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Market Equilibrium and Market Demand: Imperfect Competition. Chapter 9. Market Structure Characteristics. We characterize an industry by No. of firms and size dist. Product differentiation Unique products? Barriers to entry The picture to the right concerned with two markets:. - PowerPoint PPT Presentation
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MarketEquilibrium and Market Demand:
Imperfect Competition
Chapter 9
Market Structure CharacteristicsWe characterize an
industry byNo. of firms and size dist.Product differentiation
Unique products?Barriers to entryThe picture to the right
concerned with two markets:
Pages 145-1482
No. 2 yellow corn: many producers and sellers (Perfect Competition)
Farm equipment: few manufacturers and sellers (Oligopoly)
Perfect CompetitionWe have been assuming the firm and market
reflect conditions of perfect competitionNot a bad assumption for many agric. subsectorsA large number of small firms
2 million farmsA homogeneous product
No. 2 yellow cornFreely mobile resources
No barriers to entry caused by patents, etc. or barriers to exit (???)
Perfect knowledge of market conditions Quality outlook information from government, university
and private sources Dramatic reduction in costs of obtaining information and
increase the speed of information acquisition
3
Imperfect CompetitionMany markets in which farmers buy
inputs and sell their products however do not reflect perfect competition conditions
Chapter 9 focuses on specific types of imperfect competitors in the farm input marketThese firms are capable of setting prices
farmers must pay for specific inputs
4
Imperfect Competition in Selling
5
Measures of Concentration
Page 148-1516
Quantitative measures of the degree of competition in a marketConcentration Ratio (CR)
% of the total market revenue accounted for by 2 (CR2), 4 (CR4), 8 (CR8), 20 (CR20), etc. largest firms in the industry
Low CR values→ a high degree of competition High CR values → an absence of competition
Page 148-1517
Quantitative measures of competitionHerfindahl-Hirschman Index (HHI)
The square of % market share of each firm summed over the largest 50 firms or all firms if there are < 50 firms in the industry
Perfect competition, HHI is small Only 1 firm, HHI is 10,000 = (1002) U.S. Justice Department
o HHI < 1,000 competitive marketso HHI > 1,800 could be considered concentrated
industry worthy of Justice Dept. examination of any purchases of other firms in the industry
Measures of Concentration
Page 148-1518
HHI CR4 CR8 CR20 CR50 HHI CR4 CR8 CR20 CR50All Food Manufac. 102 14.8 22.8 37.6 50.8 Soft Drinks 1095 58.1 70.8 83.8 94.0
Flour Manufac. 831 54.5 67.7 82.9 95.5 Cigarettes ----- 97.8 99.4 100.0 -----Soybean Processing 1931 81.5 91.1 98.4 99.9 Carpet/Rug Mills 1650 63.6 74.5 87.5 95.9
Breakfast Cereal 2425 80.4 91.9 99.6 100.0 Pulp Mills 1024 53.9 81.9 99.7 100.0Fluid Milk 1075 46.0 58.1 71.7 86.8 Petrochemical 2535 79.6 93.5 99.8 100.0
Cheese Manufac. 379 31.5 46.9 70.8 88.8 Aluminum 2250 76.7 94.6 99.9 100.0Poultry Processing 738 45.7 57.5 76.9 91.5 Farm Equipment 1829 59.0 65.4 74.1 83.3
Snack Food 1989 53.2 60.7 73.2 85.8 Auto/Light Truck 2022 73.7 91.6 99.3 99.8
Whether an industry is concentrated depends on how narrowly it is defined In terms of the product it produces Extent of the geographic area it serves
Measures of Concentration
Consolidation in the U.S. Dairy Industry
Page 1659
Page 148-15110
Measures of Concentration
Page 148-15111
Measures of ConcentrationCooperative CR Values of Total U.S. Milk Marketed
Page 148-15112
Measures of ConcentrationArea Dec ′97 Dec ′98 Dec ′99 Area Dec ′97 Dec ′98 Dec ′99
Atlanta 38.5 47.8 52.4 Atlanta 81.6 80.3 75.9Boston 66.2 85.4 88.1 Boston 84 89.3 83.4Charlot
te64.4 74.7 73.9 Charlot
te38.5 47.8 52.4
Cincinnati
66.8 79.3 81.9 Cincinnati
90.3 87.6 97.4
Dallas 85 84.3 79.4 Dallas 87.7 90.4 92.5Denver 69.3 68.1 66.9 Denver 59 63.4 63.3Miami 89.4 96.5 96.3 Miami 45.7 43.7 54.5
