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REVISION SERIES

PJL ☺

PJL

PJL ☺

SSSSPPPPEEEECCCCTTTTRRRRUUUUMMMM of competition

Degree of competition
Degree of competition
Perfect Competition
Perfect
Competition
Monopolistic Competition
Monopolistic
Competition
RRRR UUUU MMMM of competition Degree of competition Perfect Competition Monopolistic Competition Oligopoly Monopoly

Oligopoly

RRRR UUUU MMMM of competition Degree of competition Perfect Competition Monopolistic Competition Oligopoly Monopoly

Monopoly

Structure

influences
influences

Conduct

Structure influences Conduct influences Performance

influences

Performance

Number of sellers Nature of product Structure Knowledge of product Barriers to entry

Number of sellers

Nature of product

Structure

Knowledge of product

Barriers to entry

Features

Perfect

Monopolistic

Oligopoly

Monopoly

Competition

Competition

Number of sellers

Many small firms, each with insignificant market share

Many small firms, each with insignificant market share

Few dominant and mutually interdependent firms, who together control a significant portion of market share

Single seller

Barriers to entry

No barriers to entry

Very low

High barriers to entry

Very high

barriers to

barriers to

entry

entry

Type of

product

Homogeneous

products

 

Usually

Unique product with no close substitutes

Differentiated

products

differentiated

products

Knowledge of product

Perfect

 

knowledge

 

Imperfect knowledge

differentiated products Knowledge of product Perfect   knowledge   Imperfect knowledge

Barriers to entry

anything that prevents or impedes the entry of firms into an industry and thereby limits the amount of competition faced by existing firms

limits the amount of competition faced by existing firms Artificial Natural • Contrived barriers (e.g., cartel,
limits the amount of competition faced by existing firms Artificial Natural • Contrived barriers (e.g., cartel,
limits the amount of competition faced by existing firms Artificial Natural • Contrived barriers (e.g., cartel,
limits the amount of competition faced by existing firms Artificial Natural • Contrived barriers (e.g., cartel,

Artificial

Natural

• Contrived barriers (e.g., cartel, mergers and acquisitions)

• Legal barriers (e.g., patents, copyrights, tariffs)

• Price war

• Non-price competition

- Product differentiation

- Advertising

• Very huge sunk costs relative to mkt demand

natural monopoly

• Exclusive control of essential raw materials

Reminder for Perfect Competition

Price determined by mkt
Price determined by mkt
Mkt Ss
Mkt Ss

Mkt Dd

P

Perfect Competition Price determined by mkt Mkt Ss Mkt Dd P P Individual firms must take
Perfect Competition Price determined by mkt Mkt Ss Mkt Dd P P Individual firms must take

P

Individual firms must take the mkt price

Mkt Ss Mkt Dd P P Individual firms must take the mkt price P* P* Indv’s

P*

P*

Indv’s Dd

P Individual firms must take the mkt price P* P* Indv’s Dd Qty Qty Industry (Market)

Qty

firms must take the mkt price P* P* Indv’s Dd Qty Qty Industry (Market) Individual Firm

Qty

Industry (Market)

Individual Firm

• Individual firms can sell all they want at the prevailing market price, P*

ReminderReminderReminderReminder forforforfor MonopolisticMonopolisticMonopolisticMonopolistic CompetitionCompetitionCompetitionCompetition

• No market demand curve

• Firms have some degree of monopoly power over its products

• Contingent on product differentiation • Non-price competition

some degree of monopoly power over its products • Contingent on product differentiation • Non-price competition

Reminder for Monopoly

Reminder for Monopoly • Firm’s DD curve = Industry DD curve • Contingent on the maintenance

• Firm’s DD curve = Industry DD curve

• Contingent on the maintenance of barriers to entry

• Monopoly can influence either price or output, but not both

Something to Think About

Type of market structure depends on definition of industry

EXAMPLE:

• Restaurants

• Restaurants in Vivocity

• Spanish restaurant in Vivocity

Price competition Non-price competition Conduct Others (e.g., price discrimination)

Price

competition

Non-price

competition

Conduct

Others (e.g., price discrimination)

Conduct of PC Firm

Conduct of PC Firm • If firm sells its goods above the set market price, consumers

• If firm sells its goods above the set market price, consumers will simply buy from any other firm

• No incentive to lower price either, since the seller can sell all he wants at the prevailing market price

• Therefore, no price competition

• Also no non-price competition either, since homogeneous product

Conduct of Monopolistic Competition

• Tend to avoid price competition prices cannot be cut indefinitely + potential gain in market share is small + no supernormal profits to fall back on

Prefer non-price competition product promotion + product development

• Degree of non-price competition will be less than oligopoly

competition product promotion + product development • Degree of non-price competition will be less than oligopoly
LN P14
LN P14

Product Differentiation

• Real physical differences

• Imaginary differences

LN P14 Product Differentiation • Real physical differences • Imaginary differences • Different conditions of sale

• Different conditions of sale

LN P14 Product Differentiation • Real physical differences • Imaginary differences • Different conditions of sale

Product Differentiation

Increase demand

GIVE ME MORE!!!!!

