Exam-3 Chapter 9 Imperfect Competition And Mulitinational Corporation Flashcards
Multinational corporations
Firm that operates through out the world
Product differentiation
Means that the goods produced by a business are perceived by the consumers to be different from the goods produced by their competitors.
Substitutes
Gods that can be used in place of each other
In perfect competition, the goods are
Perfect substitutes, that is, they are identical.
Product differentiation means that
Goods are imperfect substitutes
Why do consumers feel that some goods arebetter than other goods ?
Because of quality, physical characteristics or image. Perception is just as powerful as fact.
When does ultimate product differentiation occur
When goods that are technically substitutes to the casual observer are no longer regarded as such.
Example: some people buy Ford pickups would never buy a Chevy.
Or some drink Pepsi and refuse to drink coke.
What will strong product differentiation create
Huge competitive advantages for the firm and disadvantages for the competitors.
What are the advantages of product differentiation
Both advantages are related to price.
- consumers will be less price sensitive when product differentiation is strong. Economists would say product differentiation makes the demand for a good less elastic. To the business, it means that they can charge higher prices without significantly affecting the quantity demanded.
- It allows firms to compete using factors other than price called non - price competition. While a firm can compete only on the basis of price, where product differentiation exists, the price is often less important than quality, service, features, image, and other non monetary factors. Example: local restaurants compete on the basis of taste of their food and their services, in addition to price.
Monopolistic competitors
Are small businesses with differentiated products.
What are the assumptions of Monopolistic competitors
- Many are small firms. - so small that that the action of 1 firm does not impact more than a small portion of the market.
- Differentiated products- the products of these firms are close, but not perfect substitutes.
- Free entry and exit of firms- there are no barriers to entry of her firms into this market, nor are existing firms prevented from going out of business.
Monopolistic competitive firms include
Restaurant, hair salons, convenience stores, and lawn care business.
Are multi billion dollar industries or chain stores like McDonald’s or Burger King , monopolistic competitors or not?
Yes , for the most part each restaurant is part of the monopolistic competitive industry. Those that are part of the national chains, will have advantages over their competitors.
Just like a competitive firm, a monopolistic competition will find its its highest profit at
The point where marginal revenue is equal to marginal costs.
What is the difference between the competitive firm and monopolistic competition
The difference is in how the price is determined.
Competitive firm - is a price taker, for whom price is constant and equal to marginal revenue.
Monopolistically competitive firm- is a price searcher. It has control over its price. This control comes from product differentiation. Some consumers will be willing to pay more for a particular product than for its substitutes.
Why is the ability of a monopolistic competitive firm , to control its prices limited?
As there are so many firms in a monopolistically competitive industry that the effect of the product differentiation is typically small.
The firm faces tremendous competition for the consumers dollar, and so many competitors selling in so many different ways, that the firms prices are likely to be similar.
Price discrimination
Small sandwich stores offering senior or student discounts ( third degree discrimination) or buy 10 get one free deals ( second degree discrimination)
In the short run, the monopolistically competitive firm may earn
An economic profit.
The existence of product differentiation helps this firm, compared to a competitive firm, because the ability to differentiate and adjust prices gives it a greater opportunity to create an economic profit.
In the long run, monopolistically competitive firms must remember that
There are many firms and free entry of new firms. Any formula that is successful in the short run will be copied by existing and new firms. So this firm can expect only a normal profit in the long run.
Just as with the competitive firm, this is because of the entry of new firms into the market.
A firm in monopolistic competition,such as a restaurant
Will always face tremendous pressure from competitors, must continually differentiate its produce, and can expect profits to be in jeopardy from time to time. And it means, that poorly run firms will not survive long.
In a monopolistically competitive firm, what is larger, price or marginal revenue?
Price will be larger than marginal revenue for the monopolistically competitive firm.
Summarize monopolistic competition
- Output will be slightly lower [restricted] compared with the competitive solution, except where price discrimination increases the level of output. This is always true when P>MR, because we always set MC =MR to maximize profit.
