under monopolistic
competition

O Q1 Q2 Q
MONOPOLISTIC COMPETITION

• Limitations of the model


– imperfect information
– difficulty in identifying industry demand
curve
– entry may not be totally free
– indivisibilities
– importance of non-price competition
• The public interest
– comparison with perfect competition
Long run equilibrium of the firm under perfect and
monopolistic competition
£

LRAC

P1

P2
DL under perfect
competition

DL under monopolistic
competition

O Q1 Q2 Q
MONOPOLISTIC COMPETITION

• Limitations of the model


– imperfect information
– difficulty in identifying industry demand
curve
– entry may not be totally free
– indivisibilities
– importance of non-price competition
• The public interest
– comparison with perfect competition
– comparison with monopoly
Imperfect Competition

Oligopoly
OLIGOPOLY

• Key features of oligopoly


– barriers to entry
– interdependence of firms
– incentives to compete versus incentives to
collude
• Factors favouring collusion
• Collusive oligopoly: cartels
– equilibrium of the industry
Profit-maximising cartel
£

Industry D = AR

O Q
Profit-maximising cartel
£

Industry MC

P1

Industry D = AR
Industry MR
O Q1 Q
OLIGOPOLY

• Key features of oligopoly


– barriers to entry
– interdependence of firms
– incentives to compete versus incentives to
collude
• Factors favouring collusion
• Collusive oligopoly: cartels
– equilibrium of the industry
– allocating and enforcing quotas
Oil Prices
$ per barrel
35 Actual price
Iraq invades OPEC’s first
Iran quotas
30 World-wide
Iraq invades slowdown
Kuwait
25 Revolution World-wide
in Iran recovery

20
First oil from
North Sea
15
New OPEC
Cease-fire in quotas
10 Iran-Iraq war Recession
in Far East
5 Yom Kippur
War: Arab oil
embargo
0
70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00
Oil Prices
$ per barrel
35 Actual price
Iraq invades OPEC’s first
Iran quotas Cost in 1973 prices
30 World-wide
Iraq invades slowdown
Kuwait
25 Revolution World-wide
in Iran recovery

20
First oil from
North Sea
15
New OPEC
Cease-fire in quotas
10 Iran-Iraq war Recession
in Far East
5 Yom Kippur
War: Arab oil
embargo
0
70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00
OLIGOPOLY

• Tacit collusion
– price leadership
• dominant firm
Dominant firm price leadership
£
Sall other firms

P1
a

Dmarket
Dleader
b
P2

O Q
Division of the market between leader and followers
Dominant firm price leadership
£
MCleader Sall other firms

l f t
PL
Dmarket

Dleader

MRleader

O QL QF QT Q
Determination of price and output
Price leader aiming to maximise profits for a given market share
£
Assume constant
market share
for leader

AR = D market

AR = D leader

MR leader
O Q
Price leader aiming to maximise profits for a given market share
£

MC

l t
PL
AR = D market

AR = D leader

MR leader
O QL QT Q
OLIGOPOLY

• Tacit collusion
– price leadership
• dominant firm

• barometric
OLIGOPOLY

• Tacit collusion
– price leadership
• dominant firm

• barometric

– rules of thumb
OLIGOPOLY

• Tacit collusion
– price leadership
• dominant firm

• barometric

– rules of thumb

• Collusion and the law


OLIGOPOLY

• Tacit collusion
– price leadership
• dominant firm

• barometric

– rules of thumb

• Collusion and the law

• The breakdown of collusion


The incentive for a firm to produce more than its quota,
or undercut the cartel’s price
£
MC

£10 is the cartel’s


12
profit-maximising price
10

4 AR

2
MR
0
1000 2000 3000 Q
The Industry
The incentive for a firm to produce more than its quota,
or undercut the cartel’s price
£

Firm is tempted MC
to increase
12 output to 600

10 Cartel Price
(= MR if price remains fixed)
8

4 AR

2
MR
0
200 400 600 800 Q
Firm A
OLIGOPOLY

• Non-collusive oligopoly: game theory


– alternative strategies: maximax and
maximin
Profits for firms A and B at different prices

X’s price
£2.00 £1.80

A B
£2.00 £10m each £5m for Y
£12m for X
Y’s price
C D
£1.80 £12m for Y £8m each
£5m for X
OLIGOPOLY

• Non-collusive oligopoly: game theory


– alternative strategies: maximax and
maximin
– simple dominant strategy games
Profits for firms A and B at different prices

X’s price
£2.00 £1.80

A B
£2.00 £10m each £5m for Y
£12m for X
Y’s price
C D
£1.80 £12m for Y £8m each
£5m for X
OLIGOPOLY

• Non-collusive oligopoly: game theory


– alternative strategies: maximax and
maximin
– simple dominant strategy games
• the prisoners’ dilemma
The prisoners' dilemma

Amanda's alternatives
Not confess Confess

Not
A B Nigel gets
Each gets 10 years
confess Amanda gets
1 year
Nigel's 3 months
alternatives C Nigel gets D
3 months Each gets
Confess 3 years
Amanda gets
10 years
OLIGOPOLY

• Non-collusive oligopoly: game theory


– alternative strategies: maximax and
maximin
– simple dominant strategy games
• the prisoners’ dilemma
– more complex non-dominant strategy
games
Profit possibilities for firm X
Profit possibilities for firm X
Profit possibilities for firm X
Profit possibilities for firm X
OLIGOPOLY

• Non-collusive oligopoly: game theory


– alternative strategies: maximax and
maximin
– simple dominant strategy games
• the prisoners’ dilemma
– more complex non-dominant strategy
games
– Importance of threats and promises
OLIGOPOLY

