Principles Of Microeconomics Chapter 11 PDF

Principles of Microeconomics SAYRE // MORRIS // GHAYAD Eleventh Edition CHAPTER 11 Imperfect Competition Prepared by Ifeanyi Uzoka, Sheridan College © 2024 McG...

Principles of Microeconomics SAYRE // MORRIS // GHAYAD Eleventh Edition CHAPTER 11 Imperfect Competition Prepared by Ifeanyi Uzoka, Sheridan College © 2024 McGraw Hill  CHAPTER 11 Imperfect Competition Learning Objectives: 1. Explain the importance and effects of product differentiation, including advertising 2. Differentiate between the two types of imperfect competition 3. Explain why monopolistically competitive firms tend to have excess capacity and are unlikely to earn long- run economic profits © 2024 McGraw Hill 11-2  CHAPTER 11 Imperfect Competition Learning Objectives: 4. Describe the main characteristics of oligopoly markets 5. Explain why large firms are often tempted to collude and form cartels 6. Explain price leadership and why oligopolistic firms are reluctant to change prices very often © 2024 McGraw Hill 11-3  Imperfect Competition A market structure in which producers are identifiable and have some control over price Two forms: 1. Monopolistic Competition 2. Oligopoly © 2024 McGraw Hill 11-4  LO1: Product Differentiation © 2024 McGraw Hill 11-5  Imperfect Competition Product Differentiation: Attempt to distinguish a firm’s products from those of its competitors – developing a recognized brand name, product logo, or packaging – securing a superior location or developing a reputation for exceptional service – engaging in product development – advertising © 2024 McGraw Hill 11-6 LO2: The Difference Between the Two Types of Imperfect Competition © 2024 McGraw Hill 11-7  Types of Imperfect Competition Monopolistic Competition – A market in which many firms sell a differentiated product and have some control over price Oligopoly – A market dominated by a few large firms © 2024 McGraw Hill 11-8  Measuring Industry Concentration Concentration Ratio: measures the percentage of an industry’s sales controlled by the largest few firms. – 4-firm concentration ratio: % of sales revenue by four largest firms in industry If < 40% may be monopolistic competition If > 40% likely oligopoly © 2024 McGraw Hill 11-9  Test Your Understanding The grummit industry Company Sales $m: consists of 10 A $22 companies. B $6 a. Calculate the 4-firm C $17 concentration ratio for D $12 this industry. E $8 b. What type of market F $15 does this industry Next 4 (total) $12 operate in? Total $92 © 2024 McGraw Hill 11-10  Test Your Understanding The grummit industry consists of 10 companies. a. Calculate the 4-firm Company Sales $m: concentration ratio for this A $22 industry B $6 conc. ratio = largest 4 firms C $17 total of all firms D $12 E $8 = 22 + 17 + 15 + 12 = $66 = F $15 $92 $92 Next 4 (total) $12 = 71.7% Total $92 © 2024 McGraw Hill 11-11  Test Your Understanding The grummit industry consists of 10 companies. Company Sales $m: b. What type of market does A $22 this industry operate in? B $6 Oligopoly (conc. ratio higher C $17 than 40%) D $12 E $8 F $15 Next 4 (total) $12 Total $92 © 2024 McGraw Hill 11-12  LO3: Monopolistic Competition © 2024 McGraw Hill 11-13  Monopolistic Competition Characteristics: 1. Many small firms acting independently 2. Freedom of entry 3. Products are differentiated 4. Each firm has some control over price © 2024 McGraw Hill 11-14  Elasticity in Monopolistic Competition In general, the elasticity of demand will depend on – The number of rival firms – The degree of product differentiation In monopolistic competition – There are many rival firms – There is not a lot of differentiation This leads to a lot of choice for consumers, i.e. an elastic demand curve © 2024 McGraw Hill 11-15  Monopolistic Competition in the Short Run May have economic profit in the short run Maximize profits producing where MR = MC At this point, if P > C then have economic profit of Q × (P – C) © 2024 McGraw Hill 11-16  Monopolistic Competition in the Long Run If have positive profits, new firms will enter More consumer choice moves the firm’s demand left and flattens it Will have (only) normal profits in the long run © 2024 McGraw Hill 11-17  Test Your Understanding Assume that a representative firm in monopolistic competition is experiencing economic losses. What series of events will occur to return this firm to its long-run equilibrium? © 2024 McGraw Hill 11-18  Test Your Understanding Assume that a representative firm in monopolistic competition is experiencing economic losses. What series of events will occur to return this firm to its long- run equilibrium? 1. Some firms within the industry will go out of business (exit) 2. The demand curve shifts to the right for all remaining firms 3. Steps 1 and 2 continue until demand is tangent to the average cost curve, and experience normal profits © 2024 McGraw Hill 11-19  Excess Capacity in the Long Run A perfectly competitive firm faces perfectly elastic demand D1 and produces at QPC A monopolistically competitive firm faces elastic demand D2 and produces at QMC which is below QPC (below economic capacity) QPC − QMC is excess capacity © 2024 McGraw Hill 11-20  Appraisal of Monopolistic Competition 1. Produces a lower output than a perfectly competitive firm 2. Does not achieve productive efficiency – Long-run equilibrium price does not equal minimum average total cost 3. Charges a higher price than a perfectly competitive firm 4. Does not achieve allocative efficiency – Price exceeds marginal cost © 2024 McGraw Hill 11-21  Test Your Understanding a. If this firm is monopolistically competitive, what output will it produce? b. How much excess capacity exists at this output level? © 2024 McGraw Hill 11-22  Test Your Understanding a. If this firm is monopolistically competitive, what output will it produce? Q2: where MC=MR b. How much excess capacity exists at this output level? © 2024 McGraw Hill 11-23  Test Your Understanding a. If this firm is monopolistically competitive, what output will it produce? Q2: where MC=MR b. How much