- Price will be higher than marginal cost, since the firm is a price searcher. This means the firm will not be resource allocative efficient,
unless price just a nation is used to mitigate the outcome and set
P= MC, but this is extremely unlikely. - Price will not be equal to the lowest possible average total cost because the firm faces a U-shaped ATC curve, and it restricts Output, the monopolistically competitive firm Will not be able to reach productive efficiency either.
monopolistically competitive firms
Will charge higher prices
Produce lower levels of outputs
Produce at higher cost per unit
Be generally less efficient
What are the characteristics of an oligopoly
- The industry consist of only a few firms. There is no specific number of firms, other than at least two, but there is a test. The number of firms must be few enough that the firms are interdependent.
- The forms in an oligopoly are interdependent. This means that action of one firm affects the other.
- Strong barriers to entry and exit. It is difficult or impossible to start a new business in this industry.
Oligopolies include
Airlines, automakers, steelmakers, college textbook publishers, oil companies, television networks, record companies, movie studios etc.
What is a problem in the oligopoly
The problem for the Oligopoly is that it is directly affected by the actions of its competitors.
There is no set or usual strategy for an oligopolist.
Many economists just believe that the best way to look at an oligopoly is to view it as if
There were a game being played, where each firm is a player and they are competing to win the game.
The strategy becomes more complex as the number of players increase.
What is the most basic form of game theory
Prisoners dilemma
Prisoners dilemma
Is a two-person game. There must be two suspects to the crime. We offer each of them a deal : confess and implicate your comrade, and we’ll ask the judge to go easy on you. There are three possible outcomes for each person;
- Both suspects keep silent and get to go free
- One suspect confesses, gets a short sentence, and the other suspect goes for a long prison term.
- Both confess and both get long prison terms.
What is the best strategy in prisoners dilemma
The best strategy would be for neither to confess,but that is actually unlikely to happen. Because they are separated, they have fear that their partner in crime will confess to save themselves, so they are likely to confess to protect themselves.
What is the dominant strategy in prison is dilemma
The dominant strategy in business dilemma is for both to confess, which is the worst possible outcome
What does prisoners Dilemma say for oligopoly
If the firms complete, they will hurt each other.
If they cooperate, they will both benefit.
How do you oligopolies differ from other form of businesses
Oligo bodies different from other form of businesses and that they will attempt to find ways to collude or work together. They believe that competition is destructive and cooperation bring profits
How do firms in oligopoly collude
Their collusion can take form of explicitly working together
Or it can be a tactic collusion, which means that the collude secretly, without public meeting or communication.
Standard equilibrium
Means that everyone reaches a point where benefits and cost are equal. Everyone is happy at standard equilibrium.
Nash equilibrium
Is an outcome where no one can make a change that improves their position. Your position maybe terrible, but every option is worse.
What is the key to understanding oligopoly
Collusion
Cartel
A cartel is a group of firms that operate through direct collusion. That is they get together and openly agree on how to run or control their businesses.
There is one price for the product in the market. This is because arbitrage is possible
Trusts
Example the tobacco companies would meet and decide how to divide up there Market. These groups were called trusts
What is the most obvious modern version of the cartel?
OPEC the organization of petroleum exporting countries
A cartel lets an oligopoly act like
A monopoly
Single price monopolies
Restrict output to raise the price
If cartels work so well, why doesn’t everyone have one?
Cartels are illegal in the United States and in most developed nations
There is a fundamental problem with them that almost always leads to their demise. [In OPEC’s case, periods when they are unable to control the prices]
Cartels function as long as
Everyone follows the rules. Some members, however, will maximize their profits if they break the rules.
Name an instance when cartels will fail
The cartel may also fail when countries need money.
How to oligopolies take advantage of the gains from collusion if they cannot meet and legally collude?
Through tactic collusion.
Example Coca-Cola and Pepsi cola these companies compete fiercely for soda drinkers, yet never using prices.