1999 U.S. CR4: 26.8
14-Market
Avg. 69 74.2 75.6
Percentage of Fluid Milk Marketed by 4 Largest Processor Dec. 1997- Dec. 1999 by City (Source: GAO, 2001)
Topics for DiscussionMonopolistic Competition
Definition Production and Pricing Decisions
Oligopolies Definition/Examples Production and Pricing Decisions
Monopolies Definition/Examples Production and Pricing Decisions
Comparison of Market StructuresPages 106-10713
14
Imperfect Competition in SellingAt the firm level, unlike perfect
competitors who face a perfectly elastic (horizontal) demand curveImperfect competitors selling a
differentiated product have a downward sloping demand curve
A
B
Firm’s demand curve underimperfect competition
A B
Firm’s demand curveunder P.C.
$$
15 Page 149
Price Quantity Total Rev. Avg. Revenue Marginal Revenue
15 0 0 -------- -----14 2 28 14 1413 4 52 13 1212 6 72 12 1011 8 88 11 810 10 100 10 69 12 108 9 4
8 14 112 8 27 16 112 7 06 18 108 6 -25 20 100 5 -44 22 88 4 -63 24 72 3 -82 26 52 2 -10
1 28 28 1 -120 30 0 ----- -14
Table 9-1 ImperfectCompetition
Marginal Revenue (MR) : Change in revenue from the sale of the last unit of output (ΔTR÷ΔQ)
Average Revenue (AR): Total Revenue/Total output (TR÷Q)
20
Note: Price = Average Revenue
Firm faces a downward sloping demand curve → MR ≤ AR2
Page 15016
Imperfect Competition in Selling
Marginal Revenue (MR): Change in revenue from the sale of the last unit of output
TRMRQ
Page 150
Marginal revenue in this instance is also downward sloping
MR=0 at the point where TR is at a maximum17
Imperfect Competition in SellingMaximum Total Revenue
Types of Imperfect Competitors in Input Markets
Monopolistic Competition Oligopoly Monopoly
18
Let’s start here…
Monopolistic CompetitorsMany sellers
Each firm has relatively small market share
Power to set prices somewhat like a monopoly
Face competition like perfect competition
Collusion is not possible given number of firms in the industry
No barriers to entry or exitPage 148-15119
Monopolistic Competitors
Page 148-15120
Product Differentiation: Each firm makes a product that is slightly different from the products of competing firmsClose substitutes but not perfect substitutesAn attempt to ↑ price will normally results in a ↓ in
volume soldCompetition on Quality, Price, and
MarketingQuality in design, reliability, service provided to
buyer and ease of access to productThe firm faces a downward sloping demand curveFirm must market intensively: promotions,
distribution, packaging, etc.
Monopolistic Competitors
Page 148-15121
Product differentiation does not necessarily mean there are any physical differences among productsThey might all be the same, but how they are
sold may make all the difference
Monopolistic Competitors
Page 148-15122
The monopolistic competitor tries to set his/her product apart from the competitionMain method is via advertisingWhen this is done successfully, the demand curve
becomes more vertical or inelastic Buyers are willing to pay more because they believe it is
much better than their other choices
Basis for product differentiationPhysical differences ConvenienceAmbience ReputationAppeals to vanity Snob appeal
Monopolistic Competitors
Page 148-15123
Typical Monopolistic CompetitorTries to set firm apart from competition
New Product Development and Innovation Advertising
oCreate consumer perception of product differentiation – real or imagined
oAttempt to keep demand as inelastic as possibleSelling costs can be extremely high
Monopolistic CompetitorsShort run profits can exist but long
run profits are reduced to 0 with industry entrants
Fast food industry is a good example All services basically the same Extensive use of marketing to
differentiate products/services across firms
Striving to produce more products and services Page 148-15124
Monopolistic CompetitorsHow much of the product does this
firm produce? Determine output level where MC = MR (Why does this make sense?)
