Perfect competition

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Perfect competition

• Everything you ever wanted to know ?

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FOUR CONDITIONS FOR PERFECT COMPETITION

• Many buyers and sellers participate in the market
• Sellers offer identical products
• Buyers and sellers are well informed about
  products
• Sellers are able to enter and exit the market
  freely

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1. Many buyers and sellers

• No individual buyer or seller can influence the
  total market quantity or the market price
• Supply and demand determines price without any
  influence from individual suppliers or consumers
• Sellers MUST charge this price or they will sell
  NONE of their product

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2. Identical products

• All suppliers offer the same product or service
• There are no differences consumers cant tell
  the difference
• There is no way to differentiate
• Commodity a product that is considered the same
  regardless of who makes or sells it
• low-grade gasoline, notebook paper, milk
• a buyer will not pay extra for one particular
  companys goods but will always choose the
  supplier with the lowest price

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3. Informed buyers and sellers

• Buyers and sellers know enough about the market
  to find the best deal they can get
• You have full information about the product and
  its price

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4. Free market entry and exit

• What are barriers to entry?
• How expensive or difficult it is to get into a
  certain business or to get out of it
• Start-up costs the expenses that a new business
  must pay before the 1st product reaches the
  customer
• High start-up costs or technological know-how
  keep many entrepreneurs from entering a market
• Ex less expensive to start up a sandwich shop
  than a giant supermarket

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Free market entry and exit, cont

• In perfect competition
• Firms can very easily enter a market when they
  can make money
• Firms can very easily exit a market when they
  cant earn enough to stay in business

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Price and output

• So why do we care and why are we starting with
  perfect competition?
• Because of all of the competing sellers
• Perfectly competitive markets are the most
  efficient
• Competition keeps prices and production costs low
• Firms have no choice but to use land, labor,
  organizational skills, machinery, and equipment
  to their best advantage
• Prices that consumers pay are very close to what
  it cost to produce the good
• prices are the lowest possible
• prices just cover the most efficient sellers
  costs of doing business

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MONOPOLY

• Everything you ever wanted to know ?

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Monopolies

• What is the point of the game Monopoly? How do
  you win?
• What is the problem with monopolies?

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Imperfect Competition and Market Power

• Weve learned about perfectly competitive
  markets, so what does it mean when a market is
  imperfectly competitive?
• Firms have some control over the price of their
  output
• Having market power means that a firm is able to
  raise price without losing all of the quantity
  demanded for its product.

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Characteristics of Pure Monopoly

• Single firm in an industry
• No close substitutes
• Significant barriers to entry prevent other firms
  from entering
• Not price-takers, but instead they are
  price-makers!

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Barriers to Entry

• In real life, a monopoly forms when barriers
  prevent firms from entering a market that has a
  single supplier.

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• Sometimes it just makes sense for a monopoly to
  form. Here are some reasons why

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1. Economies of Scale

• A producers average cost drops as production
  rises
• High start-up costs can be spread out among more
  and more goods as production rises
• Large, initial fixed costs like paying for a
  factory and machinery
• Would you spend 1 million to build a huge bakery
  if you were only planning on selling a few dozen
  cookies each week?

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Economies of Scale - example

• A factory costs 1,000 to build and each unit of
  output costs 10 to make
• Producing 1 unit will cost 1,010
• Producing 2 units will cost 1,020 (or 510 each)
• What happens to the costs as this business
  produces more?
• It just makes sense for them to get really big!
• Once they are big, it will be hard for others to
  enter the market and compete with them.

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2. Natural Monopolies (mentioned later in
chapter)

• A market that runs most efficiently when one
  large firm provides all of the output
• Public water or electricity
• Would it make sense for there to be more than one
  firm providing the water or electricity in an
  area?
• Resources would be wasted
• The government allows these types of monopolies.

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3. Government Monopolies

• A monopoly created by the government
• There are technological, franchise, license, and
  industrial organizations

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Government Monopolies

• Technological monopolies
• Patent gives a company exclusive rights to sell
  a new good or service
• Why does the government want to provide patents
  to pharmaceutical companies or other inventors?

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Government Monopolies

• Franchise contract issued by a local authority
  that gives a single firm the right to sell its
  goods within an exclusive market
• Shaler Area has this deal with a soft drink
  company. Which one?
• Not that you would know about this, BUTin
  Pennsylvania, what is the only store that is
  permitted to sell liquor? Why do you think this
  is?

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Government Monopolies

• License grants firms the right to operate a
  business
• Radio and tv broadcast frequencies

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Government Monopolies

• Industrial Organizations
• Government allows companies in an industry to
  restrict the number of firms in a market
• Major League Baseball and other sports leagues
  can restrict the number and location of their
  teams

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Monopoly Demand

• A perfect competitor faced a perfectly elastic
  demand curve that came from the industry.
• There is no distinction between the firm and the
  industry for a monopolist (they ARE the
  industry!)
• Their demand curve is downward sloping, then.
• The monopolist will then choose the point on
  their demand curve where it wants to be.

