Microeconomics Unit 4 Imperfect Competition

Unit 4: Imperfect Competition Characteristics of the Four Market Structures Perfect Competition Monopolistic Competition Oligopoly Monopoly ¥ Many small firms ¥ Large number of sellers ¥ A Few Large Firms ¥ One firm (Less than 10) ¥ Identical products ¥ Differentiated products ¥ Unique product ¥ High Barriers ¥ Easy to enter and exit ¥ Easy to enter and exit ¥ High barriers to ¥ Control Over Price enter and exit ¥ No need to advertise ¥ A lot of non-price competition ¥ Mutual ¥ Price Maker ¥ Firms are ÒPrice Interdependence TakersÓ ¥ Some control over price Demand and Marginal Revenue Elastic and Inelastic Range Why is demand greater than marginal revenue for all Price imperfectly competitive firms? Elastic Inelastic To sell another unit, the firm must lower the price of the next unit and the units it could have sold at a higher price. (It cannot price discriminate) Why are monopolies inefficient? 1. Price is too high 2. Quantity is too low 3. They cause deadweight loss (P > MC) Monopoly Graph (profit) Draw and label a monopoly making profit Price MC Total Revenue MR Demand Quantity PM ATC Profit QM MR D Quantity Monopoly Graph (loss) Draw and label a monopoly making a loss Price MC ATC PM Loss MR QM Demand Quantity Total Revenue Quantity Barriers to Entry Identify four common barriers that allow companies to gain and maintain market power 1. Economies of Scale 2. Control of Scare Resources 3. Governmental or Legal Barriers 4. Technological Superiority Natural Monopolies What is a natural monopoly? An industry where it is cheaper and more efficient to have a monopoly rather than several smaller competing firms. Example: electric companies Regulating Monopolies Draw a natural monopoly. Identify: unregulated quantity (QM), socially optimal quantity (QSO) and fair return quantity (QFR) Price Calculation Practice MC ATC MR QM Demand QFR QSO Quantity 1. If this monopoly is unregulated, what is the total revenue, total cost, and profit? TR= $1000, TC = $800, Profit =$200 2. Shade in Deadweight loss See above Monopoly Practice If this was competitive market 1. Price and quantity: P4, Q2 2. Consumer surplus: ACP4 If this is an unregulated monopoly 3. Price and quantity: P5, Q1 4. Consumer surplus: ABP5 5. Deadweight loss: BCG 6. Quantity total revenue maximized:Q3 MR=0 7. Quantity if it perfectly price discriminates:Q2 8. Elastic range of the demand curve: AD 9. If the government placed a per unit tax on this monopoly then price __↑_ and quantity __↓_ 10. If the government placed a lump sum subsidy on this monopoly then price same and quantity same. (Lump sum subsidies donÕt shift MC) Price Discrimination Perfectly Price Discriminating Monopoly Identify the three conditions necessary for a firm to Draw and label a price discriminating monopoly price discriminate Price MC 1. The firm must not be a price taker 2. The firm must be able to segregate the market and identify consumers that are willing to pay more 3. The firm must be able to make sure consumers ATC Profit cannot resell the product to other consumers If a regular unregulated monopoly started perfectly price discriminating, what would happen to consumer surplus and deadweight loss? There would be no consumer surplus and no D = MR deadweight loss QM Quantity Oligopolies and Game Theory Assume that two business owners are deciding 1. If David decides to advertise now and Lindsey between advertising now and advertising later. The decides to do it later, what is DavidÕs expected chart shows expected profit with LindseyÕs on the left profit? $1000 2. What is LindseyÕs dominant strategy? Now 3. What is DavidÕs dominant strategy? None 4. If both owners have the information but do not actively collude, what will be the outcome? Both will choose Now Assume the advertising company offers a deal that increases the profit for both owners by $2,000 but only if they advertise later. Based on these changes: 5. What is LindseyÕs dominant strategy? None 6. What is DavidÕs dominant strategy? Later Price Kinked Demand Curve Draw non-colluding oligopoly MC Nash Equilibrium Definition of Nash EquilibriumThe optimal outcome where neither player can make themselves better off by deviating from the current strategy ATC P Q MR D Assume these two firms can choose between pricing high and pricing low. What is the Nash Equilibrium? Quantity Firm 1 High, Firm 2 Low ($60, $90) Monopolistic Competition Draw a Mono. Comp. firm in long-run equilibrium Excess Capacity (define below and label on graph) Price MC The gap between the minimum ATC output and the profit maximizing output. Given current resources, the firm can produce at the ATC lowest costs (minimum ATC) but they decide not to. PMC If a monopolistically competitive firm is making a P = ATC, No profit in the short-run, what will happen to the demand economic profit and number of firms in the long run? in the long-run ¥ New firms enter to make profit ¥ Firms must share same amount of consumers ¥ Demand for each firm falls until each firm makes MR D Quantity no economic profit QMC What are examples of non-price competition? What are the two goals of advertising? ¥ Brand names or packaging 1. Increase the demand for the product or service ¥ Product attributes 2. Make the demand more inelastic ¥ Service ¥ Location