Imperfect competition.pptx

Imperfect competition is an economic concept used to describe marketplace conditions that render a market less than perfectly competitive, creating market inefficiencies that result in losses of economic value.

In the real world, markets are nearly always in a condition of imperfect competition to some extent. However, the term is typically only used to describe markets where the level of competition among sellers is substantially below ideal conditions.A situation of imperfect competition exists whenever one of the fundamental characteristics of perfect competition is missing. When there is perfect competition in a market, prices are controlled primarily by the ordinary economic factors of supply and demand.

Notably, the stock market may be viewed as a continually imperfect market because not all investors have ready access to the same level of information regarding potential investments.

Imperfect competition commonly exists when a market structure is in the form of monopolies, duopolies, oligopolies, or monopsony (very rare)
Market structures that effectively render competition imperfect are most often characterized by a lack of competitive suppliers. Imperfect competition often exists as a result of extremely high barriers to entry for new suppliers. For example, the airline industry has high barriers to entry due to the extremely high cost of aircraft.

The most extreme condition of imperfect competition exists when the market for a particular good or service is a monopoly, one in which there is a sole supplier. A supplier that has a monopoly on the provision of a good or service essentially has complete control over prices.

Because it has no competition from other suppliers, the sole supplier can essentially set the price of its goods or services at any level it desires. Monopolies often charge prices that provide them with significantly higher profit margins than most companies operate with.

A duopoly is a market structure in which there are only two suppliers. Although duopolies are somewhat more competitive than monopolies, the level of competition is still far from perfect, as the two suppliers still have significant control of marketplace prices.

An example of a duopoly exists in the United Kingdom’s detergent market, where Procter & Gamble (NYSE: PG) and Unilever (NYSE: UL) are virtually the only suppliers. The two suppliers in a duopoly often collude in price setting.

Oligopolies are much more common than either monopolies or duopolies. In an oligopoly, there are several – but a small, limited number – of suppliers. The market for cell phone service in the United States is an example of an oligopoly, as it is essentially controlled by just a handful of suppliers. The small number of suppliers, which limits buying choices for consumers, provides the suppliers with substantial, although not complete, control over pricing.

A rare form of imperfect competition is monopsony. A monopsony is a single buyer, rather than any supplier.

1. Imperfect competition –Monopoly, Oligopoly and Monopolistic Competition Dr. Rashmi Ahuja

2. Imperfect Competition Imperfectly competitive firms Have some control over price. Price may be greater than the cost of production. Long-run economic profits are possible. Face a downward-sloping demand curve. Contribute to loss of efficiency. Are very common in every economy.

3. Different forms of imperfect competition Monopoly (most inefficient) Oligopoly (more efficient than a monopoly) Monopolistic competition (closest to perfect competition)

4. With perfect competition If the firm raises its price, sales will be zero. If the firm lowers its price, sales will not increase. The firm’s demand curve is the horizontal line at the market price. With imperfect competition The firm has some control over price or some market power . The firm faces a downward-sloping demand curve. In the case of a monopoly, the firm’s demand curve is the market demand curve.

5. The demand curves facing perfectly and imperfectly competitive firms Quantity $/unit of output D Market price Price Quantity D Perfectly competitive firm Imperfectly competitive firm

6. What is Monopoly? Monopoly is a market situation in which there is only one producer of a commodity with no close substitutes.

7. Monopolies pose a dilemma for the government…….. Should the government allow monopolies to exist? Are there circumstances in which the government should actually promote the existence of monopolies? Should the government regulate the prices monopolies charge? Will such price regulation increase economic efficiency?

8. Monopoly environment Single firm serves the “ relevant market. ” [Local Monopolies] The demand for the firm ’ s product is the market demand curve. No close substitutes Firm has control over price. [Price Maker] But the price charged affects the quantity demanded of the monopolist ’ s product. Price Discrimination

9. The firm’s demand curve is identical to the market demand curve for the product. A monopolist can sell additional output only if it reduces prices. The MR curve lies below the demand curve at every point but the first. Monopoly = Industry

10. Monopolies emerge due to a lack of competition created by barriers to entry. Barriers to entry have three sources: – Ownership of a key resource. The government gives a single firm the exclusive right to produce some good. Costs of production make a single producer more efficient than a large number of producers. [Economies of scale] Where do monopolies come from?