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Price and Output Decision

• Will demand MR (marginal revenue) for a
  monopolist?
• NO!!!

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OUTPUT DECISIONS FOR A MONOPOLIST

• What do you think? Can a monopolist literally
  charge the highest price possible?
• We know that monopolists can obviously charge a
  higher price than a perfect competitor, but they
  face a dilemma

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The Monopolists Dilemma

• Even a monopolist faces the law of demand!!!
• They can charge a high price, but then they cant
  sell all they want (at a higher price, people
  will not buy as much)
• If Duquesne Light quadrupled the price of
  electricity, what kinds of things would people do?

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Dilemmaanother example

• BreatheDeep (asthma medication) people with
  severe asthma might pay very high prices for the
  drug, but people with milder cases may choose a
  cheaper, weaker medicine if the price rises too
  high
• BreatheDeep will try to figure out the best
  combination of price and output to maximize their
  profit.
• Higher price less output
• Higher output lower price

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Example

• Can they charge the people with severe asthma a
  high price and people with mild asthma a lower
  price to entice them to still buy BreatheDeep?
• Mostly, the answer is NO. You have to charge
  every customer the same price.
• When a monopolist wants to sell more, they
  must lower the price for all customers.

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Sowhere IS marginal revenue, then?

• MR will lie below price b/c
• When they sell more (by lowering price for ALL
  customers), this will bring in more revenue for
  the business, but this increase is offset
  somewhat by the lower price charged for all
  previous units that could have been sold at a
  higher price.
• Therefore, the increase in revenue from
  increasing output by one more (MR) is less than
  the price

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Price and Output Decisions in Pure Monopoly
Markets
Demand in Monopoly Markets
Marginal Revenue and Market Demand
TABLE 13.1 Marginal Revenue Facing a Monopolist TABLE 13.1 Marginal Revenue Facing a Monopolist TABLE 13.1 Marginal Revenue Facing a Monopolist TABLE 13.1 Marginal Revenue Facing a Monopolist TABLE 13.1 Marginal Revenue Facing a Monopolist TABLE 13.1 Marginal Revenue Facing a Monopolist TABLE 13.1 Marginal Revenue Facing a Monopolist TABLE 13.1 Marginal Revenue Facing a Monopolist
(1)Quantity (1)Quantity (2)Price (2)Price (3)Total Revenue (3)Total Revenue (4)Marginal Revenue (4)Marginal Revenue
0 11 0 -
1 10 10 10
2 9 18 8
3 8 24 6
4 7 28 4
5 6 30 2
6 5 30 0
7 4 28 -2
8 3 24 -4
9 2 18 -6
10 1 10 -8

At every level of output except 1 unit, a
monopolists marginal revenue (MR) is below
price. This is so because (1) we assume that the
monopolist must sell all its product at a single
price (no price discrimination) and (2) to raise
output and sell it, the firm must lower the price
it charges. Selling the additional output will
raise revenue, but this increase is offset
somewhat by the lower price charged for all units
sold. Therefore, the increase in revenue from
increasing output by 1 (the marginal revenue) is
less than the price.
? FIGURE 13.3 Marginal Revenue Curve Facing a
Monopolist
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Profit-Maximization

• The profit-maximization rule still holds here!
• So the monopolist will set output by producing up
  to where MC MR
• However, once they choose that level of output,
  they can charge price by looking at their demand
  curve!

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Price and Output Decisions in Pure Monopoly
Markets
The Monopolists Profit-Maximizing Price and
Output
A profit-maximizing monopolist will raise output
as long as marginal revenue exceeds marginal
cost. Maximum profit is at an output of 4,000
units per period and a price of 4. Above 4,000
units of output, marginal cost is greater than
marginal revenue increasing output beyond 4,000
units would reduce profit. At 4,000 units, TR
PmAQm0, TC CBQm0, and profit PmABC.
? FIGURE 13.5 Price and Output Choice for a
Profit-Maximizing Monopolist
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Price and Output Decisions in Pure Monopoly
Markets
Perfect Competition And Monopoly Compared
? FIGURE 13.7 Comparison of Monopoly and
Perfectly Competitive Outcomes for a Firm with
Constant Returns to Scale
In the newly organized monopoly, the marginal
cost curve is the same as the supply curve that
represented the behavior of all the independent
firms when the industry was organized
competitively. Quantity produced by the monopoly
will be less than the perfectly competitive level
of output, and the monopoly price will be higher
than the price under perfect competition. Under
monopoly, P Pm 4 and Q Qm 2,500. Under
perfect competition, P Pc 3 and Q Qc
4,000.
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Monopoly and Profit

• Obviously, this is going to generate profit for a
  monopolist (price will be set far above ATC)
• If they were perfect competitors, what would
  happen in the long run?
• Will the same thing happen for the monopolist?

