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Flashcards in Imperfect Competition Deck (17):

What does imperfect competition refer to?

Monopolistic Competition and Oligopoly: between the two extremes (perfect competition and monopoy)

Industry with many small firms = Monopolistic Competition
(some degree of market power)

Industry with a few large firms = oligopoly
(considerable degree of market power; compete against each other)


Industrial concentration?

Concentration ratio?

Concentrated = small number of large firms

A concentration ratio is the fraction of total market sales controlled by a specified number of the industry’s largest firms.
= market share by specified number of firms/total market share


Characteristics of imperfect competition?

1) firms choose their own products = differentiated

2) firms choose their own prices

3) non-price competition (advertising)


Difference between monopolistic competition and oliogpoly?

amount of strategic behaviour displayed by firms (oligopolies consider other competitors)


Characteristics of monopolistic competition?

- Monopolistic competition is a market structure of an industry in which there are:

- many firms

- freedom of entry and exit

- differentiated products, giving it some control over its price. this differentiation separates monopolistic competition from perfect competition

Long run profits = 0


Assumptions of monopolistic competition?

1) Each firm produces its own version/variety of the industry’s DIFFERENTIATED product. Thus, it faces a demand curve that is negatively sloped and highly elastic because competing firms produce many close substitutes.
♣ Ex: each firm produces its own brand

2) All firms have access to the same technology and so have the SAME COST curves. big assumption due to supply chains

3) The industry contains so MANY firms that each one IGNORE competitors when making price and output decisions. not engaging in competitive behavior with other firms, just the # of firms affect demand curve and price you get (different than oligopoly)

4) Firms are free to enter and exit the industry – no long-run profits


Long-run for monopolistic competition?

What happens if the firms are making:
- profits
- breakeven
- losses

NOT producing at minimum LRAC = just shy of the minimum

(MC still intersects LRAC at its minimum)

If making profits in short-run:
- attract new firms
- decrease the demand for each existing firm, shift demand left
- demand shifts left until profits = 0

If breaking even in short-run:
- no incentive to leave or enter the industry

If losing money in short-run:
- firms will leave the industry
- increase the demand for each existing firm, shift demand right
- demand shifts right until profits = 0 (P = ATC)


Monopolistic competition and welfare

*Monopolistically competitive markets do not have all the desirable welfare properties of perfectly competitive markets = exists Deadweight Loss

Because P > MC (charging more than competitive price) and market quantity < socially efficient quantity.


Oligopoly characteristics

Types of goods
# of firms

• Can sell identicial or differentiated goods

• Oligopoly is an industry that contains two or more firms, at least one of which produces a significant portion of the industry’s total output.

• Determining the level of output that maximizes profits is complicated for an oligopolistic firm because it must consider its rivals’ likely responses to its actions = interdependent

• Oligopolists exhibit strategic behaviour—behaviour designed to take account of the reactions of one’s rivals to one’s own behaviour.


Duopoly: agreement between two firms

Duopoly collusion in class example

Ex; monopoly quantity is 60, price is $40, PROFIT (max profit, not max revenue) is $1800

What happens if one firm breaks the agreement and produces MORE (40 units)

Find Nash Equilibrium?

Two firms will produce quantities that ADD to the monopoly output (ex: 30 each)

Two firms will charge the Monopoly Price ($40 per unit)

*this is where joint profits are maximized, however each firm has an incentive to increase production to increase individual profits

If one firm produces 40 units:
- find new monopoly output is 30 + 40 = 70 units
- find new monopoly price = $35 (given chart)

Revenue for the cheating firm = P*X = $35 * 40 = 1400
Cost = (40/70)*total combined cost @$35 = $400
Profit = Rev. - Cost = 1400 - 400 = $1000

Nash Equilibrium:
- best strategy considering other firm's strategies
- cannot increase profit by changing decision of how much to produce
--> change each individual firm's Q and see if they would want to change their Q based on profits

If the non-cheating firm knew that the cheating firm was producing 40 units, then the non-cheating firm would also produce 40 units because of greater profits
- both firms would NOT want to change their production, as increasing production would not result in an increase in profits = Nash equilibrium


What happens as the size of the oligopoly increases? (increase in the # of firms in the market)

- price effect becomes smaller
- oligopoly looks more like competitive market
- P approaches MC
- market quantity approaches perf. competitive quantity


Basic Dilemma of Oligopolies

If firms cooperate (collusive outcome or cooperative equilibrium), then they maximize joint profits

No cooperation = non-cooperative outcome
However each firm has the incentive to cheat and obtain greater profits


Game Theory players etc.

When game theory is applied to oligopoly:
¥ the players are firms.
¥ their game is played in the market.
¥ their strategies are their price or output decisions.
¥ the payoffs are their profits. shown in the Payoff Matrix

¥ If the two firms “cooperate” to jointly act as a monopolist, each earns large profits
¥ If the two firms “compete”, both firms earn low profits


Pay-off Matrix:
Find the -

Dominant Strategies of each player
Nash Equilibrium

Dominant Strategy of each player: A strategy that is the best for a firm, NO MATTER what strategies other firms use
- if other player does strategy 1, what will I do? = star it
- if other player does strategy 2, what will I do? = star it
If I do the SAME strategy in both cases, I have a dominant strategy
If I have different strategies DEPENDING on what Firm A chooses, then I have no dominant strategy
(repeat for other player)

Nash Equilibrium:
- usually intersection of dominant strategies
- if other player does strategy 1, what will I do? = star it
- if other player does strategy 2, what will I do?
- If I do strategy 1, what will other player do?
- If I do strategy 2, what will other player do?
Two check marks in the quadrant = Nash Equilibrium
- to explain why, go through each quadrant and see if the players have an incentive to move
Ex: If i know the other player is going to produce 1/2Q, then I will move and produce 2/3Q (not nash)


If the game is played for many rounds, what happens?

Dominant strategies may not consider long-run benefits of COOPERATING (higher pay-off by cooperating, and then cheating for the last, single shot round)


Types of barriers to entry: Oligopoly

1) Brand Proliferation as an Entry Barrier
2) Advertising
3) Predatory pricing
♣ A firm will not enter a market if it expects continued losses
after entry.
♣ EXISTING firms can create such an expectation by keeping prices below their own costs until the entrant goes bankrupt.
♣ The existing firm sacrifices profits, but it also discourages potential
future rivals.


Are oligoplies efficient?

o To the extent that price remains above competitive levels (and output below), oligopolies will be less efficient than perfect competition.