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

$ per barrel 35 30 25 20 15 10 5 0

Oil Prices
OPEC’s first quotas Iraq invades Kuwait

Iraq invades Iran

Actual price
World-wide slowdown World-wide recovery

Revolution in Iran

First oil from North Sea New OPEC quotas Recession in Far East

Cease-fire in Iran-Iraq war Yom Kippur War: Arab oil embargo

70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00

$ per barrel 35 30 25 20 15 10 5 0

Oil Prices
Actual price
OPEC’s first quotas Iraq invades Kuwait

Iraq invades Iran

Cost in 1973 prices
World-wide slowdown World-wide recovery

Revolution in Iran

First oil from North Sea New OPEC quotas Recession in Far East

Cease-fire in Iran-Iraq war Yom Kippur War: Arab oil embargo

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 b

Dleader
P2

O

Q

Division of the market between leader and followers

Dominant firm price leadership
£

MCleader

Sall other firms

PL

l

f

t 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

PL

l

t
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

12 10 8 6 4 2
0

£10 is the cartel’s profit-maximising price

AR MR
1000 2000 3000 Q

The Industry

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

12 10 8 6 4 2
0

Firm is tempted to increase output to 600

MC

Cartel Price
(= MR if price remains fixed)

AR MR
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
£2.00 £10m each

B
£5m for Y £12m for X

Y’s price
£1.80

C
£12m for Y £5m for X

D
£8m each

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
£2.00 £10m each

B
£5m for Y £12m for X

Y’s price
£1.80

C
£12m for Y £5m for X

D
£8m each

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 Not confess Confess

A
Each gets 1 year

B

Nigel's alternatives C Nigel gets
Confess
3 months Amanda gets 10 years

Nigel gets 10 years Amanda gets 3 months Each gets 3 years

D

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 ate

Airbus 00 se 5 decides
te r

Boeing –£10m (1) Airbus –£10m

B1

400

sea

Boeing decides A

50 0

40

se a

ter

Boeing +£30m (2) Airbus +£50m

0s

ea

te

r

s 00 5

e

r ate

Boeing +£50m (3) Airbus +£30m

B2

Airbus decides

400

sea

ter

Boeing –£10m (4) Airbus –£10m

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
£

P1

Current price and quantity give one point on demand curve

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 b
O Q1

D = AR
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 b
O Q1

D = AR
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

D
Q

O

200

First-degree price discrimination
P

P1

D
Q

O

200

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

D
Q

O

200

Third-degree price discrimination
P

P2 P1

D
Q

O

150

200

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 MRX O O

(a) Market X

Profit-maximising output under third degree price discrimination

DY DX O MRX O MRY O

(a) Market X

(b) Market Y

Profit-maximising output under third degree price discrimination

DY DX O MRX O MRY O MRT

(a) Market X

(b) Market Y

(c) Total (markets X + Y)

Profit-maximising output under third degree price discrimination
MC

DY DX O MRX O MRY O MRT

(a) Market X

(b) Market Y

(c) Total (markets X + Y)

Profit-maximising output under third degree price discrimination
MC

DY DX O MRX O MRY O 3000 MRT

(a) Market X

(b) Market Y

(c) Total (markets X + Y)

Profit-maximising output under third degree price discrimination
MC

5 DX O MRX O

DY MRY O 3000 MRT

(a) Market X

(b) Market Y

(c) Total (markets X + Y)

Profit-maximising output under third degree price discrimination
MC

5 DX O 1000 O MRX

DY MRY O 3000 MRT

(a) Market X

(b) Market Y

(c) Total (markets X + Y)

Profit-maximising output under third degree price discrimination
MC

5 DX O 1000 O MRX 2000

DY MRY O 3000 MRT

(a) Market X

(b) Market Y

(c) Total (markets X + Y)

Profit-maximising output under third degree price discrimination
MC 9 5 DX O 1000 O MRX 2000 DY MRY O 3000 MRT

(a) Market X

(b) Market Y

(c) Total (markets X + Y)

Profit-maximising output under third degree price discrimination
MC 9 5 DX O 1000 O MRX 2000

7 DY MRY O 3000 MRT

(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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