Features of monopolistic competition ppt

monopolistic competition and oligopoly ppt and monopolistic competition examples ppt
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Lecture 11 Imperfect Competition Business 5017 Managerial Economics Kam Yu Fall 2013Outline 1 Introduction 2 Monopolistic Competition 3 Oligopoly Modelling Reality The Stackelberg Leadership Model Collusion Regulating Monopoly 4 Business Regulation Public Interest Theory Economic Theory of Regulation 5 Market for Corporate Control Firm Integrations Are Hostile Takeovers Ecient? Kam Yu (LU) Lecture 11 Imperfect Competition Fall 2013 2 / 29Introduction Monopolistic Competition and Oligopoly We have so far studied two extreme forms of market structure. In perfect competition, no single rm has the market power to in uence the market price. In the long run rms make no economic pro t. A monopolist which sells a product with no close substitute enjoy great market power and makes economic pro ts in the long run. Most market structures in our economy are something in between. In monopolistic competition, each rm sells a di erentiated product with its market niche. The rms enjoy some market power and face their own downward sloping demand curves. In an oligopoly, price, quantity, and therefore pro ts depend on the interactions of the rm. The form of competition and market outcome are indeterminate. Kam Yu (LU) Lecture 11 Imperfect Competition Fall 2013 3 / 29Monopolistic Competition Market Power The market power of a monopolistic competitive rm depends on a number of factors: Number of competitors Production capacity of competitors Ease of new rms entering the market Degree of product di erentiation Brand name recognition and loyalty Price di erence awareness of consumers Kam Yu (LU) Lecture 11 Imperfect Competition Fall 2013 4 / 29Monopolistic Competition Short-Run Competition A typical rm faces a downward sloping demand curve, with a steeper marginal revenue curve. Pro t maximization is achieved by setting MC = MR. The rm produces Q and mc charges P on the demand mc curve. Economic ineciency compared with the perfectly competitive market. Kam Yu (LU) Lecture 11 Imperfect Competition Fall 2013 5 / 29Monopolistic Competition Long-Run Competition As long as the rms are making economic pro ts, new rms will enter the market. The demand and MR curves of a typical rm shift down because of increased competitive. Demand also becomes more elastic. This continues until all economic pro ts have eroded, with price P mc1 and quantity Q on the LRAC curve. mc1 Note that in the long run the rm is not producing at the minimum eciency scale, meaning economic ineciency. This occurs as long as the demand curve facing an individual rm is not perfectly elastic. Firms in monopolistic competitive often engage in non-price competitive such as advertisement and customer relationships. Kam Yu (LU) Lecture 11 Imperfect Competition Fall 2013 6 / 29Monopolistic Competition Long-Run Pro ts Kam Yu (LU) Lecture 11 Imperfect Competition Fall 2013 7 / 29Oligopoly Modelling Reality Just a Handful of Sellers Typically just a few sellers in a market with not much product di erentiation. Barriers to entry are high. Demands are more inelastic than that in a monopolistic competition. Therefore the oligopolists have more market power. Consequently if an oligopolist behaves like a monopolist, the dead-weight loss is larger than that of a monopolistic competitive rm. However, this is not always the case. Pricing decisions of oligopolists are mutually interdependent. There is a wide variety of economic models on their behaviours. Kam Yu (LU) Lecture 11 Imperfect Competition Fall 2013 8 / 29Oligopoly Modelling Reality Oligopolist as a Monopolist Kam Yu (LU) Lecture 11 Imperfect Competition Fall 2013 9 / 29Oligopoly The Stackelberg Leadership Model One Market Leader The market is dominated by one big producer with cost advantage (advanced technology, patents, big brand name, etc.). The rest of the rms are followers with no market power. The total supply curve of the followers is the sum of their MC curves. Without the leader, this supply curve MC meets the market demand c curve D at price P and quantity Q . m 1 2 Excess demand exists at any price below P , these excess demands 1 become the demand curve D for the dominant producer, with d corresponding marginal revenue MR . d The dominant producer maximizes pro t by setting MC = MR with the price-quantity combination (P ;Q ). d d The followers are price takers, now face market price P . The excess d demand between the consumers and the followers is Q Q , which 3 1 is equal to Q . d Kam Yu (LU) Lecture 11 Imperfect Competition Fall 2013 10 / 29Oligopoly The Stackelberg Leadership Model Price Leader and Followers Kam Yu (LU) Lecture 11 Imperfect Competition Fall 2013 11 / 29Oligopoly Collusion How Cartels are Formed If product di erentiation is weak, consumers are more price sensitive. Pricing