Imperfect Competition

Dr Murari Premnath Sharma Asso. Prof.

PDVVP Foundation’s

Institute of Business Management and Rural Development

Vilad Ghat, Ahmednagar.Maharashtra. India

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Market structure

Number of firms

Ability to affect price

Entry barriers

Example

Perfect competition Imperfect competition: Monopolistic competition Oligopoly Monopoly

Many Many Few One

Nil Small Medium Large

None None Some Huge

Fruit stall Corner shop Cars Post Office

Imperfect Competition

• Imperfectly Competitive Firms– Have some control over price– Price may be greater than the cost of production– Long-run economic profits are possible

Slide 4

Imperfect Competition• Various Forms of Imperfect Competition

– Pure Monopoly (most inefficient)• The only supplier of a unique product with no close

substitutes

– Oligopoly (more efficient than a monopoly)• A firm that produces a product for which only a few rival

firms produce close substitutes

– Monopolistic Competition (closest to perfect competition)

• A large number of firms that produce slightly differentiated products that are reasonably close substitutes for one another

– Duo Poly Competition (only two competition)• Two firms that produces products

The Essential Difference Between Perfectly and Imperfectly Competitive Firms

The perfectly competitive firm faces a perfectly elastic demand for its product.The imperfectly competitive firm faces a downward-sloping demand curve

In perfect competition Supply and demand determine equilibrium price. The firm has no market power.At the equilibrium price, the firm sells all it wishes.With imperfect competition The firm has some control over price or some market power.The firm faces a downward sloping demand curve.

Pure MonopolyMeaning:-

Monopoly is the form of market organization in which there is a single firm selling a commodity for which three are no close substitutes”. D. SalvatoreThe price is under the full control of the monopolist but not the demand is determined by purchasers.

Pure MonopolyCharacteristic

• Only one seller in market and large number of buyers.

• No Close Substitutes• Product totally differentiated• No free entry or exit/ Barriers to Entry. • Full Control over price• Price discrimination (different price to different Consumer)

• Imperfect information• Where a perfectly competitive firm is a price taker,

the monopolist is a price searcher.

Advantages/Disadvantages of Monopoly

Advantages 1) Research and Development2) Economic of Scale3) Competition for corporate control

Disadvantages 1. Prices and costs2. Power and wealth.

Basic Assumption of MonopolyAssumptions:-

1) There is one seller or producer of a homogeneous product.2) 2) There are no close substitutes for the product.3) The is pure competition in the factor market so that the price of

each input he buys is given to him.4) The monopolist is a rational being who aims at maximum profit

with the minimum of costs.5) There are many buyers on the demand side but non is in the

position to influence the price of the product by his individual actions. Thus the price of the product is given for the consumer.

6) The monopolist does not charge discriminating price. He treats all consumers alike and charges a uniform price for his product

7) Monopoly price is uncontrolled. Three are no restrictions on the power of the monopolist.

8) There is no threat of country of other forms.

Monopoly prices during short-run

1) Super Normal Profit2) Normal Profit3) Minimum Loss

Quantity

D

1 5 10

2218141062

MR

MC

ATC

Monopoly price during short run.

$

Quantity

D

1 5 10

2218141062 MR

MC

ATC

Monopolistically Competitive SR

$

Quantity

P*

D

1 5 10

Monopolist’s Demand Curve

Conditions for price Discrimination Under Monopoly

1) Market Imperfection2) Agreement among Rival Sellers3) Geographical or Tariff Barriers4) Differentiated Products.5) Ignorance of Buyers.6) Artificial Differences between Goods.7) Differences in Demand.