excess capacity exists at this output level? Q4 – Q2 © 2024 McGraw Hill 11-24  Franchises Each member firm pays a fee to be part of the franchise and have an exclusive geographic territory Since only other large-scale franchises can compete, this limits entry of competitors © 2024 McGraw Hill 11-25  Franchises Franchises can create a nationwide organization where individual franchisees get benefits from: 1. large-scale advertising 2. bulk purchasing 3. branding © 2024 McGraw Hill 11-26 Blocking Entry To Increase Profits If entry of competitors can be blocked, positive economic profits can be maintained in the long run. This can be done through: 1. Professional associations 2. Government policy such as licensing 3. Franchising © 2024 McGraw Hill 11-27  LO4: Oligopoly © 2024 McGraw Hill 11-28  Oligopoly Characteristics 1. It is dominated by a few large firms 2. Entry by new firms is difficult 3. Non-price competition between firms is widely practiced 4. Each firm has significant control over its price 5. Mutual interdependence exists between firms © 2024 McGraw Hill 11-29  Oligopoly Products can be either standardized (undifferentiated ) (e.g., steel) or (differentiated) (e.g., automobiles) Mutual interdependence – The condition in which a firm’s actions depend, in part, on the anticipated reactions of rival firms © 2024 McGraw Hill 11-30  LO5: The Temptation to Collude © 2024 McGraw Hill 11-31  Collusion Collusion: – An agreement among suppliers to set the price of a product or the quantities each will produce Game Theory: – A method of analyzing firm behaviour that highlights mutual interdependence among firms © 2024 McGraw Hill 11-32  Game Theory Nash Equilibrium – A situation where each rival chooses the best actions given the anticipated actions of the others © 2024 McGraw Hill 11-33  Game Theory Scenarios: - Aman doesn't cheat: Best - 125; worst - 100. - If Aman does cheat: Best 140; worst 105. Therefore, cheat. - Omar doesn't cheat: Best - 125; worst - 100. - If Omar does cheat: Best 140; worst 105. Therefore, cheat. © 2024 McGraw Hill 11-34  Test Your Understanding Assume two firms dominate the running-shoes industry. One of them hires a high-profile sports figure to endorse its product. a. What would the other firm to do in response? b. After this, what market share would each firm have? c. Given your answers above, what might these firms be tempted to do? © 2024 McGraw Hill 11-35  Test Your Understanding Assume two firms dominate the running-shoes industry. One of them hires a high-profile sports figure to endorse its product. a. What would the other firm to do in response? Game theory suggests that the other firm would be forced to respond by buying a similar endorsement deal © 2024 McGraw Hill 11-36  Test Your Understanding Assume two firms dominate the running-shoes industry. One of them hires a high-profile sports figure to endorse its product. b. After this, what market share would each firm have? Relative market share would probably remain unchanged from what it was initially © 2024 McGraw Hill 11-37  Test Your Understanding Assume two firms dominate the running-shoes industry. One of them hires a high-profile sports figure to endorse its product. c. Given your answers above, what might these firms be tempted to do? The two firms would be tempted to come to an (illegal) agreement avoiding expensive adverting in the future © 2024 McGraw Hill 11-38  Collusive Oligopoly Cartel – An association of sellers acting in unison – For example, Organization of Petroleum Exporting Countries (OPEC) – Able to increase prices by restricting output – Cartels work to the advantage of their members only if there is no cheating among the participants © 2024 McGraw Hill 11-39  The Effect of OPEC’s Policy on the World Market for Oil In 1973, the 12 members of OPEC agreed to reduce their output of oil. Since the demand for oil is inelastic, the drop in supply caused the price to increase from $2 to $8. © 2024 McGraw Hill 11-40  Test Your Understanding Suppose that Spartan Inc. and Trojan Ltd. have entered into a collusive agreement to share the industry’s total profits of $50 million equally. However, if either cheats, it will increase its own profits by $10 million at the cost of the other firm. If they both cheat, the profits of each are reduced by $5 million. a) Construct a matrix showing the various options. b) Which option will they likely chose? © 2024 McGraw Hill 11-41  Test Your Understanding a. Construct a matrix showing the various options. Spartan Inc stick to agreement cheat Cell A Cell B stick to $25 $35 agreement $25 $15 Trojan Ltd Cell C Cell D cheat $15 $20 $35 $20 b. Cell D: they will both end up cheating © 2024 McGraw Hill 11-42  LO6: Noncollusive Oligopoly © 2024 McGraw Hill 11-43  Non-Collusive Oligopoly Price Leadership – When rival firms engage in what amounts to price fixing without overt collusion – A leader, usually the largest or most efficient firm, sets price and other firms follow – Must balance the advantages of a price increase with the risks of creating an opening for new entrants © 2024 McGraw Hill 11-44  The Kinked Demand Curve The reaction of rivals is inconsistent If a firm drops price, rivals will also drop price, so demand is inelastic below the current price If a firm raises price, rivals will not raise their prices, so demand is elastic above the current price © 2024 McGraw Hill 11-45  An Appraisal of Oligopoly Some believe that oligopolies – Are too powerful – Results in productive and allocative inefficiency Others take the view that oligopolies are: – At the cutting edge of new technological development – In the long run, push the average costs of production down © 2024 McGraw Hill 11-46  CHAPTER 11 Key Concepts to Remember 1. The importance of product differentiation 2. The two types of imperfect competition, monopolistic competition and oligopoly, and their characteristics 3. Monopolistically competitive firms have normal profits and excess capacity in the long run 4. The strategies of collusion and price leadership © 2024 McGraw Hill 11-47