Monopolistic competition and oligopoly Flashcards
What does imperfect competition refer to?
Market structures that fall between perfect competition and pure monopoly
What is monopolistic competition a type of?
Imperfect competition
Define monopolistic competition
A market structure in which many firms are selling products that are similar but not identical
What markets have monopolistic competition?
Markets that have some features of competition and some features of monopoly
What are 3 characteristics of monopolistic competition?
Many sellers
Product differentiation
Free entry and exit
Explain the many sellers characteristic of monopolistic competition
There are many firms competing for the same group of customers
Explain the product differentiation characteristic of monopolistic competition
Each firm produces a product that is at least slightly different from those of other firms
Rather than being a price taker, each firm faces a downward-sloping demand curve
Explain the free entry and exit characteristic of monopolistic competition
Firms can enter or exit the market without restriction
What encourages new firms to enter the market?
Short-run economic profits
What 4 things happen when new firms enter the market?
The number of products offered increases
The demand faced by firms already in the market decreases
Incumbent firms’ demand curves shift to the left
Demand for incumbent firms’ products fall, and their profits decline
(incumbent means firms already in the market in this case)
How do monopolistic competitors maximise their profit?
By producing the quantity at which marginal revenue equals marginal cost
When would a monopolistic competitor make profit?
When price is above average total cost for that quantity
When would a monopolistic competitor make a loss?
When price is below average total cost for that quantity
What encourages firms to exit the market?
Short-run economic losses
What 4 things happen when firms exit a market?
The number of products offered decreases
The demand faced by remaining firms increases
The remaining firms’ demand curves shift to the right
The remaining firms’ profits increase
What is the profit-maximising quantity called when the firm is making a loss?
The loss-minimising quantity
What happens in the long-run equilibrium in terms of entry and exit?
Firms will enter and exit until the firms are making exactly zero economic profits
What happens to the demand curve in the long-run equilibrium?
The demand curve is tangential to the average total cost curve
What happens to the price in long-run equilibrium?
Price equals average total cost
What happens when the long-run equilibrium is reached?
No new firms have any incentive to enter and no existing firms have any incentive to leave
What are two characteristics in terms of long-run equilibrium?
As in a monopoly, price exceeds marginal cost and because MC = MR, price is greater than MR, meaning that the MR curve is lower than the demand curve
As in a competitive market, price equals average total cost
Why does price exceed marginal cost in the long-run equilibrium?
Profit maximisation requires marginal revenue to equal marginal cost
The downward sloping demand curve makes marginal revenue less than price.
What are the two differences between monopolistic and perfect competition?
Excess capacity
Mark-up
What happens to excess capacity in perfect competition in the long-run?
There is no excess capacity in perfect competition in the long run
Why isn’t there any excess capacity in perfect competition in the long-run?
Because free entry results in competitive firms producing at the point where average total cost is minimised, which is the efficient scale of the firm
What happens to the excess capacity in monopolistic competition in the long-run?
There is excess capacity in monopolistic competition in the long-run
Why is there excess capacity in monopolistic competition in the long-run?
Output is less than the efficient scale of perfect competition
What does price equal in perfect competition?
Price equals marginal cost
What does price equal in monopolistic competition?
Price is above marginal cost
What do monopolistic firms have a mark up over?
They have a mark-up over marginal cost
Why do monopolistic firms have a mark up over marginal cost?
As price exceeds marginal cost, an extra unit sold at the posted price means more profit for the monopolistically competitive firm
Where can the excess capacity be found on a graph?
It is the point between the efficient scale (flat part of ATC) and the quantity produced (where the demand curve tangents the ATC)
Where can you find the mark up on the graph?
It is the point between the price and the marginal cost
What causes normal deadweight loss of monopoly pricing in monopolistic competition?
The mark up of price over marginal cost causes deadweight loss
Why is the pricing of monopolistic firms as regulated as monopolies?
The administrative burden of regulating the pricing of all firms that produce differentiated products would be overwhelming
Explain product-variety externality
Because consumers get some consumer surplus from the introduction of a new product, entry of a new firm conveys a positive externality on consumers
Explain business-stealing externality
Because other firms lose customers and profits from the entry of a new competitor, entry of a new firm imposes a negative externality on existing firms
Why do businesses advertise?
To attract more buyers to their products
How much do firms that sell highly differentiated consumer goods spend on advertising?
Firms that sell highly differentiated consumer goods spend a lot on advertising
How much do firms that sell industrial products typically spend on advertising?
Firms that sell industrial products typically spend very little on advertising
How much do firms that sell homogeneous products spend on advertising?
Firms that sell homogeneous products spend nothing at all
What are two criticisms of advertising?
Firms advertise in order to manipulate people’s tastes
It impedes the competition by implying that products are more different than they actually are
What are 3 positives about advertising?
Provides information to consumers
Increases competition by providing a greater variety of products and prices
The willingness of a firm to spend on advertising dollars can be a signal to consumers about the quality of the product being offered
What is a disadvantage of brand names?
