Chapter 11 Flashcards
Who largely produces Canada’s output?
Industries where the firms are small relative to the size of their industry
What does the perfectly competitive model explain?
The behaviour of individual price-taking firms that produce more-or-less identical products
What does the theory of monopolistic competition explain?
It explains why there are many small firms, but where each firm has some degree of market power
Where does market power come from?
It comes from being alone in your market
What do firms do in monopolistic competition?
They make or create their own niche market
What does the theory of oligopoly help us understand?
It helps us understand industries in which there are a small number of large firms, each with considerable market power, and that compete actively with each other
What is an industry with a small number of relatively large firms said to be?
It is said ot be highly concentrated
What is the formal measure of industrial concentration given by?
By the concentration ratio
What is the concentration ratio?
It is a fraction of the total market sales controlled by a specificied number of the industry’s largest firms
What are the main problems with using concentration ratios?
It is difficult to define the market with reasonable accuracy
Define imperfect competition
Imperfect competition is a market structure that does not observe monopolies but rather looks at firms who are not in perfect competition (i.e. a market where firms are not price takers)
What are the characteristics of imperfectly competitive firms?
They are firms that typically engage in behaviour that is absent in either monopoly or perfect competition:
spend large sums of money advertising
engage a variety of forms of non-price competition, such as offering competing standards of quality and product guarantees
may engage in activities that appear to be designed to hinder the entry of new firms, which prevents the erosion of existing profits
What is a differentiated product?
It is a group of products similar enough to be called the same product but dissimilar enough that all of them do not have to be sold at the same price
What is a price setter?
It is a firm that faces a downward-sloping demand curve for its product. It chooses which price to set
What is the key difference between monolistic competition and oligopoly?
It is the amount of strategic behaviour displayed by firms
What is monolistic competition?
It is a market structure that was originally developed to deal with the phenomenon of production differentiation
First developed by US economist Edward Chamberlin in 1933
What are the characteristics of monopolistic competition?
There are many firms
Freedom of entry and exit
Product is somewhat differentiated from others
Firms have some control over its price
What are the 4 assumptions of monolistic competition?
- Each firm produces its own version of the industry’s differentiated product. Thus, it faces a demand curve that, although negatively sloped, is highly elastic because competing firms produce many close substitutes.
- All firms have access to the same technology and so have the same cost curves.
- The industry contains so many firms that each one ignores competitors when making price and output decisions.
- Firms are free to enter and exit the industry.
In the short run, what is a firm operating in a monopolistically competitive market structure similar to?
A monopoly
In the long run, what is each firm producing an output of in a monopolistically competitive market structure?
An output less than that corresponding to the lowest point on its LRAC curve
What would happen if the firm increases output in a monopolistically competitve market structure?
The cost per unit decreases but revenue decreases by more than cost decreases
Selling more would reduce revenue by more than it reduces cost
What would happen if the firm produces less output than that corresponding to the lowest point on its LRAC in a monopolistically competitve market structure?
The firm has excess capacity
What is excess-capacity theory?
It is the property of long-run equilibrium in monopolisitc competition that firms produce on the falling portion of their long-run average cost curves
How is excess capacity measured?
By the gap between present output and the output that coincides with minimum average cost
What is an oligopoly?
It describes an industry that contains two or more firms, at least one of which produces a significant portion of the industry’s total output
How is profit maximization complicated in an oligopoly?
It is complicated for an oligopolistic firm because it must consider its rivals’ likely responses to its actions
Oligopolists exhibit strategic behaviour - behaviour designed to take account of the reactions of one’s rivals to one’s own behaviour
What can oligopolistic firms do to maximize profits?
They can cooperate to produce among themselves the monopoly output in order to maximize their joint profits
What happens if oligopolistic firms cooperate to maximize their joint profits?
They will reach a cooperative (or collusive) outcome
What is a non-cooperative outcome?
It is an industry outcome that is reached when firms proceed by calculating only their own gains without cooperating with other firms is called a non-cooperative outcome
What is game theory?
It is the theory that studies decsion making in situations in which on player anticipates the reactions of other players to its own actions
What happens when game theory is applied to oligopoly?
The players are firms
Their game is played in the market
Their strategies are their price or output decisions
The payoffs are their profits
What is a duopoly?
It is a two-firm oligopoly where both firms are producing an identical product, and there is a single market price
What is the only choice that duopoly’s have?
How much output to produce
What happens if the two firms in a duopoly cooperate to jointly act as a monopolist?
Each firm will produce one-half of the monopoly output and each earns large profits
What happens if the two firms in a duopoly compete?
Each will produce more than half of the monopoly output, and both firms earn low profits
What is Nash equilibrium?
It is an equilibrium that result when each player is currently doing the best it can, given the current behaviour of the other players
What is the best action for each firm in simple game theory?
To compete, no matter what the other firm is doing
What does Nash equilibrium have both firms do?
Compete and produce the higher level of output
What are the 2 settings in which game theory can be used?
How firms interact when they charge different prices for their differentiated products
How firms interact when the decision is to develop a new product
What is collusion?
It is when firms agree to cooperate to restrict output and raise prices. This can occur with or without explicit agreements
What is overt collusion of covert collusion?
It is when firms agree to cooperate to restrict output and raise prices. The difference between the two types of collusion are dependent on whether the agreement is open or secret
What is tacit collusion?
It is when collusion occurs without explicit agreement
What do firms in an oligopoly choose to do with each other? (competitive behaviour)
They choose to actively compete with each other in an attempt to attract consumers away from their rivals, to increase their overall share of the market, and to increase their profits
How can oligopolists compete with each other?
They can do so through pricing, advertising, product quality, and innovation
Do consumers gain from the competition that oligopolist firms engage in?
Yes they do
What are the four kinds of entry barriers that oligopolistic firms create in order to earn profits in the long run?
- Brand proliferation
- Advertising
- Predatory pricing
- Purchasing rival firms
What is Brand proliferation as an entry barrier for oligopolistic firms?
It is when there is a large number of differentiated products in a market which leaves a small share available for a new firm
What is Advertising as an entry barrier for oligopolistic firms?
Where heavy advertising has established strong brand images for existing products, a new firm may have to spend heavily on advertising to create its own brand images in consumers’ minds
A new entrant with small sales but large advertising costs finds itself at a substantial cost disadvantage relative to its established rivals
What is Predatory pricing as an entry barrier for oligopolistic firms?
A firm cannot enter a market if it expects continued losses after entry. Because of this, existing firms can create such an expectation by keeping prices below their own costs until the entrant goes bankrupt. The existing firm sacrifices profits, but it also discourages potential future rivals.
What is Purchasing rival firms as an entry barrier for oligopolistic firms?
By purchasing the rival, the large firm can prevent this firm from growing and becoming a competitive threat.
What do some oligopolistic industries come close to in the short run?
Joint profit maximization
What do other oligopolistic industries come close to achieving when they are intensely competitive?
Competitive prices and outputs
In what instance do oligopolies become less efficient than perfect competition?
To the extent that the price remains above competitive price levels
What do profits that survive competitive behaviour in the long run attract?
Entry
When do profits persist?
When entry is restricted
What do some economists argue that oligopoly leads to more of?
Oligopoly leads to more innovation than would occur in either perfect competition or monopoly
Why is oligopoly an important market structure in modern economies?
Because there are many industries in which the minimum efficient scale is simply too large to support many competing firms
What is the challenge of oligopolies?
To keep oligopolists competing, rather than colluding, and using their competitive energies to improve products and to reduce costs, rather than merely to erect entry barriers
