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Level 5 Economics: Theory of the Firm [3]
Economic Principles Economic Environment
• Imperfect Competition
Level 5 Economics: Theory of the Firm [3]Learning Outcome Three
Theory of the Firm:3. Imperfect Competition
Tiwai Point Aluminium Smelter – Meridian's biggest customer
Wikimedia Commons
• barriers to entry into a market give existing suppliers market power– high capital costs / economies of scale– technological expertise
• registration systems / licensing / examinations
– patents / copyrights: "Intellectual Property Rights"• incl. trademarks: names and symbols (silver fern?)
– franchising / dealerships• parallel importing – dealer networks bypassed
– excessive government regulations ("red tape")– use of market power
• predatory pricing, control of inputs [examples?]
Barriers to Industry Entry limit Competition
S&R, S ch.6
diamonds, pounamu (NZ jade), local landline
ExerciseForm groups of 2 or 3.
Imagine you plan to start a new business.
Think of 2 industries inNew Zealand or in your home country
in which it would be extremely difficult for your new firm to enter the market.
Are some markets within that industry easier for a new firm to enter than others?
Efficient and Competitive Markets• Efficient Market for a commodity
– Price = Marginal Benefit = Marginal Cost[accounting for benefits to consumers and other parties][accounting for costs to producers and other parties]
• Perfectly Competitive Market– is efficient, without government intervention
• there are no "other parties"; only consumers, producers
– also Price = Minimum Average Cost
• Imperfectly Competitive Market– without government intervention, is not efficient
Monopoly• market with a single seller – a price-maker
– absence of competitors gives monopoly firms market power
• the most imperfect form of competition– NZ examples: NZ Bus, Auckland Airport (AIA), Vector
• competitive forces arise from substitutes– not all substitutes are obvious; eg home renovation
may be a substitute for overseas holidays• labour monopolies: unions and societies• Natural Monopoly
– technical efficiencies maximised if just one firm– large economies of scale exist Mankiw fig 1
back
Advertisement from Auckland City Harbour News 25 August 2004
natural monopoly
Note KR: "Average Total Cost" here means what we call "Long-Run Average Cost" (LAC)
from Mankiw, Principles of Economics (4e), p.315
Revenue curves for perfect competition and monopoly• for perfect competition marginal revenue is
constant because S&R, S fig 6.2 (reminder)
– each firm is too small to influence the market supply curve
– hence the perfectly competitive firm cannot, on its own, influence the equilibrium market price
• a monopolist's marginal revenue curve is downward sloping S&R, S fig 6.3
– a monopolist's output is also the market's output an increase in a monopolist's supply reduces
the market price Impact on price: competition and monopoly compared.
Demand Curves Faced by Firms with Different Initial Market Shares
$4.50
$5.00
$5.50
$6.00
$6.50
$7.00
$7.50
160 170 180 190 200 210 220 230 240 250
output (Q) of individual firm
mar
ket-
clea
rin
g p
rice
(P
) p
er it
em s
old
0.1% market share 1% market share 5% market share
20% market share 50% market share 100% market share
Market Demand Curve
Average Revenue Curves, firms in industries with different levels of competition
20% increase in firm’s output; what happens to price?
Duopoly
Oligopoly
Monopoly
Equilibrium of the Firm; Imperfect Competition
• applying the MC=MR rule to establish Qe
• Profit () equals S&R, S fig 7.10
total revenue (TR) minus total cost (TC) = Q.AR–Q.AC = Q(AR–AC) = Q(P–AC) ∵ AR=P always
• firms maximise profit when S&R, S fig 7.11
marginal revenue (MR) equals marginal cost (MC)– under imperfect competition, MR < price
AR and MR slope down to the right
• firm's equilibrium, Imperfect Competition– above-normal profits apply and persist S&R, S fig 7.12a
Imperfect competition esp. monopoly.