I only want this!!!!!

Product Differentiation Increase demand GIVE ME MORE!!!!! I only want this!!!!! Demand more price inelastic

Demand more price inelastic

Conduct of Oligopoly

Conduct of Oligopoly Collusive model VS Competitive model

Collusive

model

VS

Conduct of Oligopoly Collusive model VS Competitive model

Competitive

model

Collusion formal Cartel Reduce unpredictability of rivals’ reactions informal/tacit Price leadership Dominant

Collusion

formal

Cartel

Collusion formal Cartel Reduce unpredictability of rivals’ reactions informal/tacit Price leadership Dominant

Reduce unpredictability of rivals’ reactions

informal/tacit

Price leadership

of rivals’ reactions informal/tacit Price leadership Dominant Price Leadership • Act as one to determine price
of rivals’ reactions informal/tacit Price leadership Dominant Price Leadership • Act as one to determine price

Dominant

Price

Leadership

• Act as one to determine price by controlling combined output

• Predetermined market share

• Incentive to cheat

Barometric

Leadership

determine price by controlling combined output • Predetermined market share • Incentive to cheat Barometric Leadership
Competition Kinked Demand Curve Firm will not match each other’s price increase perceive a price

Competition

Kinked Demand Curve

Firm will not match each other’s price increase perceive a price elastic demand

Price

D = AR MR
D = AR
MR

Firms will match each other’s price reduction perceive a price inelastic demand

Quantity

Region of indeterminacy

Competition Kinked Demand Curve Price MC1 MC2 MC3 D = AR MR Q* Quantity Significance

Competition

Kinked Demand Curve

Price MC1 MC2 MC3 D = AR MR Q* Quantity
Price
MC1
MC2
MC3
D = AR
MR
Q*
Quantity

Significance of region of indeterminacy

Should MC fluctuate within this region, firm will absorb higher costs

same profit-maximising level

Competition

Kinked Demand Curve

Offers some insight as to why prices in oligopoly tend to be rigid (“sticky”)

to why prices in oligopoly tend to be rigid (“sticky”) However, • Model does not explain

However,

• Model does not explain how the prices are set in the first place

• Price stability could be due to other factors

Menu costs Fear of harming firm’s image

Other Points to Note

Other Points to Note • Degree of non-price competition distinguishes oligopolies and MPC firms - Real

Degree of non-price competition distinguishes oligopolies and MPC firms

- Real incentives for oligopolies compete extensively using non-price competition potentially huge profits!

using non-price competition potentially huge profits ! • Behaviour of oligopolies may change quite radically over

• Behaviour of oligopolies may change quite radically over time

Conduct of Monopoly

• Monopoly will strive to maintain its barriers to entry (e.g., through advertising, legal protection, R&D)

• Price discrimination

strive to maintain its barriers to entry (e.g., through advertising, legal protection, R&D) • Price discrimination
Price Discrimination
Price
Discrimination
LN P21
LN P21

Definition

Price discrimination occurs when

Same commodity at different prices

 

For reasons other than differences in cost of production

 

• Examples:

Different bus fares for adults and kids Different movie prices for weekends

Definition

Price discrimination is not a result of differences in cost of production

Price differentiation:

of differences in cost of production Price differentiation: $2 chicken rice at hawker centre vs $3

$2 chicken rice at hawker centre vs $3 chicken rice at foodcourt

Conditions

• Market power

Conditions • Market power • Market segmentation (no resale) • Each market has different PED

• Market segmentation (no resale)

Conditions • Market power • Market segmentation (no resale) • Each market has different PED

• Each market has different PED

First Degree P.D.

• Charge the maximum price the customer is willing and able to pay for each unit bought (reservation price)

• aka perfect price discrimination

• Dd curve is now new MR curve

– incremental revenue earned from each additional unit is simply the price paid for that unit

First Degree P.D.

