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SAYRE | MORRIS Seventh Edition
Imperfect Competition
CHAPTER 11
11-1© 2012 McGraw-Hill Ryerson Limited
Alanna Holowinsky, Red River College
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Imperfect Competition
Learning Objectives:
LO1: Understand the importance and effects of product differentiation, including advertising
LO2: Understand the differences between the two types of imperfect competition
LO3: Explain why monopolistically competitive firms tend to have excess capacity and are unlikely to earn long-run economic profits
CHAPTER 11
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Imperfect Competition
Learning Objectives:
LO4: understand the main characteristics of oligopoly markets
LO5: understand why large firms are often tempted to collude and form cartels
LO6: understand price leadership and why oligopolistic firms are reluctant to change prices very often
CHAPTER 11
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Imperfect Competition
• A market structure in which producers are identifiable and have some control over price
• Two forms:
1. Monopolistic Competition
2. Oligopoly
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LO1
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Imperfect Competition
Product Differentiation • Attempt to distinguish a firm’s products from
those of its competitors
• Firms often compete on basis other than price
• Logos, symbols, brand names, location, service, product development
• Often involves extensive advertising
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LO1
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Advertising
Benefits of Advertising • Provides the consumer with vital information
• Enhances competition between firms
• Lowers the prices of products
• Finances magazines and television shows
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LO1
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Advertising
Criticisms of Advertising • Mostly not informative and wasteful
• Encourages concentration within industries
• Raises prices to the detriment of consumers
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LO1
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Self-Test Assume that two firms dominate the running-shoes industry. One
of them hires a high-profile sports figure to endorse its product by appearing in its advertising.
a) What would you expect the other firm to do in response, and why?
b) After the second firm has reacted in the way you said it would above, what do you think the relative share of the market that each firm enjoyed would be?
c) Given your answer in b) above, what might these two firms be tempted to do?
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LO1
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Self-Test Assume that two firms dominate the running-shoes industry. One
of them hires a high-profile sports figure to endorse its product by appearing in its advertising.
a) What would you expect the other firm to do in response, and why?
11-9© 2012 McGraw-Hill Ryerson Limited
LO1
Game theory analysis suggests that the other firm would be forced to respond with a new advertising campaign possibly using another high profile sports figure.
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Self-Test Assume that two firms dominate the running-shoes industry. One
of them hires a high-profile sports figure to endorse its product by appearing in its advertising.
b) After the second firm has reacted in the way you said it would above, what do you think the relative share of the market that each firm enjoyed would be?
11-10© 2012 McGraw-Hill Ryerson Limited
LO1
Relative market share between the two firms probably would not change much from what it was initially.
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Self-Test Assume that two firms dominate the running-shoes industry. One
of them hires a high-profile sports figure to endorse its product by appearing in its advertising.
c) Given your answer in b) above, what might these two firms be tempted to do?
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LO1
The two firms would be tempted to come to an (illegal) agreement avoiding expensive adverting campaigns in the future.
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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
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LO2
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Measuring Industry Concentration
Concentration Ratio • The percentage of an industry’s total sales that
is controlled by the largest few firms
• 4-firm concentration ratio: % of sales revenue by 4 largest firms in industry
• If < 40% may be monopolistic competition
• If > 40% likely oligopoly
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LO2
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4 Firm Concentration Ratios
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LO2
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Self-Test The grummit industry consists of 10 companies.
Company Sales $m:
A $22
B $6
C $17
D $12
E $8
F $15
Next 4 (total) $12
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LO2
a) Calculate the 4-firm concentration ratio for this industry.
b) What type of market does this industry operate in?
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Self-Test The grummit industry consists of 10 companies.
Company Sales $m:
A $22
B $6
C $17
D $12
E $8
F $15
Next 4 (total) $12
11-16© 2012 McGraw-Hill Ryerson Limited
LO2
a) Calculate the 4-firm concentration ratio for this industry.
b) What type of market does this industry operate in?
71.7% ($66/$92)
Oligopoly (it is higher than the 40%)
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Monopolistic Competition
Characteristics • Many small firms acting independently
• Freedom of entry
• Products are differentiated
• Each firm has some control over price
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LO3
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Monopolistic Competition
• May have economic profit in the short run
• In the long run, the representative firm in a monopolistically competitive market makes only normal profits
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LO3
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Monopolistically Competitive Equilibrium (SR)
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LO2
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Monopolistically Competitive Equilibrium (SR)
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LO2
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Self-Test 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?
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LO2
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Self-Test 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?
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LO2
Some firms within the industry will go out of business (exit). Graphically, this would shift the demand curve faced by each of the remaining firms to the right so that it once again became tangent to the average cost curve.
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LO2
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Appraisal of Monopolistic Competition
• produces a lower output than a perfectly competitive firm
• does not achieve productive efficiency because the long-run equilibrium price does not equal minimum average total cost
• charges a higher price than a perfectly competitive firm
• does not achieve allocative efficiency because price exceeds marginal cost
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LO3
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Self-Test a) What output will this firm produce?
b) How much excess capacity exists at this output level?
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LO3
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Self-Test a) What output will this firm produce?
b) How much excess capacity exists at this output level?
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LO3
Q2. (where MC=MR.)
Excess capacity of Q4 – Q2
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Oligopoly
Characteristics • It is dominated by a few large firms.• Entry by new firms is difficult.• Nonprice competition between firms is widely
practised.• Each firm has significant control over its price.• Mutual interdependence exists between firms.• Products can be either homogeneous or
differentiated.
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LO4
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Oligopoly
Mutual interdependence • the condition in which a firm’s actions depend, in
part, on the reactions of rival firms
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LO4
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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
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LO5
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Game Theory
Nash Equilibrium • a situation where each rival chooses the best
actions given the (anticipated) actions of the other(s)
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LO5
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Game Theory
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LO5
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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
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LO5
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Self-Test Suppose that Spartan Inc. and Trojan Ltd, the only two firms
in the industry, have entered into a collusive agreement to share the industry’s total profits of $50 million equally. However, if any one of them cheats, it will increase its profits by $10 million at a cost of $10 million to the other firm. If they both cheat, they will each reduce their profits by $5 million.
a) Construct a matrix showing the various options.
b) Which option will they likely chose?
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LO5
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Self-Test a) Construct a matrix showing the various options.
b) Which option will they likely chose?
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LO5
Cell D. They will end up both cheating.Spartan Inc
stick to agreement cheat
Cell A Cell B
Cell C Cell D
stick to agreement
cheat
Trojan Ltd
$25
$25
$35
$15
$15
$35
$20
$20
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Noncollusive 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, other firms follow
• Must balance the advantages of a price increase with the risks of creating an opening for new entrants
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LO6
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© 2012 McGraw-Hill Ryerson Limited 11- 36
LO6
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© 2012 McGraw-Hill Ryerson Limited 11- 37
LO6
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Oligopoly
• Some believe that oligopolies are too powerful and produce inefficiently
• Others take the view that oligopolies are at the cutting edge of new technological development and, in the long run, push the average costs of production down
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LO6
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Key Concepts to Remember:
• The importance of product differentiation
• The two types of imperfect competition – monopolistic competition and oligopoly
• Collusion and cartels
• Price leadership
CHAPTER 11 SUMMARY
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