Chapter 14 - Imperfect Competition Flashcards
In monopolistic competition, why is the firm’s demand curve flatter than the total market demand curve?
This is because the steepness of the firm’s demand curve is a function of elasticity of demand for the product!
- this will be more elastic than the market demand because it is easier for consumers to switch to another firm’s product (similar but not identical) than switch consumption to an entirely different product!
- Firm makes SR profits - inducing other firms
- in the LR MR and firm’s demand curve shift to the left, eroding profits
- leaves no incentive for firms to enter
Chamberlin Model (describe)
- Downward sloping demand curve as products are viewed as close substitutes
- assumption of large independent firms
- each firm will act as if its own price and quantity decisions have no effect on the behaviour of other firms in the industry
- symmetry between firms i.e. it makes sense for one firm to alter its price, it will make sense for all others to do likewise
- demand schedule = highly elastic
Monopolistic competition 2 demand curves
dd = chamberlinian firms demand curve
(flatter demand curve due to demand for firm and products are close substitutes)
DD = when all firms change prices together (more inelastic due to it being demand for entire market)
Chamberlin Equilibrium in the Short-Run
Prof-Max at MR = MC
- dd = DD at P*
- intuition for this: P-level at which other firms’ prices are fixed along dd = P*, and every firm will fix price here too
Chamberlin Equilibrium in the Long-Run
Short run profits attracts new entrants
- this shifts each firm’s demand curve to the left
- each firm competes on equal footing for a share of total industry demand, new entrants = share of industry declines
in the LR
- dd shifts left and is tangent to the LRAC
- MR = MC
- zero economic profit
Perfect competition vs. Monopolistic
PC, P = MC (allocatively efficient) but monopolistic is NOT
as MR = MC
- also doesn’t produce at the min point of LAC but at tangent
However:
- would people be happier to buy standardised products for less price? inefficient due to only positioning of LAC may not be just as people are willing to pay for variety
Criticisms of the Chamberlin Model
(George Stigler) many criticisms:
- concept of “industry group” can be too broad especially due to the substitutability
- chamberlinian product group quickly expands to include virtually every consumer product in the economy
- it is not too far from the perfect competition model
Spatial Interpretation
can be used for geographic location but also variety to other product characteristics for example Flight Times
TC = F + MQ
ATC = F/Q + M (thus more customers = lower ATC)
Ctrans = tL 1/2N
- 1/2N = avg distance for round trip (1/4N = one way)
Cmeals = NF+LM
objective = minimise the cost of Cmeals + Ctrans!
Optimal number of outlets (Spatial Interpretation)
Slope of C meals = F
- represents the cost of an additional outlet
Slope of C trans = -tL/2N^2
- represents the savings in transportation cost from adding an additional outlet
If slope Cmeals< Ctrans then adding another outlet = reduced transportation cost which compensates extra FC from additional outlet
Satisfy F = tl/2N*^2
Optimal yields
N* =( tL/2N)^1/2
Hotelling Model (describe)
Differential factor = location
- hot dog vendor problem
each vendor positions themselves at the middle of the beach even though that location doesn’t minimise the average distance that their customers must travel
Cournot Model
Definition = Oligopoly model in which each firm assumes that rivals will continue producing at their current output levels
DEMAND curve: P = a - BQ
- MR: twice as steep as demand therefore
MR (1) = a -BQ(2) - 2BQ(1)
then equate MR to MC to find reaction functions (symmetry)
- reach stable equilibrium where Q(1) = Q(2) = a/3b
- where reaction functions meet neither firm will want to change quantities
- to calculate market price use total quantity in the demand equation
How profitable are Cournot duopolist?
- Combined output = 2a/3b
- market price will be P = a - b(2a/3b) = a/3
- total revenue equal to (a/3)(a/3b) = a^2/9b
Bertrand Competition
Definition = oligopoly model in which each firm assumes that rivals will continue charging their current prices
- firms compete over price, production takes place after price is determined
- Symmetry in price method, each firm undercutting price till P = MC (natural economic limit)
- Two firms split the market equally
Stackelberg Model
Using Cournot behaviour to find reaction function, to then input into Stackelberg demand equation.
- Firm 1 = Stackelberg Leader, Firm 2 = Stackelberg Follower
- First find reaction function using Cournot, then put into demand
(remember e.g. P = 36 - 3Q, change to P = 36 - 3Q(1) - 3Q(2) - find MR from demand curve (2x steep)
- MR = MC to find Q1
- then find Q2 and total Q to find Firm’s Price
- find TR by multiplying market price with each quantity and deducting total cost!
Strategic entry deterrence
investments are effective to deter rivals
- never used but effective…
- they change potential rivals expectations about how the firm will respond when its market position is threatened.
Tit for Tat strategy
The first time you interact, you cooperate.
- in each subsequent interaction you simply do what the firm did in the previous interaction
- over a v long period of time tit-for-tat strategy would be cooperation in each and every interaction