Price 8 7 Firm can capture all of the consumer surplus if o/p is divisible
Price
8
7
Firm can capture all of the
consumer surplus if o/p
is divisible into infinitely
small units
6
MR = Dd
Qty
1
2
3

First Degree P.D.

Evaluation

First Degree P.D. Evaluation • In practice, almost impossible – impractical – unknown reservation price

• In practice, almost impossible

– impractical

– unknown reservation price

Second Degree P.D.

• Charge different prices for different blocks of the same good according to how much consumer purchases

• aka block pricing

Second Degree P.D.

Price 8 Additional revenue by the monopoly = loss of consumer surplus 7 6 AR
Price
8
Additional revenue by
the monopoly = loss of
consumer surplus
7
6
AR = Dd
Qty
100
200
300

Third Degree P.D.

• Charge different prices for same good according to different buyers • Higher price charged in market with more price inelastic demand curve

• Distribute o/p in each market such

that MC = MR = same in both markets

Third Degree P.D.

Note: higher price charged in the market with the less price elastic demand curve

Horizontal summation

Price Price Price MC 9 7 5 5 5 MR Total Dy Dx MRx MRy
Price
Price
Price
MC
9
7
5
5
5
MR Total
Dy
Dx
MRx
MRy
1000
Qty
2000
Qty
3000
Qty
Market X
Market Y
Market X + Y
Oligopolist, arguably, will engage in greater degree of non-price competition , as there is a

Oligopolist, arguably, will engage in greater degree of non-price competition, as there is a possibility of capturing a significant share of the market (unlike the monopolistically competitive firm)

Both oligopolists and monopolistically competitive firms are likely to avoid price competition in favour of non-price competition

Because of different features of the market structures, firms in each of these markets may behave differently

Conduct

in each of these markets may behave differently Conduct Because of the mutual interdependence of firms,

Because of the mutual interdependence of firms, oligopolists may choose collude, compared to other market structures where such conduct is unlikely.

Profitability SR LR Price and output levels X-inefficiency Allocative efficiency Productive efficiency Efficiency

Profitability

SR

LR

Price and output levels

X-inefficiency

Allocative

efficiency

Productive

efficiency

Efficiency

Performance

Consumer

Choice

Innovation

Equity

Profitability • Firms in all 4 market structures can earn supernormal, normal and subnormal profits

Profitability

• Firms in all 4 market structures can earn supernormal, normal and subnormal profits in the SR

• Firms in all 4 market structures earn at least normal profits in the LR (i.e., cannot make subnormal profits in the LR)

• Oligopolists and monopolists can earn supernormal profits in the LR

Conditions for Profit-Maximisation

MC = MR

• If MC < MR the addition of the last unit of output adds more to total revenue than it does to total cost

[YES! Produce that last unit]

• If MC > MR the addition of the last unit of output adds more to total cost than it does to total revenue

[NO! Don’t produce that last unit]

it does to total revenue [NO! Don’t produce that last unit] • Hence, firm will product
it does to total revenue [NO! Don’t produce that last unit] • Hence, firm will product

• Hence, firm will product up to the point where MC = MR

Conditions for Profit-Maximisation

P/C/R

For a perfectly competitive firm

MC MR > MC MC > MR
MC
MR > MC
MC > MR

DD = MR = AR

Q

Q

Conditions for Profit-Maximisation

For an imperfectly competitive firm

MR > MC MC > MR
MR > MC
MC > MR

SR Equilibrium

SR Equilibrium • In the SR, firms in all market structures can make – Supernormal profits

• In the SR, firms in all market structures can make

– Supernormal profits

– Normal profits

– Subnormal profits

SR Equilibrium

SR Equilibrium • In the SR, PC firms can make – Supernormal profits TR = ?

• In the SR, PC firms can make

Supernormal profits

TR = ?

TC = ?

TR > TC

MC Price MC = MR ATC B P P = AR = MR C .
MC
Price
MC = MR
ATC
B
P
P = AR = MR
C
.
A
Output
0
q

SR Equilibrium

SR Equilibrium • In the SR, PC firms can make – Normal profits TR = ?

• In the SR, PC firms can make

Normal profits

TR = ?

TC = ?

TR = TC

MC Price ATC MC = MR B P P = AR = MR Output q
MC
Price
ATC
MC = MR
B
P
P = AR = MR
Output
q
0

.

SR Equilibrium

SR Equilibrium • In the SR, PC firms can make – Subnormal profits MC Price TR

• In the SR, PC firms can make

– Subnormal profits MC Price TR = ? ATC MC = MR TC = ?
– Subnormal profits
MC
Price
TR = ?
ATC
MC = MR
TC = ?
A
C
.
TR < TC
P
B
P = AR = MR
Output
0
q

.

