Imperfect Markets 06. PDF

Chapter 7 Imperfect markets  Units Unit 1: Dynamics of imperfect markets Unit 2: Monopolies Unit 3: Oligopolies Unit 4: Monopolistic competition  Long queues, grappling shoppers and even headfirst dives into shelves. That's what Prime Hydration - a drink promo...

Chapter 7 Imperfect markets  Units Unit 1: Dynamics of imperfect markets Unit 2: Monopolies Unit 3: Oligopolies Unit 4: Monopolistic competition  Long queues, grappling shoppers and even headfirst dives into shelves. That's what Prime Hydration - a drink promoted by YouTubers KSI and Logan Paul - has sparked in shops It's become an online sensation since being launched, with its limited availability causing a craze With restocks selling out as fast as they arrive, it's also spawned a black market with people selling bottles for huge prices online. Limit the supply, and then you create the demand," he explains. "This is called scarcity marketing. It's a technique to encourage customers to make a purchase before the discount goes away or before there is a perceived limited supply." Imperfect Market An imperfect market is a market in which perfect competition does not exist They have the power to influence the price as these products do not have perfect substitutes  Unit 1 Dynamics of imperfect markets  Monopoly: One firm operates as a supplier of a product in the market Oligopoly: When a small number of very large firms produce similar or identical products Monopolistic competition: There are many buyers and sellers, however some businesses have a larger market share  Comparison between markets Perfect Monopoly Oligopoly Monopolistic market competition Number of Many One Few Many firms Nature of Homogenous Heterogenous Heterogenous Homogenous the product Price low high high high Output high low low high Barrier to No barrier High barrier High barrier No barrier entry Collusion Not possible No need Although Not possible illegal, its rife Availability perfect imperfect imperfect Perfect of information Size of normal supernormal supernormal normal profits  Imperfect Market Demand The law of demand is indicated in an imperfect market. The higher the price, the less demand. In a perfect market, Consumers go to competitors when prices increase. In an imperfect market, fewer customers buy but some still do at the high price. Imperfect markets limit supply and charge high prices which leads to Supernormal profits Eg. They will always sell between R8-10 to maximise profits and never less  Imperfect Market Average Revenue AR: revenue earned per unit sold AR: TR/ total Q AR: example 18/2 units = 9 Average revenue will decrease as cheaper prices are given with more units sold. (Economies of scale) The AR curve will also resemble the demand curve (AR = D)  Imperfect Market Marginal Revenue MR: measures the change in total revenue from producing one additional unit MR: change in TR/ change in Q MR: Example: @ 2 units, the change in TR is 8 (18-10). 8/1= 8 The graph tells us that in order to sell the second unit, we must lower the price to R8 Imperfect Market Marginal Revenue MR: change in TR/ change in Q Q P TR AR MR 0 0 0 1 10 10 10 10 2 9 18 9 8 3 8 24 8 6 4 7 28 7 4 5 6 30 6 2 6 5 30 5 0 Imperfect Market Total Revenue TR: The total money received from sales TR: P x Quantity As the quantity increases, so does the total revenue. However, only up to a certain point After point Q2, even though more quantity is sold, the selling price decreases. An imperfect market business will not sell after Q2 Imperfect Market Total Revenue Q P TR 1 100 100 3 80 240 5 60 300 7 40 280 9 20 180 Imperfect Market Cost curves are the same in imperfect markets as in perfect markets TC , AC, MC  Unit 2 Monopolies MONOPOLIES Characteristics Unique product 1 Business in the market High barrier to entry Price setters Imperfect information  MONOPOLIES Types Natural monopoly : A business that operates with high fixed costs and the market is not large enough for a competitor to enter. State owned monopoly: One that is part of the public sector Local monopoly: Exists in a particular area where it is not worthwhile for a competitor to open or for some reason can not set up in that area Artificial monopoly: One that comes through uncompetitive practices such as buying out the competition or intimidation  MONOPOLIES The monopoly graph will always have 4 curves Note that more revenue will be gained even though the price of a product decreases with more quantity (AR/D) : Decreases in price as more units sold (MR): Decreases in price as more units sold (MC): Starts low and decreases as more units produced, however picks up again (AC): starts high but decreases as more units produced, however picks up again  MONOPOLIES A monopoly will always produce where MC = MR as profits are maximised (Qf) The price is determined by AR and quantity at the profit maximisation point (supernormal profit) At this point the business cant make more profit per unit by producing more as this is the profit maximising output level At Qf, the business makes a supernormal profit (green shade) as AR is above AC This is the most likely situation for a monopoly in the short and long run MONOPOLIES If costs rise too much or revenue falls too low, A business could end up making a loss. A loss is determined when AR is lower than AC If the AR curve is below the AC curve at the profit maximising output, the business will make a loss MONOPOLIES Loss Supernormal profit  Unit 3 Oligopolies OLIGOPOLIES Characteristics Small number of large businesses Non-price competition High set up costs Stay informed (of competitors) Products can be differentiated OLIGOPOLIES Non-price competition Product differentiation: Cell phone companies such as Apple and Samsung use different operating systems Advertising/Branding: Helps to establish brand loyalty. If you are able to gain brand loyalty, you are able to get economic profit even though substitutes are available Loyalty schemes: e.g. Woolworths and checkers have loyalty cards OLIGOPOLIES Collusion Collusion refers to businesses in the same industry coming to an agreement to not be competitive with each other and increase their profits. Collusion occurs in 2 ways: Cartels: A formal agreement between oligopolies to restrict production and increase prices Price leadership: An industry dominant business that changes prices to influence competitors. There is a pattern that when a dominant firm raises the prices, the competitors do the same. This is a type of collusion OLIGOPOLIES A theory that states that the prices of goods and services are stable in oligopolies (Price agreed upon) If one business raises the price, they will loose a huge market share to a competitor. If they lower the price, it will cause a price war which disadvantages all oligopolies  OLIGOPOLIES Kinked demand curve The business average revenue (AR) is kinked (bent). This is the prevailing market proce The equilibrium point is at the kink where P=Q The top half of the demand curve is elastic. If a firm increases its price, it will drastically loose sales The bottom half of the demand curve is inelastic. A decrease in price by 1 firm will lead others to do the same. Consumers will most likely remain with the same firm  OLIGOPOLIES Kinked demand curve Profit maximization point is where the demand curve is bent (E) (R10) An increase in price (R12) will lead to a drastic decrease in quantity  OLIGOPOLIES Kinked demand curve Marginal revenue is broken at Q This is because quantity sold does not change between a certain price level Therefore oligopolist charge the highest price within the broken area (P1) Because of the above reason, oligopolies set prices at high levels as quantity sold will remain the same Profit maximisation point will be at the highest point in the broken area  Unit 4 Monopolistic Competition Monopolistic competition Characteristics Monopolistic competition occurs when there are many producers that sell products that are differentiated from each other Heterogenous products Many buyers and sellers Low barrier to entry and exit Businesses are price setters Information is imperfect e.g. Food restaurants and Clothing stores  Monopolistic Competition Supernormal profit: AC is below AR Normal profit: AC touches AR Loss: AC is above AR