Monopolistic Competition

Monopolistic Competition Monopolistic competition refers to market situation where there are many firms selling a differentiated products. “ There is competition which is keen, through not perfect, among g many firms making very similar products”“ Monopolistic competition is a market structure where there is large number of small sellers, selling differentiated but close substitute products”

J.S Bains“The term monopolistic completion refers to the market structure in which the sellers do have a monopoly (they are the only sellers) of their own product, but they are also subjects to substantial competitive pressures from sellers of substitute products”. Baumol

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Monopolistic competitionCharacteristics:

• Many sellers in market / many firms/ Large No of Sellers• Differentiated products /product differentiation• Ease of entry or exit / no barriers to entry/ Freedom of Entry or

Exit. • Independent Behaviour • Products grops• Selling Costs. • Control over prices. • Information is readily available• Non-price competition usually occurs

• so the firm faces a downward-sloping demand curve– The absence of entry barriers means that profits are competed

away...

Advantages & Disadvantages of Monopolistic Competition

Advantages 1) There are no significant barriers to entry, therefore

markets are relatively contestable2) Differentiation creates diversity, choice, and utility.3) The market is more efficient than monopoly but less

efficient than perfect competition.Disadvantages :-4) Some differentiated does not create utility but generates

unnecessary waste. (Extra Packaging, Advertising Expenses)

5) Assuming profit maximization, there is locative inefficiency in both the long and short run.

Price Output Determination in Monopolistic Competition. (Short run Equilibrium of the Industry

Assumptions:- 1) The number of sellers is large and they act

independently of each other. Each is a monopolist in his own sphere.

2) The product of each seller is differentiated from the other products.

3) The firm has a determinate demand curve(AR) which is elastic.

4) The factor services are in perfectly elastic supply for the production of the product in question.

5) The short-run cost curves of each firm differ from each other and

6) No new firms entre the industry.

Monopolistic Competition

Demand curves facing the firm

d

d

D

D

p

q

P

Q

Edward Chamberlin: Monopolistic Competition

• Theory of Monopolistic Competition 1933• Very different starting point from Robinson• Not an issue with Marshall’s laws of return,

but a response to the existence of advertising and product differentiation

• Firms have monopoly over their own brands but there are many close substitutes

Monopolistic Competition: Large Group

• Equilibrium for the individual firm is where mr (derived from the dd curve) = MC

• For this to be consistent with equilibrium for the group the firm must also be on its share of the market demand curve

• In the long run all firms must just be making normal profits due to free entry condition

• Long run equilibrium will be to the lest of min LRACT

Large Group EquilibriumShort Run

d

d

mr

MCp

q Q

PD

D

Long run

LRATC

D

Dd

dmr

MC

p

q Q

P

Small Group Model• Small number of firms• Barriers to entry• If all firms charge the same price then each

firm only faces the DD demand curve• Similar to monopoly equilibrium

D

DMR

MCp

q Q

P

$

Quantity

D

1 5 10

2218141062 MR

MC

ATC

Monopolistically Competitive SR

$

Quantity

D

1 5 10

2218141062 MR

MCATC

Monopolistically Competitive LR

Oligopoly

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Oligopoly

• A market with a few sellers./A few large firms• The essence of an oligopolistic industry is the need for

each firm to consider how its own actions affect the decisions of its relatively few competitors.

• Oligopoly may be characterised by collusion or by non-co-operation.

• A few large firms• Products standardized or differentiated• Difficult entry• Knowledge not available to all firms

General Problem of Oligopoly Analysis

• Problem of interdependence• Cournot model of duopoly• Stackelberg and price leadership models• More recent game theory approaches–

oligopoly as a prisoners’ dilemma game• Cournot-Nash equilibrium• One shot and repeated games• Evolutionary game theory and evolutionary

stable strategies

Oligopoly Industries

• Sugar• Light bulbs• Gas• Steel• Glass

Oligopoly Industries

• Autos• Breakfast cereals• Cigarette makers• Soap• Beer

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The kinked demand curve

Q0

P0

Quantity

£Consider how a firm may perceive its demand curve under oligopoly.

It can observe the currentprice and output,

but must try to anticipaterival reactions to anyprice change.

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Q0

P0

Quantity

£

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 response to a price reduction is likely to be relatively inelastic.

The demand curve will be steep below P0.D

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The kinked demand curve (3)

… but for a price increaserivals are less likely to react,

so demand may be relatively elasticabove P0

so the firm perceivesthat it faces a kinkeddemand curve.