SR Equilibrium • In the SR, firms under imperfect market structure can make – Supernormal

SR Equilibrium

• In the SR, firms under imperfect market structure can make

Supernormal profits

TR = ?

TC = ?

TR > TC

Price P
Price
P

C

MC = MR

structure can make – Supernormal profits TR = ? TC = ? TR > TC Price

MC

MC ATC

ATC

A B
A B
A B

A

B

MR
MR

AR

Output

0

q

SR Equilibrium • In the SR, firms under imperfect market structure can make – Normal

SR Equilibrium

• In the SR, firms under imperfect market structure can make

Normal profits

TR = ?

TC = ?

TR = TC

MC = MR MC Price ATC A P AR MR Output q 0
MC = MR
MC
Price
ATC
A
P
AR
MR
Output
q
0
SR Equilibrium • In the SR, firms under imperfect market structure can make – Subnormal

SR Equilibrium

• In the SR, firms under imperfect market structure can make

– Subnormal profits MC MC = MR ATC Price TR = ? A C TC
– Subnormal profits
MC
MC = MR
ATC
Price
TR = ?
A
C
TC = ?
P
B
TR < TC
AR
MR
Output

0

q

LR Equilibrium • In the LR, PC firms can only make normal profits , because

LR Equilibrium

• In the LR, PC firms can only make normal profits, because of the assumption of no barriers to entry

– If supernormal profits are made, firms enter the industry with ease and compete in the industry supernormal profits eroded

– If subnormal profits are made, firms leave the industry with ease the remaining firms return to normal profits

LR Equilibrium S0 MC P S1 p ATC P0 p0 d0 d1 P1 p1 D

LR Equilibrium

S0 MC P S1 p ATC P0 p0 d0 d1 P1 p1 D Qty qty
S0
MC
P
S1
p
ATC
P0
p0
d0
d1
P1
p1
D
Qty
qty
Q0
Q1
q1
q0

Market

Individual Firm

LN P8
LN P8
LR Equilibrium • In the LR, the MPC firm can only make normal profits –

LR Equilibrium

• In the LR, the MPC firm can only make normal profits

– Supernormal profits new firms enter (ease of entry)

– Subnormal profits existing firms exit (ease of exit)

LR Equilibrium • Supernormal profits – new firms enter – potential substitutes – consumers have

LR Equilibrium

• Supernormal profits

– new firms enter

potential substitutes

– consumers have wider range of products to choose from

dd falls and becomes more price elastic for each firm’s product

normal profits in the LR

LR Equilibrium Normal Profits in the LR MC = MR MC = MR MC Price

LR Equilibrium

Normal Profits in the LR

MC = MR MC = MR MC Price ATC A P AR1 AR2 MR1 MR2
MC = MR
MC = MR
MC
Price
ATC
A
P
AR1
AR2
MR1
MR2
Output
q
0

LR Equilibrium

LR Equilibrium • In the LR, the monopoly can make supernormal profits , as long as

• In the LR, the monopoly can make supernormal profits, as long as it is able to keep potential firms from entering the industry

• In the LR, the monopoly will continue production only if it can at least make normal profits

Price and Output • Compared to monopoly, PC has higher output and lower price •

Price and Output

• Compared to monopoly, PC has higher output and lower price

• UNLESS monopoly can tap significant EOS (in which case, output may be higher, price may be lower)

P/C/R

P

P

M

C

MC Monopoly = SS PC industry DD = AR MR Q Q M Q C
MC Monopoly = SS PC industry
DD = AR
MR
Q
Q M
Q C

Assuming same cost conditions

P/C/R

P

P

C

M

SS PC industry MC Monopoly DD = AR MR Q Q C Q M
SS PC industry
MC Monopoly
DD = AR
MR
Q
Q C
Q M

Assuming different cost conditions

Efficiency • Condition: P = MC • Only PC firm and monopoly that practices perfect

Efficiency

• Condition: P = MC

• Only PC firm and monopoly that practices perfect price discrimination is allocatively efficient

• All firms can be productively efficient if they produce on LRAC

• Monopolist may be X-inefficient

P/C/R

P

P

M

C

MC Monopoly = SS PC industry MR
MC Monopoly = SS PC industry
MR

Q M

Q C

DD = AR

Q

Equity • PC firm is equitable, since consumer and producer surpluses are maximised • Under

