EC-103Semester 2Lectures 6 & 7Market structure andImperfect Competition
Most markets fall between the two extremes ofmonopoly and perfect competition• An imperfectly competitive firm– would like...
Imperfect competition• An oligopoly– an industry with a few producers– each recognizing that its own price depends both on...
4Market structureNumberof firmsAbility toaffectpriceEntrybarriersExamplePerfect competitionImperfect competition:Monopolis...
Monopolistic competition• Characteristics:– many firms– no barriers to entry– product differentiation• so the firm faces a...
Monopolistic competition (2)• Firms end up in TANGENCYEQUILIBRIUM, makingnormal profits• Firms do not operate atminimum LA...
Oligopoly• A market with a few sellers• The essence of an oligopolistic industry is theneed for each firm to consider how ...
Collusion and cartels• COLLUSION– an explicit or implicit agreement betweenexisting firms to avoid or limit competitionwit...
Collusion is difficult if:• There are many firms in the industry• The product is not standardized• Demand and cost conditi...
The kinked demand curveQ0P0Quantity£Consider how a firm mayperceive its demand curveunder oligopoly.It can observe the cur...
Q0P0Quantity£The kinked demand curve (2)The firm may expect rivalsto respond if it reducesits price, as this will be seena...
The kinked demand curve (3)…but for a price increaserivals are less likely toreact,so demand may berelatively elasticabove...
The kinked demand curve (4)Given this perception, thefirm sees that revenue willfall whether price is increasedor decrease...
Game theory: some key terms• Game– a situation in which intelligent decisions arenecessarily interdependent• Strategy– a g...
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.Game Theory and theEconomics of CooperationGame ...
Game Theory and the Economicsof CooperationBecause the number of firms in anoligopolistic market is small, each firmmust a...
The Prisoners’ DilemmaThe prisoners’ dilemma providesinsight into the difficulty inmaintaining cooperation.Often people (f...
The Prisoners’ DilemmaBonnie’s DecisionConfess Remain SilentConfessRemainSilentClyde’sDecisionClyde gets8 yearsBonnie gets...
The Prisoners’ DilemmaThe dominant strategy is the beststrategy for a player to followregardless of the strategies pursued...
The Prisoners’ DilemmaCooperation is difficult tomaintain, because cooperation isnot in the best interest of theindividual...
Oligopolies as aPrisoners’ DilemmaIraq’s DecisionHighProductionLow ProductionHighProductionLowProductionIran’sDecisionIran...
Oligopolies as aPrisoners’ DilemmaSelf-interest makes it difficult for theoligopoly to maintain a cooperativeoutcome with ...
Why People SometimesCooperateFirms that care about future profits willcooperate in repeated games rather thancheating in a...
The Prisoners’ Dilemma GameConsider two firms in a duopoly each with a choiceof producing “high” or “low” output:Firm B ou...
The Prisoners’ Dilemma• Each firm has a dominant strategy toproduce high• so they make 1 unit profit each• but they would ...
More on collusion• The probability of cheating may be affectedby agreement or threats• Pre-commitment– an arrangement, ent...
Strategic entry deterrence• Some entry barriers are deliberately erectedby incumbent firms:– threat of predatory pricing– ...
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Lectures 6 & 7 05.03.13

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  • See the introduction to Chapter 9 in the main text.
  • See the introduction to Chapter 9 in the main text.
  • See the introduction to Chapter 9 in the main text, and Table 9-1.
  • See Section 9-2.
  • See Section 9-2, and Figure 9-2.
  • See Section 9-3.
  • See Section 9-3.
  • See Section 9-3.
  • See Section 9-3, and Figure 9-4.
  • See Section 9-3, and Figure 9-4.
  • See Section 9-3 in the main text, and Figure 9-4.
  • See Section 9-3 in the main text, and Figure 9-4.
  • See Section 9-4 in the main text.
  • 16
  • 17
  • 17
  • 19
  • 19
  • 17
  • 20
  • 21
  • See Section 9-4 in the main text, and Figure 9-5.
  • See Section 9-4 in the main text.
  • See Section 9-4 in the main text.
  • See Section 9-7 in the main text.
  • Lectures 6 & 7 05.03.13

