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MGEA02H3 (28)
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Department
Economics for Management Studies
Course Code
MGEA02H3
Professor
Gordon Cleveland

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Chapter 11 Imperfect Competition and Strategic Behaviour Notes
11.1 The Structure of the Canadian Economy
Industries with Many Small Firms
x about two-thirds of Canada’s total annual output is produced by industries made up of firms that are small relative to the size of
the market in which they sell and the PC model does quite well in explaining behaviour of some of these industries
x theory of monopolistic competition was originally developed to help explain economic behaviour and outcomes in industries in
which there are many small firms, each with some market power
Industries with a Few Large Firms
x theory of oligopoly is about industries in which there are small number of large firms, each with market power, that compete
Industrial Concentration
x concentration ratio : the fraction of total market sales (or some other measure of market activity) controlled by a specific
number of the industry’s largest firms
11.2 What is Imperfect Competition?
Firms Choose Their Products
x differentiated product : a group of commodities that are similar enough to be called the same product but dissimilar enough that
all of them do not have to be sold at the same price
x most firms in imperfectly competitive markets sell differentiated products; in such industries, the firm itself must choose which
characteristics to give the products that it will sell
Firms Choose Their Prices
x administered price : a price set by the conscious decision of the seller rather than by impersonal market forces
x price setter : a firm that faces a downward sloping demand curve for its product; it chooses which price to set
x in market structures other than perfect competition, firms set their prices and then let demand determine sales; changes in market
conditions are signalled to the firm by changes in the firm’s sales
Non – Price Competition
x firms in imperfect competition behave in other ways that are not observed under either perfect competition or monopoly
x first, many firms spend large sums of money on advertising
x second, many firms engage in a variety of other forms of non-price competition, such as product guarantees
x third, firms in many industries engage in activities that appear to be designed to hinder the entry of new firms, thereby preventing
existing pure profits from being eroded by entry
11.3 Monopolistic Competition
x monopolistic competition : market structure of an industry in which there are many firms and freedom of entry and exit but in
which each firm has a product somewhat differentiated from the others, giving it some control over its price
The Assumptions of Monopolistic Competition
1. Each firm produces one specific brand of the industry’s differentiated product. Each firm thus faces a demand curve that,
although negatively sloped, is highly elastic because competing firms produce many close substitutes.
2. The industry contains so many firms that each one ignores the possible reactions of its many competitors when it makes its own
price and output decisions. In this respect, firms in monopolistic competition are similar to firms in perfect competition.
3. There is freedom of entry and exit in the industry. If profits are being earned by existing firms, new firms have an incentive to
enter. When they do, the demand for industry’s product must be shared among more brands.
Predictions of the Theory
x excess-capacity theorem : the property of long-run equilibrium in monopolistic competition that firms produce on the falling
proportion of their long-run average cost curves; this results in excess capacity, measured by the gap between present output and
the output that coincides with minimum average cost
x in long-run equilibrium in monopolistic competition, goods are produced at a point where average total costs are not at their
minimum, in contrast to perfect competition, where they are produced at their lowest possible cost
x from societys point of view, there is a trade-off between producing more brands to satisfy diverse tastes and producing fewer
brands at a lower cost per unit
11.4 Oligopoly and Game Theory
x oligopoly : industry that contains 2 or more firms, at least 1 of which produces significant portion of industry’s total output
x strategic behaviour : behaviour designed to take account of the reactions of one’s rivals to one’s own behaviour
The Basic Dilemma of Oligopoly
x oligopolistic firms often make strategic choices; they consider how their rivals are likely to respond to their own actions
x cooperative (collusive) outcome : a situation in which existing firms cooperate to maximize their joint profits
x non-cooperative outcome : industry outcome reached when firms maximize own profit without cooperating with other firms
Some Simple Game Theory
x game theory : theory that studies decision making in situations in which one anticipates reactions of others to its own actions
x when game theory is applied to oligopoly, the players are firms, their game is played in the market, their strategies are their
prices or output decisions, and the payoffs are their profits
x duopoly : an industry that contains only two firms
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Chapter 11 Imperfect Competition and Strategic Behaviour Notes 11.1 The Structure of the Canadian Economy Industries with Many Small Firms N about two-thirds of Canadas total annual output is produced by industries made up of firms that are small relative to the size of the market in which they sell and the PC model does quite well in explaining behaviour of some of these industries N theory of monopolistic competition was originally developed to help explain economic behaviour and outcomes in industries in which there are many small firms, each with some market power Industries with a Few Large Firms N theory of oligopoly is about industries in which there are small number of large firms, each with market power, that compete Industrial Concentration N concentration ratio : the fraction of total market sales (or some other measure of market activity) controlled by a specific number of the industrys largest firms 11.2 What is Imperfect Competition? Firms Choose Their Products N differentiated product : a group of commodities that are similar enough to be called the same product but dissimilar enough that all of them do not have to be sold at the same price N most firms in imperfectly competitive markets sell differentiated products; in such industries, the firm itself must choose which characteristics to give the products that it will sell Firms Choose Their Prices N administered price : a price set by the conscious decision of the seller rather than by impersonal market forces N price setter : a firm that faces a downward sloping demand curve for its product; it chooses which price to set N in market structures other than perfect competition, firms set their prices and then let demand determine sales; changes in market conditions are signalled to the firm by changes in the firms sales Non Price Competition N firms in imperfect competition behave in other ways that are not observed under either perfect competition or monopoly N first, many firms spend large sums of money on advertising N second, many firms engage in a variety of other forms of non-price competition, such as product guarantees N third, firms in many industries engage in activities that appear to be designed to hinder the entry of new firms, thereby preventing existing pure profits from being eroded by entry 11.3 Monopolistic Competition N monopolistic competition : market structure of an industry in which there are many firms and freedom of entry and exit but in which each firm has a product somewhat differentiated from the others, giving it some control over its price The As
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