They can cause consumers to perceive differences that don’t exist
What is an advantage of brand names?
They are a useful way for customers to ensure that the goods they are buying are of high quality
Why do brand names suggest the good is of high quality?
Brand names provide information about quality
Having a brand name gives a firm an incentive to maintain high quality
Who developed the theory of contestable markets?
William J. Baumol
John Panzar
Robert Willig
When was the theory of contestable markets developed?
In 1982
What is the theory of contestable markets?
Firms are influenced by the threat of new entrants into a market, the more contestable a market is, the lower the barriers to entry, this means that firms might not maximise their profit
What 3 things according to the theory of contestable markets mean that profits are limited?
Entry limit pricing
Predatory or destroyer pricing
Hit and run tactics
Define entry limit pricing
A situation where a firm will keep prices lower than they could be in order to deter new entrants
Define predatory or destroyer pricing
A situation where a firm holds price below average cost for a period to try and force out competitors or prevent new firms from entering the market
Define hit and run tactics
Take profit and leave
Define oligolpoly
A market structure in which only a few sellers offer similar or identical products
What are oligopolistic markets dominated by?
A few large firms that are interdependent
How should firms behave in oligopolies?
They should behave strategically
What is game theory?
The study of how people behave in strategic situations
What are strategic decisions?
Those in which each person, in deciding what actions to take, must consider how others might respond to the action
What would oligopolies like to do?
Reach the monopoly outcome
How can oligopolies turn into monopolies?
Through cooperation
Why must firms in oligopolies act strategically?
Because there are only a small number of firms
What does the profit of each firm in an oligopoly depend upon?
The amount the firm produces and the amount other firms in the oligopoly produce
What does each firm in an oligopoly know about its strategic decision?
That the other firms in the oligopoly have the same strategic decisions to make
What is the pay off matrix?
A table showing the possible combination of outcomes depending on the strategy chosen by each player
What is the pay off for each firm in an oligopoly pay off matrix?
The profit they make as a result of the agreement
What are the two possible strategies of a pay off matrix?
Keep the agreement or break the agreement
Why is cooperation difficult to maintain even when mutually beneficial?
Because there is still a better option for the individual which has a worse impact for the other
Define dominant strategy
A strategy that is best for a player regardless of the strategies chosen by the other players
Define nash equilibrium
A situation in which economic actors interacting with one another each choose their best strategy given the strategies that all other actors have chosen
What situation would cause a Nash equilibrium?
One in which all economic actors choose their dominant strategy
What happens to the Nash equilibrium if dominant strategies don’t exist?
The situation needs to be checked to see if any actor wants to deviate, if no actor wants to deviate then it is a Nash equilibrium
What are two types of imperfectly competitive markets?
Oligopoly
Monopolistic competition
Define oligopoly
A market structure in which only a few sellers offer similar or identical products
Define monopolistic competition
A market structure in which many sellers offer similar but not identical products
What does the concentration ratio measure?
The proportion of the total market share of a particular number of firms
How much power do typical firms in an oligopoly have?
They have some market power but this market power is not as great as if it were a monopoly
What are the two characteristics of an oligopoly?
Only a few firms
Limited entry
What is there tension between in an oligopoly?
Between cooperation and self interest
What is a group of oligopolists better off doing in terms of cooperation and self interest?
Better off cooperating
What provides an incentive for oligopolies not to cooperate?
Profit
What limits the group of oligopolists to act as a monopoly?
Profit encourages firms to go alone
Define duopoly?
An oligopoly with only two members
What is the simplest type of oligopoly?
A duopoly
What happens as the size of an oligopoly grows?
It looks more and more like a competitive market
Lower concentration ratio
The price approaches marginal cost, and the quantity produces approaches the socially efficient level
What happens if the oligopolists cooperate and agree on a monopoly outcome?
They can get a higher profit than when they are competing
Define collusion
An agreement among firms in a market about quantities to produce or prices to change
Define cartel
A group of firms acting in unison
From which standpoint is cooperation among oligopolists undesirable?
From society as a whole
Why is cooperation among oligopolists undesirable from a society point of view?
It leads to production that is too low and prices that are too high
What do competition laws prohibit in terms of monopolies?
They prohibit explicit agreements among oligopolists as a matter of public policy
What is it illegal to do?
It is illegal to restrain trade or attempt to monopolize a market
Who enforces competition law in the UK?
The Office of Fair Trading (OFT)
How does the European Commission apply EU anti-trust rules?
It has a number of investigative powers to help it apply the rules and may fine business undertakings that violate them
When is cooperation easier to enforce?
It is easier to enforce if the game is repeated, this is because any short term gain from a one off achievement will be ore than offset by future losses
What happens as each oligopolist tries to break the agreement?
Total production rises and price falls
How does an oligopolist break agreement?
It raises production and captures a larger share of the market
What is VER?
Voluntary Export Restraints
When did Japanese automobile companies agree to VER?
1980s
What did Japan do as a result of the VER?
It reduced exports to the US