becomes the main tool in competition among the oligopolists. There are strong incentives for the rm to form a cartel and behave collectively like a monopoly. The cartel chooses the monopoly price-quantity combination to maximize pro t, which is shared by its members. With the high monopoly price, however, each individual rm in the cartel has an incentive to cheat, making even more pro t by increasing production. To avoid collapse, the cartel must have a mechanism in place to punish the cheaters. Kam Yu (LU) Lecture 11 Imperfect Competition Fall 2013 12 / 29Oligopoly Collusion An Example of Duopoly Two identical rms with constant returns to scale technology. They form a cartel to maximize joint pro t with (P ;Q ). This m m means each rm produces at a level Q =Q =2. 1 m After the collusion agreement, each rm has the incentive to lower price a little to P and 1 capture almost the whole monopoly market. But total pro t goes down if both cheat. Kam Yu (LU) Lecture 11 Imperfect Competition Fall 2013 13 / 29Oligopoly Collusion Back to Game Theory The above colluding duopoly can be described by a Prisoner's Dilemma model. Assume that the two rms, A and B, have two choices, high price or low price. Their incentive can be analyzed with the payo matrix. For Firm A, no matter what Firm B chooses, its best strategy is to choose low price. The same is true for Firm B. Therefore the dominant strategy is low price for both rms, resulting in the inecient outcome (500; 500). This outcome is also a Nash equilibrium, which consists of the best strategy for every player given the action of all the other players. In other words, no player has the incentive to change his/her choice. Therefore in a one-shot game the collusion will fail. In a repeated game setting, the behaviours are more complicated. Kam Yu (LU) Lecture 11 Imperfect Competition Fall 2013 14 / 29Oligopoly Collusion Payo Matrix of a Duopoly Kam Yu (LU) Lecture 11 Imperfect Competition Fall 2013 15 / 29Oligopoly Collusion Cartels with Lagged Demand Recall that when a product exhibits lagged demand due to network e ect or rational addiction, a rm has the incentive to lower price now so that demand will be higher in the future. This applies to a cartel as well. But individual rm has the incentive to free-ride the other rms. Since the game is inherently dynamic, actual behaviours depends on the mechanism design of the cartel. Kam Yu (LU) Lecture 11 Imperfect Competition Fall 2013 16 / 29Oligopoly Collusion Government-Supported Cartels In a lot of cases the transaction costs of maintaining a cartel (negotiating, monitoring, and enforcing the agreement) is higher than the bene ts of collusion. The problem may be resolved with a third party doing the monitoring and enforcement task. A good candidate for this third party is the government. With legislative and executive power, the government can be very ecient in maintaining a cartel. This is why some industries lobby for government regulations or oppose deregulation. The e ects of regulations can suppress competition. Examples: airline regulations, liquor licence, banning Sunday shopping, professional licensing, etc. Kam Yu (LU) Lecture 11 Imperfect Competition Fall 2013 17 / 29Oligopoly Regulating Monopoly Natural Monopoly When the long-run average cost is declining within the range of market demand, it is cost e ective to have a single producer. The natural monopoly is socially inecient, however, if it exploits consumers with its market power. The government usually steps in to regulate the monopoly. Instead of the monopolist's pro t maximizing (P ;Q ), the m m government can impose a price ceiling at P , where the LRAC meets 1 the market demand curve. This may occur naturally without government intervention in a contestable market. Even though there is a high xed cost, some well- nanced rms may see the monopoly pro t as a sign to enter the market. The threat of a price war with a new competitor keeps the natural monopolist in check and charge a price close to the socially ecient level at P . 1 Kam Yu (LU) Lecture 11 Imperfect Competition Fall 2013 18 / 29Oligopoly Regulating Monopoly A Natural Monopolist Kam Yu (LU) Lecture 11 Imperfect Competition Fall 2013 19 / 29Business Regulation Public Interest Theory \The Government is the Problem" Many sectors in the economy are subject to various degree of government regulation. In Canada the most heavily regulated sectors are health care, education, transportation, telecommunication, agriculture, and electricity. Common reasons for regulation are social insurance, monopoly power, public safety, market stability, preservation of culture and languages, etc. Some economists think that excessive government regulation hinders the operation of the free markets and creates ineciency. Others try to explain regulation from an institutional economics perspective. Kam Yu (LU) Lecture 11 Imperfect Competition Fall 2013 20 / 29