11. Monopoly Resources Although exclusive ownership of a key resource is a potential source of monopoly, in practice monopolies rarely arise for this reason. This happens infrequently because most resources are widely available from a variety of suppliers. Examples ???? Few prominent examples of monopolies based on control of a key resource, such as the Aluminum Company of America (Alcoa) and the International Nickel Company of Canada.

12. Are Diamond (Profits) Forever? The De Beers Diamond Monopoly De Beers promoted the sentimental value of diamonds as a way to maintain its position in the diamond market.

13. Government created monopolies Governments may restrict entry by giving a single firm the exclusive right to sell a particular good in certain markets. Patent and copyright laws are two important examples of how government creates a monopoly to serve the public interest. Eg ????? 2. Public Franchises Eg. ??????

14. A situation in which economies of scale are so large that one firm can supply the entire market at a lower average total cost than can two or more firms. Natural monopoly

15. Price and cost Quantity Demand 0.06 0.04 30 billion ATC 15 billion Average total cost for a natural monopoly B A

16. Monopoly vs. Competition: Demand Curves In a competitive market, the market demand curve slopes downward. But the demand curve for any individual firm’s product is horizontal at the market price. The firm can increase Q without lowering P , so MR = P for the competitive firm. D P Q A competitive firm’s demand curve

17. Monopoly vs. Competition: Demand Curves A monopolist is the only seller, so it faces the market demand curve. To sell a larger Q , the firm must reduce P . Thus, MR ≠ P . D P Q A monopolist’s demand curve

18. Q P TR AR MR $4.50 1 4.00 2 3.50 3 3.00 4 2.50 5 2.00 6 1.50 n.a. Common Grounds is the only seller of cappuccinos in town. The table shows the market demand for cappuccinos. Fill in the missing spaces of the table. What is the relation between P and AR ? Between P and MR ? Example

19. Answers Here, P = AR , same as for a competitive firm. Here, MR < P , whereas MR = P for a competitive firm. 1.50 6 2.00 5 2.50 4 3.00 3 3.50 2 1.50 2.00 2.50 3.00 3.50 $4.00 4.00 1 n.a. 9 10 10 9 7 4 $ 0 $4.50 MR AR TR P Q –1 1 2 3 $4

20. Common Grounds’ D and MR Curves -3 -2 -1 1 2 3 4 5 1 2 3 4 5 6 7 Q P , MR MR $ Demand curve ( P ) 1.50 6 2.00 5 2.50 4 3.00 3 3.50 2 4.00 1 $4.50 MR P Q –1 1 2 3 $4

21. Formula: Monopolist’s Marginal Revenue. The marginal revenue of a monopolist is given by the formula MR = P ( 1 + E)/E where E is the elasticity of demand for the monopolist’s product and P is the price charged for the product.

22. Lerner’s Index - degree of market power L = (P-MC)/ P = - 1/ e

23. Show that if demand is elastic (say, E = −2), marginal revenue is positive but less than price. Show that if demand is unitary elastic ( E = −1), marginal revenue is zero. Finally, show that if demand is inelastic (say, E = −0.5), marginal revenue is negative.

24. Determination of price and equilibrium under monopoly Like every other firm, a monopoly maximises profit at the output when marginal revenue equals marginal cost (MR=MC). According to the rule, a monopolist maximizes profit at the rate of output where MR = MC. Total profit = profit per unit times quantity Total profit = (p – ATC) x q

25. Price and revenue Quantity Demand = average revenue Marginal revenue To sell more, the price must be lowered. The marginal revenue curve will be below the demand curve.