What price should the firm charge for this product? Locate on the downward sloping
demand curve where above quantity intersects
Associated price on this demand curvePage 148-15125
Page 15026
The firm produces QSR where MR=MC at E Prices its products at PSR by reading off the demand
curve at quantity QSR
Represents consumer’s willingness to pay for QSR
Short run profits exist if: PSR > ATCSR at QSR
Monopolistic Competitors$/unit
Q
MC
ATC
QSR
PSR
ATCSR
MR
Firm Demand
Profits
E
Page 15027
Monopolistic Competitors$/unit
Q
MCATC
QSR
PSR
ATCSR
MR
Firm Demand
Loss
E
Short run loss At QSR, PSR < ATCSR
Page 15028
Monopolistic Competitors$/unit
Q
MCATC
QLR
ATCLR = PLR
MR
Firm DemandE
In the Long Run (LR)Profits are bid away as more firms enter the market Losses will no longer exist as firms leave the market
At QLR the remaining firms are just breaking even
Monopolistic Competitors
Page 148-15129
How much is the industry dominated or not dominated by few suppliersDepends on the geographical scope –
national, regional, global An industry can be almost perfectly competitive
on a national scope, but almost a monopoly locally e.g. local farm supply cooperative
Depends on the existence of barriers to entry and exit Industries may appear concentrated but few
barriers exist to prevent entry which implies less ability to dominate market
OligopoliesA few number of sellers
Each can impact market price and quantities
Interdependent in their decision making A firm will consider how other firms will
react to pricing, promotional and other actions
Key component in marketing strategies and pricing behavior
Pages 152-15530
Rival oligopolists will match price cuts but not price increases in the short run as they want to capture larger market share
If there are differences in prices they are the result of successful product differentiation
Non-price competition between oligopolists used to uniquely identify products
Tend to have stable prices Changes in production and other costs not easily
passed on and may have to be absorbed
Pages 152-15531
Oligopolies
OligopoliesPrice leadership strategy
A particular firm dominates the market Controls the largest share of the market Other industry firms more efficient in operation,
marketing, etc. The dominant firm first sets its price to
maximize profit Remaining firms set their prices based on the
dominant firms pricing
The price set by the oligopolist seller is higher then under perfect competition Quantity produced is lower then perfect comp.
Pages 152-15532
OligopoliesThe dominant firm may be efficient
enough to set a lower price Eventually drive the other firms out of
the market
Pages 152-15533
OligopoliesExamples of Oligopolies
Auto manufacturers 2007 CR4 value of 73.7
Aircraft manufacturing 2007 CR4 value of 81.3
Farm machinery and equipment John Deere, J.I.Case and New Holland 80% of 2-wheel drive tractors close to 90% of combines sold in the U.S.
