IMPERFECT COMPETITION

Revision Notes

1. An industry has imperfect competition when one or more firms have some
degree of market power.
2. The firms are no longer price takers, like in a perfectly competitive market,
they can now influence the prices in the market.
3. Imperfectly competitive markets may have a single seller in control of the in-
dustry (a monopoly), a few sellers sharing the market power (oligopoly) or
a large number of sellers having their own niche markets within the industry
(monopolistic competition).
4. Monopolies can be natural (when the industry can support only one firm) or
artificially created by some government regulation or protection (like a patent
or import restriction).
5. The demand curve for a monopolist is downward sloping and is the same as
the industry demand curve.
6. Marginal revenue (MR) is the change in revenue that is generated by an addi-
tional unit of sales.
7. A monopolist maximizes its profit by choosing the quantity at which the
marginal revenue equals the marginal cost. It should increase its output to
the point where the additional revenue from an additional unit of product
equals the additional cost of production.
8. The Marginal principle teaches us that sound economic decisions only look at
the marginal costs and revenues and ignore any past or sunk costs.
9. Imperfect competition can also look like a collusive oligopoly where there is a
tacit or explicit collusion among the firms to artificially fix prices or output.
10. When the firms in an industry engage in collusion, they essentially act as a
monopolist. They will produce the monopoly level of output and charge the
monopoly price to maximize profits.
11. A monopolistic competition involves a large number of firms in an industry
with ease of entry and exit. It differs from the perfectly competitive setting
because the firms sell differentiated goods.
12. The demand curve for each firm is downward sloping and each firm makes a
non-zero profit.

13. When a new firm enters such an industry, it reduces the profit of each existing
firm by some amount.

14. The ultimate outcome is that firms will continue to enter the market until all
economic profits have been beaten down to zero.

15. The long-run equilibrium for the industry is where the profits are zero and no
one is tempted to enter or forced to exit the industry.

16. A third kind of imperfect competition involves a few firms which engage in
strategic behaviour.

17. This happens when the number of firms in the industry is relatively small. It
forces firms to take into account its competitors’ reactions to price and output
decisions and brings strategic considerations into their actions.

18. Another way in which firms use their market power is by price discrimination.
They segment the customers based on their elasticity of demand. Then they
charge a higher price to those with a lower elasticity and expand into new
customer base by lowering prices for them.

19. Imperfect competition reduces efficiency by distorting the perfectly competitive

prices and quantities. This creates a deadweight loss.

20. A deadweight loss is a static loss, which assumes fixed technology. It ignores
the dynamic benefits of imperfect competition in the form of research and
development and innovation of new technology.

21. Governments design policies to counter the harmful effects of imperfect compe-
tition. These can be in the form of economic regulations like control of prices,
entry and exit conditions and standards of service; or in the form of antitrust
laws which attack practices that restrain competitive forces.

22. Antitrust laws grapple with real-life issues like defining the relevant market
and case by case judgements of practices like price discrimination and tying
contracts.