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Chapter 7: Firms and How They Operate II

1. Comparison of the 4 Markets

Type

Perfect Competition

Monopoly

Monopolistic Competition

Oligopoly

Number of buyers / sellers

! Large

! Only one firm

! Large

! Few large firms

! No one buyer / seller can influence price

! Firm price taker

! Firm price setter

! FOP relatively mobile

! Interdependent

 

! When firm makes decisions, does not have to worry how its rivals will react

Barriers to

! None

! High

! No / Low

! Substantial

entry

! FOP perfectly mobile

! Natural: huge sunk costs (AFC falls over very large output – AC falls continuously – enjoys huge IEOS), exclusive ownership of essential raw materials

! Firm lowers price – profits spread thinly over many rivals – rivals suffer negligibly

! Na tural

! No transaction / transportation costs

! Artificial: legislation, collusion / mergers, non - price

! Minimal sunk costs

! Retaliation unlikely

competition,

! No collusion keen competition

advertising

! Artificial: non - price competition, contrived barriers (cartel), legal protection: exclusive rights (patents, tariffs to block foreign firms)

Nature of

! Homogeneous

! No close substitutes

! Differentiated:

! Homogeneous /

products

! Buyers no preference for any firm

! CED and PED very low

quality, design, location, promotion

differentiated

! Demand p rice elastic

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Knowledge

! Perfect

! Imperfect

! Imperfect

!

Imperfect

! Seller knows rivals’

 

prices, market costs and available technology

! Buyers know all sellers’ prices, quality and availability of products – will not purchase at a higher price than equilibrium price

! Consumers not fully aware of COP

! Production methods and prices

! Cost structures differ as some firms enjoy more favourable locations / rentals

Firm’s curve

Firm’s curve
Firm’s curve
Firm’s curve
Firm’s curve

! P > MR

! P > MR

!

P = AR = MR

! P > MR

! Cannot increase both output and price at the same time as curve is downward sloping

! Some degree of control over own prices

! Firm increases price – other firms will not

 

! No single equilibrium price in market – no market demand curve

! Firm decreases price – other firms follow – may lead to price war

 

! Price rigidity: menu costs, fear of harming firm’s image (fall in price – fall in quality)

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Examples

! Stock market

! Utilities

 

!

Bubble tea

 

! UK brewery industry

! Forex market

! Starhub’s EPL coverage

   

! Taxi companies

! Agricultural products:

! SMRT for NS and EW lines

! OPEC

many farmers i n LDCs

! Mobile service provision

Firm’s SR

 

!

Supernormal, normal / subnormal profits

 

equilibrium

 

!

MC = MR and MC must be rising

Firm’s LR

! Normal profits

! Normal / supernormal profits

 

!

Normal profits

 

! Normal /

equilibrium

! New firms will enter industry to erode supernormal profits

 

supernormal

! Firm will shut down if subnormal profits

LR

LR    
 
LR    
 

equilibrium

curve

Productive

! Efficient

! Inefficient unless by coincidence

 

! Inefficient

!

Inefficien t unless by

efficiency

! Firm produces at MES

! Will settle at LRAC that is not necessarily at MES

coincidence

 

!

Firm’s POV: all points on LRAC

 
 

!

Society’s POV: MES

 

Allocative

! Efficient

 

! Inefficient

 

efficiency

! P = MC

!

P > MC

 

!

Could be seen as premium society pays for product differentiation

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2. Analysis of Imperfect Market Structures

Type

Mono poly

Monopolistic Competition

Oligopoly

Economic

! Allocative inefficiency: P > MC, output below optimum

! Allocative inefficiency: P > MC

! Allocative inefficiency: P > MC, output below optimum

efficiency

! Productive inefficiency: do not utilise optimal plant capacity, do not exhaust potential for further EOS because all small firms

! Dynamic inefficiency: no r+d

! Productive inefficiency

! Productive inefficiency

! X - inefficiency but increasingly reduced due to globalisation, reduced customs duties and barriers to trade

! Dynamic efficiency: r+d

! Dynamic efficiency: r+d

 

Variety of

! Unique

 

! Differentiated

products

! Possible innovation and new products: BTE stimulus to the creativity required to destroy barriers – monopoly profits stimulates new entrants producing new and competing product s

! Large variety – increase in consumer welfare

R+d and

! Profits lead to unequal income distribution: dollar votes + shift of consumer surplus to producer

! More equity: no redistribution of income from consumers to shareholders

! Supernormal profits ploughed into r+d

new profits

! Supernormal profits – plough into r+d – better quality products + better methods of production – lower AC but there is no guarantee that monopolies will do this

! Normal profits: no additional profits to plough into r+d

 

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Theory vs

! MES high – IEOS – lower MC than PC industry – lower P and higher o/p but monopolies charge high prices by restricting output

P/R/C

! Wasteful competition

! High price rigidity: price stability

empirical

! Advertising provides better consumer information which helps move market structure closer to PC model but loss of consumer sovereignty

! Wasteful competition: more likely to engage in extensive advertising – encourages price competition, with increased sales volume and reaping of EOS, price reduce further

evidence

MCpc MCm MR Pc Pm AR

MCpc

MCm MR
MCm
MR

Pc

Pm

AR

MCpc MCm MR Pc Pm AR
 

! But possible monopoly power through collusion

! But multiple branding gives consumers misguided information in thinking products are from different firms

0

Q Q

Q

! Practise price discrimination [has both costs and benefits]

! Natural monopolies

 

! Perfectly contestable markets:

costs of entry and exit by potential rivals are zero, and when such entries can be made very rapidly eg. deregulation of airline industry in 1978

! Hit and run competition: market contestable for certain seasons eg. parcels service during festivals

! Reduces wasteful competition (instead of extensive advertising, money can be spent to produce more goods)

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