Imperfect Competition Flashcards
What are the main features of monopolistic competition?
- Many firms/sellers
- Differentiated product.
- Imperfect information
- No barriers to entry/exit
- Price-makers
Assuming: Independence - the individual firms’ actions will not not affect the rivals choices. The firm does not need to worry about how other firms are going to react.
Can firms in monopolistic competition earn supernormal profits in the short-run?
Yes.
Can firms in monopolistic competition earn supernormal profits in the long-run?
No.
This is because there are no barriers to entry/exit.
Are monopolistic firms productive or allocative efficient in the long run?
No.
Will monopolistic firms have excess capacity in the long run?
Yes.
They don’t produce where D=MC, therefore there is still excess capacity - underutilisation of its resources.
What are the main qualities of an oligopoly?
- Few firms/sellers
- Homogeneous/differentiated product.
- Barriers to entry/exit
- Imperfect information
- Price-makers
- Interdependence
- Price-Rigidity
Give examples of firms who are in monopolistic competition.
Restaurants, hair salons, household items and clothing
Give examples of firms in an oligopoly.
Airlines, automobile manufacturers, and pharmaceutical companies.
What is a tacit collusion?
Tacit Collusions occur under oligopolies.
They are a type of informal collusions and can be split into 2:
- Gentlemen’s Agreement - an informal oral understanding. It is done to set a minimum price. Although they are common, they are also illegal.
- Price Leadership - when one firm is a leader and the rest of the firms are price followers. The aim is that the leader sets a price, and its followers will copy them with the aim of setting a common price.
What are some benefits of a collusion?
- Lower prices due to economies of scale
- They help to increase supernormal profits. Thus, firms can invest more
- Non-price competition can serve as an incentive to improve the products, which benefits consumers
- There will be more stability for consumers and firms
Why are oligopolies interdependent?
Firms will mutually depend on each other’s decisions, as decisions will affect other firms.
This leads to Price Rigidity/Stickiness/Stability.
Price Rigidity - since firms are assumed to act based on their self-interest, then a price cut is expected to be imitated, but not a price rise.
Lowering Prices might set a price war, while increasing the prices might lose firms consumers, as they would substitute to another firm.
(Theories explaining this are on another card).
What are some theories explaining Price Rigidity?
- Kinked Demand Curve. Above the Pe - demand is elastic. If firms increase prices, they will lose consumers. Qd decreases more-than-proportionate
Below the current price - demand is inelastic. A decreases in prices, will lead competitors to do the same, eroding any possible benefits from this price cut.
Any price changes will decrease Total Revenue.
- Game Theory: Maximin strategy - choosing the best from the worst outcomes. Based on maximising one’s minimum pay off - a low risk strategy.
or a Maximax Strategy - choosing the best from the best outcome. It is based on maximising one’s maximum pay off - a high risk strategy.
- Collusions - agreements between firms that restrain market competition.
- Saucer-shaped AVC curve - when the fixed factor is divisible, the AVC curve will be flat over a range of output. Between Q1 and Q2, MC will also be flat. This means that the law of diminishing marginal returns doe snot apply as long as the fixed factor has not yet reached its full capacity.
What features of monopolistic competition are similar to perfect competition?
There are several firms, as there are no barriers to entry/exit. They are able to make supernormal profits in the short-run.
Supernormal profits are eroded in the long-run, due to low barriers to entry.
What features of monopolistic competition are similar to a monopoly?
Products are differentiated. There are close but not perfect substitutes, so the demand curve is downwards sloping with MR falling twice a much. However, it is more elastic than the monopoly’s demand curve.
Firms are price-makers.
Firms are not productive or allocative efficient in the long run
What does differentiated products mean?
A differentiated product means that the product is perceived by consumer as being different from others. This can be achieved through physical aspects, perceptions and the location where it is being sold.