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The Social Costs of Monopoly
Inefficiency And Consumer Loss
? FIGURE 13.9 Welfare Loss from Monopoly
The triangle ABC roughly measures the net social
gain of moving from 2,000 units to 4,000 units
(or the loss that results when monopoly decreases
output from 4,000 units to 2,000 units).
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• Regulating Monopoly
• Two ideas
• Socially Optimal (where S D or for a monopolist
  where MC p)
• or
• Fair price (where p ATC) so they can at least
  break-even like a perfect competitor

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PRICE DISCRIMINATION

• Can you think of a time when you paid more or
  less for something than someone else?
• It happens all the time! Price discrimination is
  the ability to divide consumers into two or more
  groups and charge a different price to each
  group.

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PRICE DISCRIMINATION

• This gives the monopolist the best of both
  worlds!
• They can charge the people willing to pay a lot a
  very high price
• But they can also sell more by charging those
  willing to pay less a lower price

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CHARACTERISTICS OF PRICE DISCRIMINATION

• Market power - firms must have some control over
  prices
• Distinct customer groups must be able to
  identify consumers willing to pay more / less and
  separate them
• Difficult resale
• Could you charge lower food prices for children
  at Heinz Field?
• What would people do?

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CAN YOU THINK OF EXAMPLES?

• Airline fares
• Coupons / rebates
• Senior citizen / student discounts
• Early bird special
• Children fly or stay free promotions

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Monopolistic Competition

• And Oligopolythe other 2 types of competition!

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What are most businesses?

• Most businesses in the world are NOT either of
  the extremes that we have learned about so
  farthey are somewhere in between PERFECT
  COMPETITION and MONOPOLY.

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Monopolistic Competition

• Different from perfect competition in one major
  way
• You can differentiate your product now!
• Examples fast food industry, clothing stores

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Four Conditions of Monopolistic Competition

• Many firms (more than 10!)
• Few barriers to entry
• Slight control over price
• You have to keep price similar, but you can
  charge a slightly different price
• Differentiated products
• Products are very similar, but you can tell the
  difference

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Nonprice Competition

• Competition through other ways than lowering
  prices
• Can take different forms
• Physical characteristics
• Location
• Service level
• Advertising, image, status

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San Francisco Restaurants

• How can some charge such high prices and others
  have to charge similar prices to competition?

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Other examples of monopolistic competition?
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Advertising good or bad thing?

• What are the arguments for?
• Arguments against?

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Price and Output

• Demand curve for a monopolistic competitor will
  be slightly less elastic than a perfect
  competitor (b/c they will have some control over
  price)
• It will definitely be more elastic less than a
  monopolist, though (a lot more competition than a
  monopolist)

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Price and Output

• To maximize profits, they will set output by
  producing up to where MC MR (any surprise?)
• They will charge price off of the demand curve
• NOTHING IS NEW HERE!!!!!

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Profit

• Monopolistically competitive firms do NOT earn
  huge profits
• If they started earning profits well above their
  costs
• 1strivals would think of new ways to
  differentiate and lure customers
• 2ndnew firms will enter the market (offering
  cheap imitations)

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Loss

• If firms were losing money, some would definitely
  exit the industry (just as in perfect competition)

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Price, Output, and Profits

• Prices under monopolistic competition will be
  higher than in perfect competition.
• However, prices will be lower than in a monopoly.
• Why?

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Output

• Compared to perfect competition and monopolies,
  output will be less than that of a perfect
  competitor but much greater than that of a
  monopolist
• So its somewhere in the middle!

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Oligopoly! (The word no one can ever pronounce)

• An oligopoly is a market structure that is
  dominated by a few, large firms
• Price will be closer to that of a monopolist
  (higher than PC and MC) and output will be lower.
• Example Pepsi and Coke

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Barriers to Entry

• Barriers for an oligopolist are pretty high

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Cooperation and Collusion

• Oligopolies often seem to work together to form a
  monopoly
• Price war when competitors cut their prices
  very low to win business (good for us!)
• Collusion an agreement among firms to set
  prices and production levels
• Price fixing an agreement among firms to sell
  at the same or very similar prices

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Cooperation and Collusion

• Why would companies want to do this?
• They can act as a monopoly and earn monopoly
  profits!

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Cartels

• These are even stronger than collusion.
• They are agreements by a formal organization of
  producers to coordinate prices and production
• They are illegal in the U.S.
• Why might these not work very well all the
  time???? Well, lets see

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GAME THEORY AN INTRO

• In this game, you have two options You can play
  an A or you can play a B.

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What will you do? Play A or B???

• If both groups in the class play a B, then you
  both gain 5. If one group plays an A and the
  other group plays a B, the group who played A
  gains 10, while the group who played the B loses
  10. If you both play A, then you both lose 1.

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PAY-OFF MATRIX
Group 1 Group 1 Group 1 Group 1
Group 2 Play A Play B
Group 2 Play A -1, -1 -10, 10
Group 2 Play B 10, -10 5, 5
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Results!
Group 1 Group 2
Round 1 -1 -1
Round 2 -1 -1
Round 3 10 -10
Round 4 -1 -1
Round 5
Round 6
Round 7