= Price for a given
Q
fig 4 Mankiw
(new fig 7.12a)
Fig 7.12a
Multichoice Monopoly Exercise (ca)
Monopolistic Competition S&R, S end of ch.7
• industry includes small firms– commonly includes larger firms as well
• eg restaurants and fast food (McDonalds)
• product differentiation / variation S&R fig 7.18, S 7.15
– eg Nike, Levis etc• market leaders through successful branding
– marketing strategy designed to raise demand for brand and thereby to avoid price-cutting• successful brand variant enjoys less elastic demand
– differentiation can be achieved also bylevels of personal service, reputation etc.
• most well-known firms are monopolistic competitors
back
Average Revenues of Undifferentiated Competitive Firms
$1.00
$3.00
$5.00
160 170 180 190 200 210 220 230 240 250
output (Q) of individual firm
mar
ket-
clea
rin
g p
rice
(P
) p
er i
tem
so
ld
Monopolistic Competition;
Average Revenues for successful
individual brands are like this.
Oligopoly / Duopoly S&R, S end of ch.7
• few sellers / two sellers [large size firms]– individual firms' supply each affect price
• examples» .
• high barriers to market entry lead to oligopoly• oligopolist firms compete for market share
– each rival firm happy to supply more (as economies of scale are common), but not happy for an increase in industry supply to force prices down
• price competition [price wars, extreme case]– works only in short-term as rivals soon respond
banking, supermarkets, newspapers, energy production and retailing
Holding Companies & Mergers• common ownership through
holding companies reduces competition– eg The Warehouse Group; other examples?
• mergers have to be approved in NZ by the Commerce Commission
Cartel: a colluding oligopolyMonopsony:• single buyer
– Fonterra (dairy), Zespri (kiwifruit) in NZ• globally, these are Monopolistic Competitors
Natural Monopoly• when a single firm can supply the whole
market while experiencing decreasing costs S&R fig 7.15 p.136, S fig 7.18 p.156 (eg Vector)– especially where large networks exist– competition would force each firm to produce at
an above-optimal cost (ie on the left side of the LAC curve)
• monopoly is not always bad– natural monopolies are usually publicly owned or subject
to price regulation to improve their economic efficiency– high cost industries with social benefits will often only be
provided by a monopoly• to operate efficiently, a subsidy may be needed fig 8.2, 8.1
fig 7.14, 7.17 for price regulation
Efficient Quantities for Societyif Price (ie Average Revenue) = Marginal Cost
– price is the marginal benefit of a private good
• 'price (AR) = marginal cost' is a condition for efficiency for society as a whole for a 'private good'– otherwise , efficiency gains can be realised:
• if price > marginal cost, there will be increased net benefits if more resources are allocated to that good
• if price < marginal cost, there will be increased net benefits if fewer resources are allocated to that good and more resources are allocated to other goods
– markets are efficient when changes in quantity supplied can not lead to welfare gains back
Net Benefits• Consumer (household) point of view
happiness – unhappiness = individual welfare
• Producer (firm) point of viewtotal revenue – total cost = profit
• Social point of viewtotal benefit – total cost = societal welfareconsidered from combined point of view:
• private user (first party)• third parties• public (collective)
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Dynamic vs. Static Efficiency
Contrasting effects of Perfect and Imperfect Competition• Market Concentration Ratios
– many industries fall between oligopoly and monopolistic competition, with market leaders
– monopoly = 1; perfect competition = 0
• Evaluation of differences S&R, S Table 8.1
– imperfect competition• can be made more efficient through policy intervention• competition creates marketing industry• dynamic competition – rivalry – creates change
• Issue to think about– do Google and Facebook dominate the Internet?
MultichoiceMonopolyRevision (cb, cc)
Demand Curves Faced by Firms with Different Initial Market Shares
$4.50
$5.00
$5.50
$6.00
$6.50
$7.00
$7.50
160 170 180 190 200 210 220 230 240 250
output (Q) of individual firm
mar
ket-
clea
rin
g p
rice
(P
) p
er it
em s
old
0.1% market share 1% market share 5% market share
20% market share 50% market share 100% market share
Market Demand Curve
back
Duopoly
Oligopoly
Monopoly
Average Revenue Curves, Firms in Industries with different levels of competition
economies of scale diseconomies of scale
eg large Supermarket
eg Dairy
eg Superette
eg small Supermarket
$
back
Example of a Long-Run Average Cost Curve LAC S&R ch.5