Cattle slaughtering CR4 value increased from 39 to 67 over the
1985-1995 period 2007 CR4 value of 59.4
Pages 152-15534
Oligopolies
Pages 152-15535
D
D
d
d
Demand curve DD All oligopolists move prices
together and share market Original demand curve dd
A single firm changes its price
Curve DD is more inelastic
Below point A, other firms match price cut
This leads to a kinked demand curve dAD
Leads to a discontinuous marginal revenue curve, dBCE
A
B
C
E
Remember oligopolists account for the reaction of other firms so there is no single demand curve
Oligopolies
Pages 152-15536
D
D
dA
B
C
E
Meeting demand along the lower segment of the kinked demand curve → the firm is maintaining its market share
MC
Oligopolies
Pages 152-15537
D
D
dA
B
C
E
MC
MC*
Shifting MC curve to MC* reflecting technological advances will not affect PE and QE
It does impact profits as MC drops
PE
QE
MonopoliesOne seller in the market
Firm and market demand curve are the same
Entry of other firms restricted by patents, etc. (i.e., barrier to entry)
Firm has absolute power over setting market price
Produces a unique productIt can have economic profits in the
long run because it can set price without competition
Page 155-15638
Monopolies
Page 155-15639
MC ATCAVC
Demand= ARMR
TVC
0
N
M
PEC
B
A
QE
Total revenue = area 0PECQE
Monopolist produces quantity where MC=MR (pt A), QE
Uses the demand curve (pt C) when setting price PE
$/unit
Quantity
Monopolies
Page 155-15640
MC ATCAVC
Demand= ARMR
TVC
0
N
M
PEC
B
A
QE
$/unit
Quantity
Total variable costs for the monopolist is equal to area 0NAQE, (green box) =AVC x QE
= 0N x QE
Monopolies
Page 155-15641
MC ATCAVC
Demand= ARMR
TFC
0
N
M
PEC
B
A
QE
$/unit
Quantity
Total fixed costs equals NMBA (orange box)=(ATC-AVC) x QE
Monopolies
Page 155-15642
MC ATCAVC
Demand= ARMR
TFC
TVC
0
N
M
PEC
B
A
QE
$/unit
Quantity
Total cost is area 0MBQE (green box + orange box)
= area ONAQE + area NMBA
Monopolies
Page 155-15643
MC ATCAVC
Demand= ARMR
TFC
TVC
0
N
M
PE
EconomicProfit
C
B
A
QE
$/unit
Quantity
Monopoly economic profit = area MPECB = Total Revenue (yellow
box) – Total Costs (green box + orange box)
Monopolies
Page 155-15644
MC ATCAVC
Demand= ARMR
TFC
TVC
0
N
M
PE
EconomicProfit
C
B
A
QE
$/unit
Quantity
Total fixed costs equals NMBA (orange box)=(ATC-AVC) x QE
Comparison of Structure ResultsLets compare the results we have
obtained from the alternative market structures
45
Perfect Competition
Page 15746
Demand
0QPC
$/unit
QuantityMR
1
23
45
6
7
89
Supply
Consumer surplus = sum of areas 1, 4, 5, 8 and 9 (Pink triangle)Producer surplus = sum of areas 2, 3, 6 and 7 (green triangle)Total economic surplus = sum of blue and green triangles = sum of areas 1 – 9
PPC
Monopoly Case
Page 15747
Demand
0QM
$/unit
QuantityMR
23
45
6
7
89
Supply
Consumer surplus = sum of areas 8 and 9 (Pink triangle)
1
Compared to P.C., consumers would be economically worse-off by areas 1, 4 and 5
Paying a higher price, PM Purchasing a smaller quantity, QM
PPC
PM
QPC
Monopoly Case
Page 15748
Demand
0QM
$/unit
QuantityMR
23
45
6
7
89
Supply
1PPC
PM
QPC
PS = to sum of areas 3, 4, 5, 6 and 7 (green area)
Compared to P.C. producers lose area 2 but gain areas 4 + 5 Producers economically better-off
than perfect competition
Monopoly Case
Page 15749
Demand
0QM
$/unit
QuantityMR
2
Supply
1PPC
PM
QPC
Purple triangle is total economic surplus under perfect competition
Orange triangle is total economic surplus under monopoly
Society as a whole economically worse-off by areas 1 + 2 (Green triangle) Known as the dead weight loss Reflects the fact that less resources in
this market are used to provide products to consumers
Summary of Impacts of Alternative Market Structures from a Selling Perspective
Page 15750
Imperfect Competition From the Buying Perspective
51
Types of Imperfect Competitors on the Buying Side
Monopsonistic competitionOligopsonyMonopsony
Let’s start here…
52
MonopsoniesSingle buyer in the input marketFocus is on the marginal input cost
of purchasing additional amounts of an input
If the objective of the buying firm is to maximize profit, what is the decision rule as to how much of an input should be purchased?