Price leadership
Is a strategy that is often used for best selling products or brands ,setting their own prices.
How do oligopolies try to prevent the entry of new competitors
- High start up cost- in industry such as automobiles, the cost of creating a company from scratch is high even into the billions of dollars.
- Product proliferation-companies that produce large number of different products [proliferation] to prevent the entry of a new competitor who takes a niche in the market left open to them.
Example if there were no oats cereals, then a new competitor could enter the market by using oats to make cereal. - Control of resources-to start an airline, one must find gates at airports at which to park the planes. If all the gates at a particular airport are owned by existing airlines, the new airlines are excluded.
Summarize oligopoly behavior
- Oligopolies will try to act like monopolies. -In a single price industry, they will restrict output to raise prices. In a multiple price industry they will use price discrimination to take consumer surplus from their customers.
- oligopolies will use non-price competition. -If they can find a way they will not use price as a basis for competition. Firms in an oligopoly that use price to compete are generally the smaller competitors.
- oligopolies will conclude. By working together they can maximize their individual profits.
- Oligopolies will attempt to limit competition. -They will edit barriers to entry and buy out competitors.
Why are oligopolies “ risk adverse”
This means that they will try to avoid risk.
The oligopoly benefits if everything stays the same. So they don’t try new things, and when a competitor does innovate,the oligopoly will only act after they see what happens.
Generally innovation comes from
The fringe, small outsiders, and not from the big players.
Example: Microsoft has not generally innovated, they have adapted innovations created by new players in the market.
In the short run, the oligopoly firm may earn an
Economic profit. The existence of product differentiation helps this firm, compared to a competitive firm, because the ability to differentiate and adjust price gives it a greater opportunity to create an economic profit.
In the long run, the oligopoly
Has barriers to the entry of new competition. Without the problem of new competitors, the economic profits of the oligopoly can exist into the long run.
Some economists believe that the oligopoly is not primarily interested in Maximizing its profits. Why?
- The oligopoly exist for the long-term. The firm may trade short-term profits for long-term success
- The separation of ownership and control makes the primary goal of the oligopoly maximizing it’s short term stock price, so that current management can stay in power.
- The oligopoly faces a complex world with many markets, suppliers, Union’s etc. some believe that it will react by setting a variety of goals with minimum levels of performance in each as the overall goal. This is called satisficing.
- The oligopoly might be interested in maximizing its revenue or share of the market, subject to the constraint that its profits not fall below a certain level. Some view this as another long-term strategy.
For an oligopoly what is larger, price or marginal revenue?
Price will be larger than marginal revenue for the oligopoly
Summarize oligopoly
- Output will be lower or restricted compared with the competitive solution, except where price discrimination increases the level of output. This is always true when P>MR, because we always set MC =MR to maximize profit
- Price will be higher than marginal cost, says the firm is a price searcher . This means the firm will not be resource allocative efficient,unless price discrimination is used to mitigate the outcome and set P= MC, but this is extremely unlikely.
- Price will not be equal to the lowest possible average total cost. If the firm faces a U-shaped ATC curve, and it restricts output , The oligopoly probably will not be able to reach productive efficiency either.
What are the exceptions to the three outcomes?
- Price discrimination can lead the firm to set P= MC and create a competitive level of output and resource allocative efficiency
- The oligopoly may not have a U shaped cost curve, which means it may be a productive efficient producer of goods.
Law of diminishing returns
Tells us that when we add one resource to a production process, without adding all the others, diminishing returns set in.
What is the way around diminishing returns
Expand the business by the replication
Example McDonald’s does not expand by making its restaurants larger, it expands by building new restaurants.
Replication
Is the expansion of the company by duplicating it’s existing production facilities.
Individual factories, restaurants and businesses generally have
U shaped cost curves. This means that there is an optimal size for them
The estimated cost curves for real multi plant firms are almost always found to be
L shaped
Multinational firms
Is one that has wholly or partially owned affiliated that operate in countries other than the home country of the firm. An example, general motors owns Opel, which build cars for sale in Europe.
