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Chapter 11.docx

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Economics (Arts)
ECON 208
Sebastien Forte

Chapter 11  Most industries in Canada have either a large number of small firms or a small number of large firms  Imperfectly competitive firms have differentiated products and often engage in non-price competition  Strategic behaviour is a key feature of oligopoly  For industries with many small firms, the perfectly competitive model does not adequately explain many industries that have a large number of relatively small firms  For industries with a few large firms, most modern industries that are dominated by large firms contain several firms and these are not competitive markets.  Industrial Concentration: the concentration ratio measures economic power in an industry shows the market shares of largest 4 or 8 producers (it shows the clout of large and small firms)  Defining a market with a reasonable accuracy is difficult.  Sometimes the market is much smaller than the whole country. Other times, it is much larger than the entire country  Ex. Of concentration ratio: in petroleum and coal, and beverage and tobacco products, the concentration ratios are 50% plus Machinery, fabricated materials and clothing have very low concentration ratios  Due to globalization, a long firm in one Canadian industry may be competing with foreign firms operating in Canada (ex. Bombardier competes with a big company in Brazil) What is imperfect competition?  A differentiated product: a group of products that are similar enough to be called the same product but different enough that they can have different prices  Most firms in imperfectly competitive markets sell differentiated products- ex. Laundry soaps, beer, cars, running shoes (anything you can find in a no name brand, things with many different products at different prices)  Typically, firms are price setters.  Often, these prices vary only slowly over time  Firms often let output vary in response to demand chocks to avoid costs of changing prices (unless the shock is long-lasting)  Imperfectly competitive firms typically engage in behaviour that is absent in either monopoly or perfect competition: o Firms often spend large sums of money of advertising o Firms often engage in non-price competition o Firms may create entry barriers to prevent erosion of current pure profits  Industries with a large number of small firms – the theory of monopolistic competition  Industries with a small number of large firms- the theory of oligopoly  A key difference is strategic behaviour displayed by firms  The assumptions of monopolistic competition 1. Each firm produces one variety of the differentiated product. Thus, it faces a negatively sloped and highly elastic demand curve. 2. All firms have access to the same technology and thus have the same cost curves 3. The industry contains so many firms that each one ignores competitors when making price and output decisions (it is large enough that they don’t have pricing power, but no large enough that there is another seller with the exact same product) 4. Firms are free to enter and exit the industry  In the short run, a monopolistically competitive firm faces a downward sloping demand curve and maximizes profits by equating MR and MC (on the Q line)  If the firm earns positive profits, it will attract firms but only to the point where they don’t need to spend more on advertising and research than their positive profits would get them  When the firm is earning positive profits, it becomes an incentive for new firms to enter the industry. The existing market demand must be shared among a large number of firms  As new firms enter, they take some of the market share existing firms already have, profits per firm are reduced, and eventually eliminated.  In the LR equilibrium, each firm has excess capacity  This result is often called the excess-capacity theorem of monopolistic competitive (capacity is the minimum of the LRAC curve)  Excess capacity means you are producing below the minimum cost (the lowest level of ATC) which means there is some inefficiency  In contrast to perfect competition, the LR equilibrium in monopolistic competition does not minimize ATC – there is excess capacity  This excess c
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