    1. 1. EC-103Semester 2Lectures 6 & 7Market structure andImperfect Competition
    2. 2. Most markets fall between the two extremes ofmonopoly and perfect competition• An imperfectly competitive firm– would like to sell more at the going price– faces a downward-sloping demand curve– recognizes its output price depends on the quantityof goods produced and sold© The McGraw-Hill Companies, 2002
    3. 3. Imperfect competition• An oligopoly– an industry with a few producers– each recognizing that its own price depends both on itsown actions and those of its rivals.• In an industry with monopolistic competition– there are many sellers producing products that are closesubstitutes for one another– each firm has only limited ability to influence its outputprice.© The McGraw-Hill Companies, 2002
    4. 4. 4Market structureNumberof firmsAbility toaffectpriceEntrybarriersExamplePerfect competitionImperfect competition:Monopolistic competitionOligopolyMonopolyManyManyFewOneNilSmallMediumLargeNoneNoneSomeHugeFruit stallCorner shopCarsPost Office© The McGraw-Hill Companies, 2002
    5. 5. Monopolistic competition• Characteristics:– many firms– no barriers to entry– product differentiation• so the firm faces a downward-sloping demand curve– The absence of entry barriers means that profits arecompeted away...© The McGraw-Hill Companies, 2002
    6. 6. Monopolistic competition (2)• Firms end up in TANGENCYEQUILIBRIUM, makingnormal profits• Firms do not operate atminimum LAC• Price exceeds marginal cost• Unlike perfect competition, thefirm here is eager to sell moreat the going market price.P1=AC1£OutputQ1DMRACMCF© The McGraw-Hill Companies, 2002
    7. 7. Oligopoly• A market with a few sellers• The essence of an oligopolistic industry is theneed for each firm to consider how its ownactions affect the decisions of its relatively fewcompetitors• Oligopoly may be characterized by collusionor by non-co-operation
    8. 8. Collusion and cartels• COLLUSION– an explicit or implicit agreement betweenexisting firms to avoid or limit competitionwith one another• CARTEL– is a situation in which formal agreementsbetween firms are legally permittede.g. OPEC
    9. 9. Collusion is difficult if:• There are many firms in the industry• The product is not standardized• Demand and cost conditions are changingrapidly• There are no barriers to entry• Firms have surplus capacity
    10. 10. The kinked demand curveQ0P0Quantity£Consider how a firm mayperceive its demand curveunder oligopoly.It can observe the currentprice and output,but must try to anticipaterival reactions to anyprice change.
    11. 11. Q0P0Quantity£The kinked demand curve (2)The firm may expect rivalsto respond if it reducesits price, as this will be seenas an aggressive move… so demand in responseto a price reduction is likelyto be relatively inelasticThe demand curve willbe steep below P0.D
    12. 12. The kinked demand curve (3)…but for a price increaserivals are less likely toreact,so demand may berelatively elasticabove P0so the firm perceivesthat it faces a kinkeddemand curve.DQ0P0Quantity£
    13. 13. The kinked demand curve (4)Given this perception, thefirm sees that revenue willfall whether price is increasedor decreased,so the best strategy is to keepprice at P0.Price will tend to be stable,even in the face of an increasein marginal cost.DQ0P0Quantity£
    14. 14. Game theory: some key terms• Game– a situation in which intelligent decisions arenecessarily interdependent• Strategy– a game plan describing how the player will act ormove in every conceivable situation• Dominant strategy– where a player’s best strategy is independent ofthose chosen by others
    15. 15. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.Game Theory and theEconomics of CooperationGame theory is the study of how peoplebehave in strategic situations.Strategic decisions are those in whicheach person, in deciding what actions totake, must consider how others mightrespond to that action.
    16. 16. Game Theory and the Economicsof CooperationBecause the number of firms in anoligopolistic market is small, each firmmust act strategically.Each firm knows that its profit depends notonly on how much it produced but also onhow much the other firms produce.
    17. 17. The Prisoners’ DilemmaThe prisoners’ dilemma providesinsight into the difficulty inmaintaining cooperation.Often people (firms) fail to cooperatewith one another even when cooperationwould make them better off.
    18. 18. The Prisoners’ DilemmaBonnie’s DecisionConfess Remain SilentConfessRemainSilentClyde’sDecisionClyde gets8 yearsBonnie gets8 yearsBonnie gets20 yearsBonnie gets1 yearBonniegoes freeClyde gets20 yearsClyde gets1 yearClyde goesfree
    19. 19. The Prisoners’ DilemmaThe dominant strategy is the beststrategy for a player to followregardless of the strategies pursued byother players.
    20. 20. The Prisoners’ DilemmaCooperation is difficult tomaintain, because cooperation isnot in the best interest of theindividual player.
    21. 21. Oligopolies as aPrisoners’ DilemmaIraq’s DecisionHighProductionLow ProductionHighProductionLowProductionIran’sDecisionIran gets$40 billionIraq gets$40 billionIraq gets$30 billionIraq gets$50 billionIraq gets$60 billionIran gets$30 billionIran gets$50 billionIran gets$60 billion
    22. 22. Oligopolies as aPrisoners’ DilemmaSelf-interest makes it difficult for theoligopoly to maintain a cooperativeoutcome with low production, high prices,and monopoly profits.
    23. 23. Why People SometimesCooperateFirms that care about future profits willcooperate in repeated games rather thancheating in a single game to achieve aone-time gain.
    24. 24. The Prisoners’ Dilemma GameConsider two firms in a duopoly each with a choiceof producing “high” or “low” output:Firm B outputHigh LowHigh 1 1 3 0FirmAoutputLow 0 3 2 2
    25. 25. The Prisoners’ Dilemma• Each firm has a dominant strategy toproduce high• so they make 1 unit profit each• but they would both be better off producinglow– as long as they can be sure that the other firmalso produces low.• So collusion can bring mutual benefits• but there is incentive for each firm to cheat
    26. 26. More on collusion• The probability of cheating may be affectedby agreement or threats• Pre-commitment– an arrangement, entered voluntarily, restrictingfuture options• Credible threat– a threat which, after the fact, is optimal to carryout
    27. 27. Strategic entry deterrence• Some entry barriers are deliberately erectedby incumbent firms:– threat of predatory pricing– spare capacity– advertising and R&D– product proliferation• Actions that enforce sunk costs on potentialentrants

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