Equity

• PC firm is equitable, since consumer and producer surpluses are maximised

• Under monopoly, part of consumer surplus lost to producer, hence inequity

• Monopoly which practices perfect price discrimination is most inequitable, since all consumer surplus transferred to producer

P/C/R

P

P

M

C

MC Monopoly = SS PC industry MR
MC Monopoly = SS PC industry
MR

Q M

Q C

DD = AR

Q

P/C/R

P M

P/C/R P M Q M M C Price discriminating monopoly DD = MR Q

Q M

MC Price discriminating monopoly

DD = MR

Q

Innovation • PC firm has neither incentive nor ability to innovate • Monopoly has the

Innovation

• PC firm has neither incentive nor ability to innovate

• Monopoly has the ability to innovate since it can earn supernormal profits, but level of innovation depends on threat of potential competition

• Oligopolist has greater ability and incentive to innovate than a monopolistically competitive firm, since it can potentially capture a significant market share

• Level of innovation depends on many factors including

– Contestability of market

– Extent and duration of government intervention

– Other costs and benefits of innovation

Consumer Choice • Homogeneous products lack of consumer choice • Differentiated products greater consumer choice

Consumer Choice

• Homogeneous products lack of consumer choice

• Differentiated products greater consumer choice

• May be a trade-off between consumer choice and lower prices, since production of homogenous products may allow for large scale production and hence the tapping of EOS

Performance by Industry

Performance of PC Firm

• Profitability

SR: supernormal, normal and subnormal

profits LR: only normal profits

normal and subnormal profits LR: only normal profits • Efficiency Allocatively efficient (P=MC)

• Efficiency

Allocatively efficient (P=MC)

Productively efficient (on LRAC)

• Equity equitable

• R&D

• Lack of ability: no supernormal profits in LR

• Lack of incentive: others will copy (perfect knowledge)

• Lack of consumer choice (homogeneous)

Performance of Monopolistic Competition

• Profitability

SR: supernormal, normal and subnormal profits

LR: can earn only normal profits

• Efficiency

Allocatively inefficient (P>MC)

Productively efficient (if on LRAC)

(P>MC) Productively efficient (if on LRAC) • Equity Reduced inequity as normal profits are made in

• Equity Reduced inequity as normal profits are made in the LR (i.e., minimum necessary to keep firm in production)

• R&D No ability: no supernormal profits Has more incentive than PC, but less than oligopoly and monopoly

• Wide consumer choice (product differentiation)

• Wasteful competition (advertisement to create imaginary differences)

Performance of Oligopoly

• Profitability

Performance of Oligopoly • Profitability SR: supernormal, normal and subnormal profits LR: can earn supernormal, at

SR: supernormal, normal and subnormal profits

LR: can earn supernormal, at least normal profits

• Efficiency

Allocatively inefficient (P>MC)

Productively efficient (if on LRAC)

• Equity Economies of scale (less than monopoly) can keep costs, and hence prices, low Extensive advertising may result in higher cost and hence higher prices

• R&D Has ability: earns supernormal profits in LR Has considerable incentive: can capture large market share

• Wide consumer choice (product differentiation)

in LR Has considerable incentive: can capture large market share • Wide consumer choice (product differentiation)

Performance of Monopoly

• Profitability

SR: supernormal, normal and subnormal profits

LR: can earn supernormal, at least normal profits

• Efficiency

Allocatively inefficient (P>MC)

Productively efficient (if on LRAC)

Could be X-inefficient

• Equity inequitable as consumer surplus lost to producer

• R&D

Has ability: earns supernormal profits in LR

Incentive: depends on degree of threat of

potential competition

• Lack of consumer choice (no close substitutes)

LR Incentive: depends on degree of threat of potential competition • Lack of consumer choice (no

Performance of Monopoly

practising price discrimination

• Loss of consumer surplus

• Consumer may not have been able to afford the good if not for price discrimination

• Higher profits:

for producer

for consumer if price increase

for consumer if reinvested in R&D to improve products and lower costs in the LR

Performance of Monopoly

practising price discrimination

• Producers may use high profits from one market to withstand possible price war in breaking into another market • Provision of goods that would otherwise not be produced due to high costs

Performance of Monopoly

practising price discrimination

Price

E

C

P

0

MC

LossesLosses ATC ATC A AA B BB D MR MR
LossesLosses
ATC
ATC
A AA
B BB
D
MR
MR

Price

q

q

Quantity

Quantity

0

TR

MC ATC ATC TC A
MC
ATC
ATC
TC
A

D = MR

q

Quantity

Quantit

Structure

influences
influences

Conduct

Structure influences Conduct influences Performance

influences

Performance