26. Profit-maximising quantity and price for a monopolist: Figure 8.3a Price and cost Quantity Demand MR MC $60 42 6 27 Profit-maximising quantity Profit- maximising price B A

27. Profits for a monopolist Price and cost Quantity Demand MR MC $60 42 6 30 Profit-maximising quantity Profit- maximising price B A ATC Profit

28. Monopoly vs competitive outcomes A monopolist produces less and charges a higher price than would a competitive industry. Therefore, monopolist is less efficient than perfect competition.

29. Increasing competition with antitrust laws Ban some anticompetitive practices, allow govt to break up monopolies. Regulation Govt agencies set the monopolist’s price. The question is what the set price should be equal to? Common options are: Price = Marginal cost Price = Average total cost. Government policy toward monopoly

30. Regulating a natural monopoly: Figure 8.7 Price and cost Quantity Demand MR MC P M P R Q R P E Monopoly price Regulated price Efficient price ATC Q E Q M Profit Loss

31. Price Discrimination PRICE DISCRIMINATION is the act of charging different prices to different consumers in order to capture consumer surplus. Three basic types of price discrimination exist: First Degree Second Degree Third Degree

32. Conditions necessary to price discriminate Firm must possess some degree of market power A cost-effective means of preventing resale between lower- and higher-price buyers (consumer arbitrage) must be implemented Price elasticities must differ between individual buyers or groups of buyers

33. First-Degree (Perfect) Price Discrimination Every unit is sold for the maximum price each consumer is willing to pay Allows the firm to capture entire consumer surplus Difficulties Requires precise knowledge about every buyer’s demand for the good Seller must negotiate a different price for every unit sold to every buyer

34. Second-Degree Price Discrimination When a company charges a different price for different quantities consumed. Lower prices are offered for larger quantities and buyers can self-select the price by choosing how much to buy Eg. Block-pricing schedules - charge one price for the first few units (a block ) of usage and a different price for subsequent blocks.

35. Third degree Price discrimination Third-degree price discrimination occurs when a company charges a different price to different consumer groups. Consumers differs by some observable characteristics. For example, movie goers may be subdivided into seniors, adults and children, each paying a different price when seeing the same movie at one theater. Pricing Rule: - Consumers with low elasticities - Higher or lower price ????

36. Calculate the profit maximising qty and price for this monopolist…. (1) Q = 100 - p; (demand curve for firm output) (2) C(Q) = 1,000 + 20Q; (cost curve)

37. Q1. Refer to the figure below. Which area shows the reduction in consumer surplus from the existence of monopoly? a. Area A. b. Area B + C. c. Area A + B. d. None of the areas indicated on the graph. Check Your Knowledge

38. Q1. Refer to the figure below. Which area shows the reduction in consumer surplus from the existence of monopoly? a. Area A. b. Area B + C. c. Area A + B. d. None of the areas indicated on the graph. Check Your Knowledge

39. Q2. In which of the following situations can a firm be considered a monopoly? a. When a firm is surrounded by other firms that produce close substitutes. b. When a firm can ignore the actions of all other firms. c. When a firm uses other firms’ prices in order to price its products. d. When barriers to entry are eliminated. Check Your Knowledge

40. Q2. In which of the following situations can a firm be considered a monopoly? a. When a firm is surrounded by other firms that produce close substitutes. b. When a firm can ignore the actions of all other firms. c. When a firm uses other firms’ prices in order to price its products. d. When barriers to entry are eliminated. Check Your Knowledge

41. Problems: Suppose that a monopolist has a total cost (LTC) of 16 + 4Q. Suppose the demand curve is P = 20 – Q. If the monopolist can charge only one price calculate ?? Suppose that a monopolist has a marginal cost of $4, and a fixed cost of $48. Suppose also that the demand curve is given by Q = 12 – (P/2). What is the marginal revenue of the monopolist as a function of Q? What is the profit maximizing price and quantity for the monopolist? What is the efficient price? What is the deadweight loss from the monopolist’s maximizing profits? What are the monopolist’s profits at the profit maximizing price?