competition economics 2

This is about how firms behave. Looking at what constrains their behaviour – other firms, consumers, government policy….. This is a third year course in economics – we are looking at important economic models/theories to discuss quesBons that are in the papers and on Ministers desks every day. My job is to make sure you know the economics and you have some idea of how to use it.

3

Stylised benchmark Much of industrial economics/compeBBon economics is about what happens when these condiBons are not met

6

See Figure 3.1 and 3.2 in LWG showing equilibrium. Horizontal firm demand curve because price taker (infinite price elasBcity of demand). AR=MR=Firm demand Firm supply curve=SRMC curve above Average Cost Curve. Say at P1 (greater than AC) – making abnormal profit Get entry because aWracted by potenBal for entry, which will shiX industry supply curve, reducing price to P2. Keep reducing unBl reach Price equal to AC. If have higher then will get entry with cheaper prices. If go lower will make loss. Least efficient firms (i.e. those with higher AC) don’t survive. Surviving firms produce efficiently given technology. Work with example: Demand: p=100-‐15q (linear demand funcBon) TC=10q (constant returns to scale, no fixed costs) π=TR-‐TC=100q-‐15q2-‐10q=90q-‐15q2 p=MC=10 implies 100-‐15q=10 which implies q=6 π=0

7

Natural monopoly – one firm produces at lower AC than more than one firm compeBng because of decreasing returns to scale.

8

See LWG Figure 3.3 to see equilibrium Profit maximisaBon at MR=MC Higher price and less output than perfect compeBBon Work with example: Demand: p=100-‐15q (linear demand funcBon) TC=10q (constant returns to scale, no fixed costs) π=TR-‐TC=100q-‐15q2-‐10q=90q-‐15q2 πmax where MR=MC which is 90-‐30q=0 which implies q=3, p=55, π=135

9

See LWG Figure 3.8 to see equilibrium

11

Note that in Ch 10 of LWG Another model that does not really stand up to scruBny because of limiBng assumpBons (no sunk costs, no barriers to entry, no long-‐run analysis taking account of incumbent reacBons) But has brought to fore importance of considering potenBal entry as constraint on firms, as well as exisBng market structure. Although a staBc model, its importance is in considering dynamic interacBons.

13

Look at monopoly pricing diagram. At price above AC (where making profits), firms will enter and take some of demand. At price below AC firm will make losses Equilibrium where price equal to AC Won’t observe entry but potenBal entry will constrain price.

14

Compare Consumer Surplus and Producer surplus under perfect compeBBon and monopoly – deadweight loss of monopoly Can do similar deadweight loss analysis for different market structures

18

Look at deadweight loss diagram and see what happens if reduce monopoly costs

19

Need to look at long-‐run (even medium-‐term) implicaBons

20

Aghion P and Griffith R (2005), Compe&&on and Growth: Reconciling Theory and Prac&ce, MIT Press Very interesBng book but some of it Is technical economic growth theory – introducBon gives good flavour of the issues without the economic growth theory. Mixed theories and empirical evidence may suggest that need to consider other factors affecBng growth policy alongside compeBBon. There are issues relaBng to the Bming of the policy – e.g. the extent to which new technologies and required factors of producBon are in place (how close to technology and producBon fronBer) – and the extent to which monopoly is considered a ‘temporary’ soluBon to promote innovaBon or created indefinitely.

21

Start looking at what determines compeBBon in a market by using Structure-‐Conduct-‐Performance model. We will spend much of the rest of the course unpicking the rigid assumpBons of the model but recognise upfront that it provides a useful framework for debaBng the issues.

22

competition economics 2

Documents