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Chapter 15

Chapter 15 Full Notes

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ECON 1131
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Chapter 15 Softening Competition: From Collusion to Effectively Competitive Markets  Economists have come to understand much of firm’s behavior in product markets as an attempt to soften competition  Firms try to capture customers and distance themselves from other firms so that they can earn and maintain profits  Cooperative/Collusive behavior: collusion by two more firms in which they explicitly agree not to compete with one another Cooperative Behavior: the Case of an Industry Cartel  Cartel: an organization of some or all of the firms in an industry established for the purpose of maximizing total profits of all the cooperating firms  The cartel performs two functions for its members: o 1: it determines the price and the total cartel output that maximizes profits for the firms as whole o 2: it divides up the total cartel profits by setting production quotas for each firm  Cartels and other cooperative behaviors are difficult to maintain because there is a strong incentive to cheat Maximizing Cartel Profits  Cartels arise out of oligopolies  Because the firms have agreed to cooperate, each is able to view the market as a pure monopolist would, rather than as one small firm among many would  Apure monopolist maximizes profit bye producing at the intersections of its marginal revenue and marginal cost curves and by charging the corresponding price along its demand curve  The cartel maximizes industrywide profit in the same way  The profit maximizing cartel output is Q ac the intersection of MR and S, the profit maximizing price is P cn the market demand curve D  The cartel has to enforce a reduction of total output from Q te Q ic order to maximize industry profits  The cartel imposes production quotas on each firm below q (say, q ) such that the e c sum of every firms q ecuals Q c Cheating: The Prisoner’s Dilemma  Problem is that each firm would like to increase production beyond its quota and has an easy way of doing so  All a firm needs to do is cheat on its fellow members by secretly lowering its price slightly below the cartel price  If all other firms honor the cartel price, the cheater sells as much as he wants at his price  The profits from cheating are far greater and the word gets out, however all firms lower their prices to protect their share of the markets, and the cartel agreement falls apart and the market returns to zero profit competitive equilibrium  The dilemma is that cheat-cheat is the only equilibrium for this game, even though both firms know that they are better off if neither cheats  The incentive to cheat is so strong that cartels are unlikely to survive unless they build in some method for dealing with cheating right from the beginning *graph pg 385 Firm 2 Do not cheat Cheat Do not Cartel Cartel Loss Maximum cheat profit Profit profit Maximum Loss 0 profit 0 profit Cheat profit Firm 1 U.S. Policy Towards Cooperative Behavior  Cartels and other forms of explicit collusion among firm were outlawed by the ShermanAntitrustAct  Noncooperative behavior: independent decision making by firms in which they openly compete with one another Monopolistic Competition  Monopolistic competition is much closer to perfect competition than it is to pure monopoly  Monopolistic competition: a market structure characterized by a large number of firms producing slightly differentiated products, by easy entry and exits, and by the unimportance of strategic behavior o The assumption of a large number of firms is certainly accurate in the US o The assumption of minimal barriers to entry and exit is also accurate for most product markets in the US o The assumption that firms do not behave strategically is NOT entirely accurate Product Differentiation  Product differentiation: a situation in which buyers distinguish or identify products by the firms that produce them, also refers to firm’s attempts to distinguish their products from similar products produced by other firms in the industry  The one noncompetitive element of monopolistic competition is the assumption that products are differentiated by firm  The degree of product differentiation in monopolistic competition is nowhere near as strong as it is in pure monopoly  Firms in effectively competitive markets consciously attempt to differentiate their products to soften competition* o They search for a niche in the marketplace that will distance them from their competitors in the eyes of consumers and allow them to capture a share of the market o To the extent firms succeed, they achieve a degree of market power-their demand curves are downward sloping 4 Principal Strategies for Differentiating Products  Horizontal differentiation: a form of product differentiation in which a firm distinguishes its product from the products of other firms in the industry by choosing where to locate its place of business o Basically geographic location  Vertical differentiation: a form of product differentiation in which a firm distinguishes its produce from the products of other firms in the industry based on quality  Varying product characteristics: o Firms attempt to differentiate their products by varying the characteristics they make available-primarily on the basis of tastes  Advertising and sales promotion: o Providing information to consumers in conjunction with the other three means of product differentiation o Use ad campaigns and sales promos to make consumers aware of the location of their store and the quality and characteristics of their products Equilibrium Under Monopolistic Competition The Short-Run Equilibrium  Firms are price setters not takers  The firm maximizes profit by producing q at thesrntersection of MR an
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