Lectures 6 & 7 05.03.13
Download as PPT, PDF0 likes274 views
This document summarizes key concepts about market structures between perfect competition and monopoly, known as imperfect competition. It discusses monopolistic competition, where many firms produce differentiated products, and oligopoly, where a few firms recognize their actions influence prices. Game theory, like the prisoner's dilemma, shows how cooperation is difficult among oligopolists due to incentives to cheat. Firms may cooperate through threats or pre-commitments to restrict future options.
Lectures 6 & 7 05.03.13
- 1. EC-103 Semester 2 Lectures 6 & 7 Market structure and Imperfect Competition
- 2. Most markets fall between the two extremes of monopoly and perfect competition • An imperfectly competitive firm – would like to sell more at the going price – faces a downward-sloping demand curve – recognizes its output price depends on the quantity of goods produced and sold © The McGraw-Hill Companies, 2002
- 3. Imperfect competition • An oligopoly – an industry with a few producers – each recognizing 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. © The McGraw-Hill Companies, 2002
- 4. 4 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 © The McGraw-Hill Companies, 2002
- 5. Monopolistic competition • Characteristics: – many firms – no barriers to entry – product differentiation • so the firm faces a downward-sloping demand curve – The absence of entry barriers means that profits are competed away... © The McGraw-Hill Companies, 2002
- 6. Monopolistic competition (2) • Firms end up in TANGENCY EQUILIBRIUM, making normal profits • Firms do not operate at minimum LAC • Price exceeds marginal cost • Unlike perfect competition, the firm here is eager to sell more at the going market price. P1=AC1 £ OutputQ1 D MR AC MC F © The McGraw-Hill Companies, 2002
- 7. Oligopoly • A market with a few sellers • 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 characterized by collusion or by non-co-operation
- 8. Collusion and cartels • COLLUSION – an explicit or implicit agreement between existing firms to avoid or limit competition with one another • CARTEL – is a situation in which formal agreements between firms are legally permitted e.g. OPEC
- 9. Collusion is difficult if: • There are many firms in the industry • The product is not standardized • Demand and cost conditions are changing rapidly • There are no barriers to entry • Firms have surplus capacity
- 10. The kinked demand curve Q0 P0 Quantity £ Consider how a firm may perceive its demand curve under oligopoly. It can observe the current price and output, but must try to anticipate rival reactions to any price change.
- 11. Q0 P0 Quantity £ The kinked demand curve (2) The firm may expect rivals to respond if it reduces its price, as this will be seen as 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
- 12. The kinked demand curve (3) …but for a price increase rivals are less likely to react, so demand may be relatively elastic above P0 so the firm perceives that it faces a kinked demand curve.D Q0 P0 Quantity £
- 13. The kinked demand curve (4) Given this perception, the firm sees that revenue will fall whether price is increased or decreased, so the best strategy is to keep price at P0. Price will tend to be stable, even in the face of an increase in marginal cost.D Q0 P0 Quantity £
- 14. Game theory: some key terms • Game – a situation in which intelligent decisions are necessarily interdependent • Strategy – a game plan describing how the player will act or move in every conceivable situation • Dominant strategy – where a player’s best strategy is independent of those chosen by others
- 15. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Game Theory and the Economics of Cooperation Game theory is the study of how people behave in strategic situations. Strategic decisions are those in which each person, in deciding what actions to take, must consider how others might respond to that action.
- 16. Game Theory and the Economics of Cooperation Because the number of firms in an oligopolistic market is small, each firm must act strategically. Each firm knows that its profit depends not only on how much it produced but also on how much the other firms produce.
- 17. The Prisoners’ Dilemma The prisoners’ dilemma provides insight into the difficulty in maintaining cooperation. Often people (firms) fail to cooperate with one another even when cooperation would make them better off.
- 18. The Prisoners’ Dilemma Bonnie’s Decision Confess Remain Silent Confess Remain Silent Clyde’s Decision Clyde gets 8 years Bonnie gets 8 years Bonnie gets 20 years Bonnie gets 1 year Bonnie goes free Clyde gets 20 years Clyde gets 1 year Clyde goes free
- 19. The Prisoners’ Dilemma The dominant strategy is the best strategy for a player to follow regardless of the strategies pursued by other players.
- 20. The Prisoners’ Dilemma Cooperation is difficult to maintain, because cooperation is not in the best interest of the individual player.
- 21. Oligopolies as a Prisoners’ Dilemma Iraq’s Decision High Production Low Production High Production Low Production Iran’s Decision Iran gets $40 billion Iraq gets $40 billion Iraq gets $30 billion Iraq gets $50 billion Iraq gets $60 billion Iran gets $30 billion Iran gets $50 billion Iran gets $60 billion
- 22. Oligopolies as a Prisoners’ Dilemma Self-interest makes it difficult for the oligopoly to maintain a cooperative outcome with low production, high prices, and monopoly profits.
- 23. Why People Sometimes Cooperate Firms that care about future profits will cooperate in repeated games rather than cheating in a single game to achieve a one-time gain.
- 24. The Prisoners’ Dilemma Game Consider two firms in a duopoly each with a choice of producing “high” or “low” output: Firm B output High Low High 1 1 3 0 FirmAoutput Low 0 3 2 2
- 25. The Prisoners’ Dilemma • Each firm has a dominant strategy to produce high • so they make 1 unit profit each • but they would both be better off producing low – as long as they can be sure that the other firm also produces low. • So collusion can bring mutual benefits • but there is incentive for each firm to cheat
- 26. More on collusion • The probability of cheating may be affected by agreement or threats • Pre-commitment – an arrangement, entered voluntarily, restricting future options • Credible threat – a threat which, after the fact, is optimal to carry out
- 27. Strategic entry deterrence • Some entry barriers are deliberately erected by incumbent firms: – threat of predatory pricing – spare capacity – advertising and R&D – product proliferation • Actions that enforce sunk costs on potential entrants
Editor's Notes
- #3: See the introduction to Chapter 9 in the main text.
- #4: See the introduction to Chapter 9 in the main text.
- #5: See the introduction to Chapter 9 in the main text, and Table 9-1.
- #6: See Section 9-2.
- #7: See Section 9-2, and Figure 9-2.
- #8: See Section 9-3.
- #9: See Section 9-3.
- #10: See Section 9-3.
- #11: See Section 9-3, and Figure 9-4.
- #12: See Section 9-3, and Figure 9-4.
- #13: See Section 9-3 in the main text, and Figure 9-4.
- #14: See Section 9-3 in the main text, and Figure 9-4.
- #15: See Section 9-4 in the main text.
- #17: 16
- #18: 17
- #19: 17
- #20: 19
- #21: 19
- #22: 17
- #23: 20
- #24: 21
- #25: See Section 9-4 in the main text, and Figure 9-5.
- #26: See Section 9-4 in the main text.
- #27: See Section 9-4 in the main text.
- #28: See Section 9-7 in the main text.