introduction to micro-economics imperfect competition.ppt

introduction to micro-economics imperfect competition

1. Imperfect Competition
Chapter 9
LIPSEY & CHRYSTAL
ECONOMICS 12e

2. Learning Outcomes
Concentration of production varies between industries, but
firms in all intermediate industry types have some power
to influence price.
In industries where there are many producers but of
different products, free entry will tend to eliminate profits in
the long run.

3. Learning Outcomes
Where there is a small group of dominant producers
(oligopoly), strategic interaction is important because the
market form of one is affected by what its rivals do.
Insights into the choices available and the nature of
outcomes can be achieved using game theory.
Oligopoly can be associated with pure profits in the long
run if there are barriers to entry.

4. ImperfectlyCompetitiveMarketStructures
Firmsinmarketstructuresotherthanperfectcompetition
facenegativelyslopeddemandcurvesandmust
administertheirprices.
INTRODUCTION -IMPERFECT COMPETITION

5. MonopolisticCompetition
Inthetheoryoflarge-groupmonopolisticcompetition,
manyfirmscompetetoselldifferentiatedproducts.
Eachmaymakepureprofitsintheshortrun.Inthelong
run,freedomofentryshiftsitsdemandcurveuntilitis
tangenttotheATCcurve,leadingtoexcesscapacityand
productionataveragecostsabovetheminimumpossible
level.
INTRODUCTION -IMPERFECT COMPETITION

6. Oligopoly
Competitivebehaviouramongoligopolistsmayleadto
anon-cooperativeequilibrium.
Itisself-policinginthesensethatnoonehasan
incentivetodepartfromitunilaterally.
Theprisoner’sdilemmagameisacaseinpoint.
INTRODUCTION -IMPERFECT COMPETITION

7. Oligopoly
Oligopolisticprofitscanpersistonlyifthereareentry
barriers.
Naturalbarriersincludeeconomiesoflarge-scaleproduction
andlargefixedcostsofenteringthemarket.
Artificialbarriersincludebrandproliferationandhighlevels
ofadvertising.
INTRODUCTION -IMPERFECT COMPETITION

8. OligopolyasaGame
Small-groupinteractioncanbeanalysedusingagame
theoryframework,whichsetsouttheavailableactionsand
thepayoffsundervariousactions.
InaNashequilibriumeachfirmisdoingthebestitcan,
giventhechoicesthatotherfirmshavemade.
Aco-operativesolutionislikelytobetheonethatmaximizes
jointprofits,buteachfirmwilltypicallyhaveanincentiveto
cheat,andexplicitco-operationbetweenfirmsmaybe
proscribedbycompetitionlaw.
INTRODUCTION -IMPERFECT COMPETITION

9. DynamicsofOligopolyIndustries
Inqualitativetermstheworkingsoftheallocative
systemunderoligopolyaresimilar[butnot
identical]towhattheyareunderperfect
competition.
Oligopolisticindustriesappeartohavecontributed
muchmoretothetechnologicalchangesthat
underliethelong-rungrowthofproductivitythan
haveperfectlycompetitiveindustries.
INTRODUCTION -IMPERFECT COMPETITION

10. ATC
MC
MR
D
E
s
p
s
q
s
Output
[I]. Short-run equilibrium
[i] Equilibrium of a Typical Firm in Monopolistic Competition

11. (i) Short run equilibrium for a firm in monopolistic competition
A typical monopolistically competitive firm is shown in short-run equilibrium is at point E
S.
Output is q
s, where MC = MR, price is p
s.
Profits are the blue area.

12. MC
ATC
E
L
D
MR
p
L
q
L q
c
p
c
Output
[ii]. Long-run equilibrium
[ii] Equilibrium of a Typical Firm in Monopolistic Competition

13. (ii) Long run equilibrium of a firm in monopolistic competition
Here the firm is in long-run equilibrium at point E
L.
Entry of new firms has pushed the existing firm’s demand curve to the left until the curve is
tangent to the firm’s ATC curve at output q
L.
Price is p
L, and total costs are just being covered. Excess capacity is q
C-q
L.
If the firm did produce at capacity, its costs would fall from p
Lper unit of output to p
C.

14. A’s output
B’s output
Two
-
thirds
monopoly
output
One
-
half
monopoly
output
One-half
monopoly
output
Two-thirds
monopoly
output
20 20 1522
22 15 17
The Oligopolist’s Dilemma: to Co-operate or to Compete
17

15. The figure gives a payoff matrix for a two-firm duopoly game.
A’s production is indicated across the top. Its profits (in millions of pounds) are shown in the yellow
circles within each square.
B’s production is indicated down the left side.
Its profits (in millions of pounds) are shown in the green circles within each square.
For example, the top right square tells us that if Bproduces one-half, while Aproduces two-thirds,
of the output that a monopolist would produce:
A’s profits will be £22 million
while B’s will be £15 million
The Oligopolist’s Dilemma: to Co-operate or to Compete

16. If Aand Bco-operate, each produces one-half the monopoly output, and earns profits of £20
million as shown in the upper left box.
In this co-operative solution, either firm can raise its profits by producing two-thirds of the
monopoly output, provided that the other firm does not do the same.
Now let Aand Bbehave non-cooperatively.
Areasons that whether Bproduces either one-half or two-thirds of the monopoly output, A’s
best output is two-thirds.
Breasons similarly.
As a result, they reach the non-cooperative equilibrium.
Here each produces two-thirds of the monopoly output, and each makes less than it would if
the two firms co-operated.
The Oligopolist’s Dilemma: to Cooperate or to Compete

17. The Prisoner’s Dilemma
John’s plea
Innocent
Guilty
J severe sentence
W no sentence
Innocent
Guilty
William’s
plea
J no sentence
W severe sentence
J light sentence
W light sentence
J medium sentence
W medium sentence

18. Two prisoners are interrogated separately.
They are told:
if they both plead innocent, they will get a light
sentence.
If one pleads innocent while the other pleads guilty, the
one who claims innocence will get a heavy sentence
while the other will be let off.
If both plead guilty, they will both get a medium
sentence.
The pay off matrix shows these conditions.
The Prisoner’s Dilemma

19. Both prisoners reason as follows
(1) if the other pleads innocent I am better off to plead
guilty and get off.
(2) if the other pleads guilty I am better off to plead
guilty and get only a medium sentence.
So the optimal non-cooperative strategy for both is to plead guilty
This gives them a medium sentence rather than the light sentence that they would get if they were
allowed to consult and agree that both would plead innocent.
The Prisoner’s Dilemma