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ECON 110 Notes

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Queen's University
ECON 110
Ian James Cromb

Chapter 11 Imperfect Competition and Strategic Behaviour Market Structures -monopoly and perfect competition can be thought of as the 2 extremes of market structure -there are many kinds of market structure that lie between -these can be separated along many dimensions -number of firms -form of competition -over quantity -over price -over products -over product quality -over advertising or other “non-price” items -extent of innovation -raise interesting issues that tell us a lot about the kind of “competition” we see in our daily lives as consumers -one way of classifying or organizing these ideas Number of Firms? one a few many (free Monopoly Oligopoly entry) (Ch 10) (Ch 11) Products? different identical Monopolistic Perfect Competition Competition (Ch 11) (Ch 9) -other than perfect competition, all of these market structures can be thought of as forms of “imperfect competition” Monopolistic Competition -a market structure that contains some “monopoly” elements as well as some that are found in “perfect competition” -differentiated (heterogeneous) products -many firms and products that are best thought of as being in the same industry EXAMPLES: books, restaurants, clothing, etc. Assumptions of (Conditions for) Monopolistic Competition: 1. each firm is a monopolist in its own product 2. there are many close substitutes -firms take the existing number of products in the market and therefore the reactions of its rivals as a given 3. free entry/exit to the industry -firms must enter or exit with their product -each firm is a “price-maker” but an “other products-taker” Basic Analytics -market demand is divided among the various products (firms) according to what individual consumers think is their favourite product given the available alternatives -each individual firm’s demand depends on the price of its product, but also the availability of other products D i qi= f(pi, availability of other products) p i D i qi Short Run Equilibrium -in the short run, can have profits (p > ATC) or losses (ATC > p > AVC) as usual $ MC i pi SRAC i D i MR i qi qi -but with free entry/exit -profits cause entry -when a firm enters it brings its product -shift existing firms’ demand left -losses cause exit -when a firm exits, it takes its product -shift existing firms’ demand right Long Run Equilibrium -long run equilibrium satisfies the following: 1. must be a SR equ’m, i.e. MR(q i) = MC(q)i 2. firms must be cost minimizing, i.e. operating on LRAC 3. firms must be earning zero economic profits, i.e. i = AC(q)i $ LRAC i MC i pi Di MR i q i qi Characteristics of LR Equilibrium -at point 1 in the diagram: pi > MC(q), ipricing power like monopoly) pi = AC(q),i(π =0 like perfect competition) Monopolistic Comp. vs Perfect Comp. -a perfectly comp. firm would be operating at 2 in the diagram -the differences are: pi > min LRAC, (“excess capacity theorem”) -society is not obtaining output at the lowest possible cost? pi > MC(q), iDWL like monopoly?) Is Monopolistic Competition Really Inefficient? -short answer is that we can’t really say -some other possible production points Force Firms to 3 -eliminates DWL in the firms’ production levels -however, losses would require subsidies from the government to continue in operation -taxes to fund subsidies would cause DWL elsewhere in the economy Force Firms to 2 -price would lie above the firms’ demand curves -would require the elimination of some firms (shifting existing firms’ demands until they go through 2) -elimination of the firms implies elimination of the products, but product selection is valuable to consumers -so there is a tradeoff between standard efficiency and “product selection” efficiency (optimal number of products) -difficult to resolve without making ad hoc judgments about the relative weightings of these two ideas -it is doubtful whether the government can do any better than what the market produces in terms of the tradeoff Empirical Relevance of Monopolistic Comp. -there are many industries that have extensive product differentiation, but very few firms -detergents, chocolate bars, etc. -monop. comp. is not
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