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Theories of Imperfect Competition

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

Sraffas 1926 article on the laws of return Criticism of Marshalls 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

Monopoly Equilibrium
A monopoly faces the market demand curve For a single price monopoly the D curve is the AR curve MR will lie below AR curve Monopoly profit max equilibrium where MC=MR Second order condition is that the MC cuts the MR from below

Monopoly Equilibrium
MC P D=AR

MR Q P a b

Point a is not an equilibrium

MC

D=AR

MR
Q

Monopoly Equilibrium
Firm will have excess profits if P > ATC If no new entry of other firms selling substitute goods excess profit can remain Idea of full equilibrium where other firms come in and all firms are where MC =MR and P = ATC but each firm still facing a downward sloping demand curve

Price Discrimination
Perfect price discrimination
D curve becomes the MR curve No restriction of output
P
MC Total revenue D=MR Q Q

Price Discrimination
Market segmentation
Profit max output where the aggregate MR=MC Allocate output between markets so as to equalize MR
$ MC

MR

MR1+MR2

Total Q

Price Discrimination

p1 MR

D1 p2 MR1 q1 q2 MR2 D2

Price discrimination of this type may or may not increase total output as compared with a single price monopolist depending on exact shapes of the demand curves. In the case of linear demand curves total output will be the same

Imperfect Factor Markets


Effects of monopoly in output market on the factor market
Firms will hire where W=MRP But MRP<VMP Monopoly exploitation of labour
Wage S w D comp D monop

Imperfect Factor Markets


Effects of monopsony in the factor market
Single buyer in the labour market Faces upward sloping supply curve for the factor Marginal cost of the factor lies above the supply curve Firm equates MRP with MC of the factor Wage below VMP Monopsony exploitation of labour

Monopsony Exploitation

MC of labour

S
mrp w D=MRP L

l Difference between mrp and w is monopsony exploitation of labour

Edward Chamberlin: Monopolistic Competition


Theory of Monopolistic Competition 1933 Very different starting point from Robinson Not an issue with Marshalls 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: Demand


Firms face two demand curves one showing the demand with the prices of other brands given (dd curve) the other is a share of the market curve which is drawn for this brand assuming all brands have the same price (DD curve) Chamberlin assumes symmetry between firms

Monopolistic Competition
Demand curves facing the firm P
D d p

Monopolistic Competition
Monopolistic competition Large group and small group models Large group: like perfect competition but for product differentiation Small group: oligopoly, barriers to entry: like monopoly but an issue of firms being aware of their interdependence

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 Equilibrium


P
d p d D q P d p d Long run D MC mr Q D Short Run

MC

LRATC

mr
D q Q

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
P
p

D
MC

MR q

D
Q

Kinked Demand Curve Model


But will all firms charge the same price? What happens if one firm changes price? That firm might believe that other firms will follow price cuts but will not follow price rises Paul Sweezy and the kinked demand curve model (1939) Discontinuity in MR curve Price inflexibility thesis

Kinked Demand Curve Model


P d p d D

D
q Q

P
P MC MC D MR Q

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

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