Why do Multinational firms exist?
- Cost - a multinational can take advantage of low labor costs in countries where they exist, low capital costs in others, and low natural resource costs in still other countries.
- Culture- a multinational can use its affiliates to adapt its operations to the different cultures that exist in different countries
- Immunity from exchange rate changes. - Changes in exchanges rates affect the price of imported goods, but not the cost of producing goods within a country
- Immunity from import restrictions - If the US taxes Brazilian steel, the Brazilian company can buy a steel mill in the US, produce the steel within the US, and avoid paying the tariff.
- Tax avoidance - Countries have different tax systems. A multinational may be able to lower its taxes by shifting is operation to take advantage of differences in tax laws among nations.
Direct export
It produces the goods entirely at home, and then sells it directly into the other nation. This method has none of the advantages of a multinational firm, but it is simple and available to small businesses as well as large.
Foreign partner
The partner in this case is not owned by domestic company but simply acts as a middle person, buying the goods from the US company and reselling it in its home country.
What are the three options to available to a business that wishes to sell its output in other countries?
- Direct export
- Foreign partner
- Foreign subsidiary or affiliate.
Foreign subsidiary or affiliate
The process of doing this is called forgiven direct investment. The affiliate is part of the larger corporation but it is a separate unit when it is advantageous for the MNC to view it that way. It is through this model that the MNC will make use of all the advantages available to it.
Vertical Integration
When a company produces some of the intermediate goods used in the production of the final product, then it is said to be vertically integrated
non-vertically integrated
-
MNC
will be at a competitive advantage compared with its wholly domestic competition
- Example = multinational auto producer can lower its costs by shifting production around the globe, a domestic company cannot, except where it can buy parts already produced elsewhere.
A MNC likely produces
more than one product for sale to consumers.
- Example = Black and Decker makes dozens of different consumer goods, from household appliances to power tools to gardening equipment.
horizontally integrated –
it produces many different unrelated consumer goods
To be the most cost effective, a MNC will?
it will produce each good where it can be produced most efficiently.
What is the conflict in Global production?
There is often a conflict in global production – we want inexpensive products, and we want domestically produced products. These two things may be incompatible.
How will a MNC avoid restrictions imports of goods from abroad?
By producing them within a country.
The United States has a tax on the
profits of corporations.
VAT (Value Added Tax)
is the equivalent of a national sales tax, except it is paid by the business. It is called a Value Added Tax because it is not charged on the sales price, but rather on the difference between the cost of the inputs and the price of the final product (the value added).
How a US company could use the multinational structure to avoid the corporate profits tax.
By shifting its profits to its foreign affiliates
Transfer price
Suppose the affiliates of the MNC produce parts that are assembled into final products by the firmin the US. The affiliate does not give the parts to the parent company, it “sells” them to it. This sale is really just an accounting transaction. The parts were on the books of the subsidiary and are transferred at some price to the books of the parent.The price charged by one part of a MNC to another part of the same MNC for goods is called a transfer price.
Flexible accounting
They have two sets of books. (Or more than that, one for every country). These multiple sets of books describe the company in whatever manner lowers the tax liability to the minimum in each country
transfer pricing
This process of using different prices to move profits around
Production differentiation creates
monopoly power for firms which are not monopolies.
Monopolistic competition
is the economists term for businesses that have the characteristics of competitive firms, except that they have differentiated products.
Firms in monopolistic competition
will charge slightly higher prices than in perfect competition, be a little less efficient, and potentially earn higher economic profits in the short run.
Oligopoly
occurs when a small number of firms exist which are interdependent. Oligopoly does not follow the same theory of other market structures, but instead follows game theory, which requires it to respond to its competitors instead of making decisions in isolation.
Multinationals have the ability to
use foreign resources and foreign locations to lower costs, avoid taxes, and avoid issues with exchange rates.