• Non-collusive oligopoly: game theory


– alternative strategies: maximax and
maximin
– simple dominant strategy games
• the prisoners’ dilemma
– more complex non-dominant strategy
games
– Importance of threats and promises
– Importance of timing
OLIGOPOLY

• Non-collusive oligopoly: game theory


– alternative strategies: maximax and
maximin
– simple dominant strategy games
• the prisoners’ dilemma
– more complex non-dominant strategy
games
– Importance of threats and promises
– Importance of timing
• decision trees
A decision tree

r Boeing –£10m
(1)
ate Airbus –£10m
Airbus 00 se
5
decides
B1 400
sea
r ter Boeing +£30m (2)
a te
se

Airbus +£50m
0
50

Boeing
decides A 40
0s Boeing +£50m
ea ate
r (3)
te s e Airbus +£30m
r 5 0 0

B2 400
sea
Airbus ter
decides Boeing –£10m
Airbus –£10m
(4)
OLIGOPOLY

• Non-collusive oligopoly: the kinked


demand curve theory
– assumptions of the model

– the shape of the demand and MR curves


Kinked demand for a firm under oligopoly
£

Current price
and quantity
give one point
on demand curve
P1

O Q1 Q
Kinked demand for a firm under oligopoly
£

D
P1

D
O Q1 Q
Kinked demand for a firm under oligopoly
£

P1

a
D = AR
b

O Q1 Q
MR
OLIGOPOLY

• Non-collusive oligopoly: the kinked


demand curve theory
– assumptions of the model

– the shape of the demand and MR curves

– stable prices
Stable price under conditions of a kinked demand curve
£

MC2

P1 MC1

a
D = AR
b

O Q1 Q
MR
OLIGOPOLY

• Non-collusive oligopoly: the kinked


demand curve theory
– assumptions of the model

– the shape of the demand and MR curves

– stable prices

– limitations of the model


OLIGOPOLY

• Oligopoly and the public interest


– advantages

– disadvantages

– difficulties in drawing general conclusions

• Advertising and the public interest

• Oligopoly and contestable markets


Imperfect Competition

Price Discrimination
PRICE DISCRIMINATION

• Meaning of price discrimination


• Types of price discrimination
– first degree
First-degree price discrimination
P

P1

O 200 Q
First-degree price discrimination
P

P1

O 200 Q
PRICE DISCRIMINATION

• Meaning of price discrimination


• Types of price discrimination
– first degree
– second degree
PRICE DISCRIMINATION

• Meaning of price discrimination


• Types of price discrimination
– first degree
– second degree
– third degree
Third-degree price discrimination
P

P1

O 200 Q
Third-degree price discrimination
P

P2

P1

O 150 200 Q
PRICE DISCRIMINATION

• Meaning of price discrimination


• Types of price discrimination
– first degree
– second degree
– third degree

• Conditions necessary for price


discrimination to operate
PRICE DISCRIMINATION

• Profit-maximising prices and output


under price discrimination
– first degree
Profit maximising under first-degree price discrimination
£ MC

D = MR

O Q1 Q
PRICE DISCRIMINATION

• Profit-maximising prices and output


under price discrimination
– first degree
– third degree
Profit-maximising output under
third degree price discrimination

DX
O O O
MRX

(a) Market X
Profit-maximising output under
third degree price discrimination

DY
DX MRY
O O O
MRX

(a) Market X (b) Market Y


Profit-maximising output under
third degree price discrimination

DY
DX MRY MRT
O O O
MRX

(a) Market X (b) Market Y (c) Total


(markets X + Y)
Profit-maximising output under
third degree price discrimination

MC

DY
DX MRY MRT
O O O
MRX

(a) Market X (b) Market Y (c) Total


(markets X + Y)
Profit-maximising output under
third degree price discrimination

MC

DY
DX MRY MRT
O O O 3000
MRX

(a) Market X (b) Market Y (c) Total


(markets X + Y)
Profit-maximising output under
third degree price discrimination

MC

5
DY
DX MRY MRT
O O O 3000
MRX

(a) Market X (b) Market Y (c) Total


(markets X + Y)
Profit-maximising output under
third degree price discrimination

MC

5
DY
DX MRY MRT
O 1000 O O 3000
MRX

(a) Market X (b) Market Y (c) Total


(markets X + Y)
Profit-maximising output under
third degree price discrimination

MC

5
DY
DX MRY MRT
O 1000 O 2000 O 3000
MRX

(a) Market X (b) Market Y (c) Total


(markets X + Y)
Profit-maximising output under
third degree price discrimination

MC

5
DY
DX MRY MRT
O 1000 O 2000 O 3000
MRX

(a) Market X (b) Market Y (c) Total


(markets X + Y)
Profit-maximising output under
third degree price discrimination

MC

9
7
5
DY
DX MRY MRT
O 1000 O 2000 O 3000
MRX

(a) Market X (b) Market Y (c) Total


(markets X + Y)
PRICE DISCRIMINATION

• Profit-maximising prices and output


under price discrimination
– first degree
– third degree
• Advantages to the firm
PRICE DISCRIMINATION

• Profit-maximising prices and output


under price discrimination
– first degree
– third degree
• Advantages to the firm
• Price discrimination and the public
interest
– advantages
PRICE DISCRIMINATION

• Profit-maximising prices and output


under price discrimination
– first degree
– third degree
• Advantages to the firm
• Price discrimination and the public
interest
– advantages
– disadvantages

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