Chapter 11: Imperfect competition and Strategic Behaviour Flashcards
What doesn’t a perfectly competitive model explain?
How many industries have a large number of relatively small firms
What is a characteristic among most modern industries dominated by large firms?
They contain several firms and are not competitive markets
What is meant when an industry is said to be highly concentrated?
When the industry has a small number of relatively large firms
What is a concentration ratio?
The fraction of total market sales controlled by a specified number of the industry’s largest firms
What is a monopolistic competition?
A large number of small firms in an industry, each with little market power
What is an oligopoly?
A small number of large firms in an industry, each with considerable market power
What is the key difference between monopolistic competition and oligopolies?
Strategic behaviour
What does the term ‘competitive’ imply when referring to the market?
Not a monopoly
What does an imperfect competition emphasize?
Firms are not price takers
What are characteristics that are typical of imperfectly competitive firms?
Firms choose their products
Firms choose their prices
What do most firms in imperfectly competitive markets sell?
Differentiated products
What is a differentiated product?
A group of products similar enough to be called the same product (beer) but dissimilar enough that all of them do not have to be sold at the same price (Stella vs Bud light)
What is a price setter?
A firm that faces a downwards-sloping demand curve for its product (chooses which price to set)
What behavior is present in imperfectly competitive firms that is not present in monopoly/perfect competition?
Firms spend large sums of money on advertising
Firms engage a variety of non-price competition (offering competing standards of quality and product guarantees)
What are 4 assumptions of monopolistic competition?
Each firm produces its own version of the industry’s differentiated product
All firms have access to the same technology
The industry contains so many firms that each one ignores competitiors when making price and output decisions
Firms are free to enter and exit the industry
Why is a firm’s demand curve highly elastic despite having a negatively sloped demand curve in a monopolistic competition?
Because competing firms produce many close substitutes
What is a consequence of all firms having access to the same technology?
They all have the same cost curves
What happens when a firm makes profits during monopolistic competition in the short run?
There is an incentive for new firms to enter the industry
The existing market demand must be shared among a larger number of firms
Profits per firm are reduced, and eventually eliminated
(in the LR equilibrium, each firm has excess capacity)
This is called the “excess-capacity” theorem of monopolistic competition
How does Monopolistic competition differ from perfect competition in terms of LR equilibrium?
The LR equilibrium in monopolistic competition does not minimize ATC
(Excess capacity)
If a firm increases its output, cost per unit decreases but revenue decreases more, so selling more would reduce revenue more than it reduces cost
This excess capacity may not be wasteful if consumers value product variety
Society faces a tradeoff between product variety and lower cost per unit
What is an oligopoly?
An industry that contains two or more firms, at least one of which producing a significant portion of the industry’s total output (very little competition)
What is central to the actions of oligopolies?
Strategic behavior
Firms consider how their rivals are likely to respond to their own actions
What are 2 ways oligopolistic firms can maximize their profits?
Cooperate (collude) to maximize joint profits
Compete and maximize individual profits
How can decision making be studied in oligopolistic situations?
Game theory
What is a Nash equilibrium?
The equilibrium that results when each player is currently doing the best it can, given the current behavior of other players
(for each firm, the best action is always to compete, no matter what the other firm is doing)
What are two types of cooperative behavior for oligopolists?
Explicit: when firms formally agree
Tacit: cooperation without explicit agreement
How can firms compete for market share? What is a consequence of these?
Advertising
Variations in quality
Discounts to increase sales
Innovation (creative destruction)
Consumers usually gain from this
Why does Nike have so many types of products? (different shoes, clothes, etc?)
Brand proliferation - a large number of differentiated products leaves a small market share available to a new firm (entry barrier)
How can advertising be used as an entry barrier?
Heavy spending on advertising requires a new firm to spend as much on advertising to compete, causing a substantial disadvantage
When wouldn’t a firm enter a market? How can existing firms use this to keep entrant firms from starting up?
If it expects continued losses after entry
Existing firms can keep prices low until the entrant goes bankrupt (sacrifice profits for competition)
“predatory pricing”
In the long run, what do profits that survive competitive behavior attract?
Entry of new firms
In the long run, profits persist only insofar as _______
Entry is restricted