D

Q0

P0

Quantity

£

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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.D

Q0

P0

Quantity

£

Concentration Ratio• A rough measure to gauge whether

or not an industry is an oligopoly• % of market the largest firms control• Usually 4-8 firms

The Growth of Firms• Horizontal Mergers

• Combinations of firms in the same industry• Vertical Mergers

• Two or more firms in different production or marketing stages within the same industry.

• Conglomerate mergers• Combinations of firms in unlike industries

Theories of Imperfect Competition

• Major Contributors:– Piero Sraffa (1898-1983)– Joan Robinson (1903-1983)– Edward Chamberlin (1899-1967)

• Sraffa’s 1926 article on the laws of return• Criticism of Marshall’s external economies as

a way of reconciling falling supply prices with competition

• Need to focus on monopoly

Joan Robinson and Imperfect Competition

• The Economics of Imperfect Competition (1933)

• Introduction of marginal revenue curves• Deals with an individual firm assuming the

firm has its own market and faces a downward sloping demand curve

• In the absence of new entry, the analysis is as for a monopoly

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Imperfect competition

• An oligopoly– an industry with a few producers– each recognising that its own price depends both on

its own actions and those of its rivals.

• In an industry with monopolistic competition– there are many sellers producing products that are

close substitutes for one another– each firm has only limited ability to influence its

output price.

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Price

PC

MCC

MR

D

Quantityper week

QC0

: Pricing under Imperfect Competition

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Price

PM

PA

PC

MCC

A

M

MR

D

Quantityper week

QM

QA

QC0

Pricing under Imperfect Competition

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Cartel Model

• A model of pricing in which firms coordinate their decisions to act as a multiplant monopoly is the cartel model.

• Assuming marginal costs are constant and equal across firms, the cartel output is point M (the monopoly output) in Figure 11.1.– The plan would require a certain output by each

firm and how to share the monopoly profits.

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Cartel Model

• Maintaining this cartel solution poses three problems:– Cartel formations may be illegal, as it is in the U.S.

by Section I of the Sherman Act of 1890.– It requires a considerable amount of costly

information be available to the cartel.• The market demand function.• Each firm’s marginal cost function.

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Cartel Model

– The cartel solution may be fundamentally unstable.

• Each member produces an output level for which price exceeds marginal cost.

• Each member could increase its own profits by producing more output than allocated by the cartel.

• If the cartel directors are not able to enforce their policies, the cartel my collapse.

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APPLICATION :- The De Beers Cartel

• In the 1870s the discovery of the rich diamond fields in South Africa lead to major gem and industrial markets.

• After a competitive start, the ownership of the richest mines became incorporated into the De Beers Consolidated Mines which continues to dominate the world diamond trade.

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APPLICATION 11.1: The De Beers Cartel

• Operation of the De Beers Cartel– Since the 1880s diamonds found outside of South

Africa are usually sold to De Beers who markets the diamonds to the final consumers through its central selling organization (CSO) in London.

– By controlling supply, the CSO maintains high prices which have been estimated to be as much as one thousand times marginal cost.

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The Cournot Model

• The Cournot model of duopoly is one in which each firm assumes the other firm;s output will not change if it changes its own output level.

• Assume – A single owner of a costless spring.– A downward sloping demand curve for water has

the equation Q = 120 - P.

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APPLICATION :-The De Beers Cartel

• Dealing with Threats to the Cartel– This large markup promotes threat of entry with

any new diamond discovery.– De Beers has used its market power to control

would-be-chiselers.• They drove down prices when the former Soviet Union

and Zaire tried market entry in the 1980s.• New finds in Australia were sold to the CSO rather than

try to fight the cartel.

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APPLICATION :- The De Beers Cartel

• The Glamour of D Beers– De Beers controls most print and television

advertising, including “Diamonds Are Forever”.– They convinced Japanese couples to adopt the

western habit of buying engagement rings.– De Beers has attempted to generate a brand name

with customers to get consumers to judge De Beers diamonds superior to other suppliers.