Page 158-16053
Monopsonies General Profit maximizing input use rule for
any firm type: To maximize profit the firm should
continue to purchase additional units of an input so long as the extra revenue generated by the additional input use is greater than the additional cost associated with that additional input use So long as ∆Revenue > ∆Cost when
purchasing additional units
Page 158-16054
MonopsoniesUnder perfect competition, the firm views
its input supply curve as a horizontal lineFirm can purchase as much as desired as the
going priceFirm’s purchases do not impact input’s price
Page 158-16055
Labor
WageRate
$12.50
Supply curve faced by a P.C. firm
L1 L1
MonopsoniesMonopsonist must consider the
marginal input cost (MIC) when purchasing inputs MIC: Extra cost associated with
purchasing an additional unit of inputMonopsonist must pay higher prices
per unit if he/she wants to purchase greater amounts of the input→MIC curve is above the input supply
curve
Page 158-16056
MonopsoniesMonopsonist is the only input buyer
→Faces an upward sloping input supply curve
Input purchasing decisions impact input prices
Page 158-16057
Labor
WageRate
$12.50
Supply curve faced by a monopsonist
L1
$15.75
L2
Marginal Input Cost
Page 158-160
Units of Variable Input
Price/Unit ($)
Total Input Cost
Marginal Input Cost
1 3.00 3.00 -----2 3.50 7.00 4.003 4.00 12.00 5.004 4.50 18.00 6.005 5.00 25.00 7.006 5.50 33.00 8.007 6.00 42.00 9.008 6.50 52.00 10.009 7.00 63.00 11.0010 7.5 75.00 12.00
58
Marginal Input Cost
Page 158-1601 2 3 4 5 6
1
3
2
4
5
6
7
8
9
10
11
$/U
nit
7 8 9 10Quantity/unit of time
Marginal Input Cost
Input Supply Curve
Data obtained from previous table
59
MonopsoniesProfit maximizing monopsonist
Use variable input to the point where Marginal Input Cost (MIC) =Marginal Revenue Product (MRP)
MRP: Addition to total revenue attributed to use of one more unit of variable input MRP = Marginal Revenue (MR) x MPP = (∆Revenue/∆Output) x (∆Output/∆Input)
= ∆Revenue/∆Input = MVP when MR = P
MIC: Extra cost associated with purchasing an additional unit of input
Page 158-16060
Monopsonies So long as MRP > MIC profits will
increase with increased input use
If MRP < MIC, profits will ↑ by reducing the amount of input used Why will this occur?
Page 158-16061
Monopsonies
Page 158-16062
MIC
Input SupplyMonopsony
Input Quantity
$
QM
CM
P.C. in output market MRP = MVP under P.C. MVP=P x MPP Profit Max. →MVP = MIC
MRP With monopsony, MIC > CM
CM = input cost/unit under monopsonyCP.C. = input cost/unit under P.C. input market
MIC = MVP
Input SupplyP.C.CP.C.
QP.C.
Monopsonies
Page 158-16063
MIC
Input SupplyM
Input Quantity
$
QM
CM
MRP
Input SupplyP.C.CP.C.
QP.C.
Resource use Higher Price paid under P.C., CP.C.
Utilization higher under P.C., QP.C.
Price difference referred to as monopsonistic exploitation
(i.e., CP.C. – CM)
Imperfect Competition on Both Sides
Page 160
Product Selling Perspective
Input Purchasing Perspective
Perfect Competition
Perfect Competition
Monopolistic Competition
Monopsonistic Competition
Oligopoly Oligopsony
Monopoly Monopsony
Can have any combination of the above for a particular firm Lets look at profit maximization under specific cases
64
Introduction to Agricultural Economics, 5th edPenson, Capps, Rosson, and Woodward
© 2010 Pearson Higher Education,Upper Saddle River, NJ 07458. • All Rights Reserved.Page 16165
Page 16166
MIC
InputSupplyM
Input Quantity
$
QMM
CMM
MRP
Case #1: Monopsonist in input purchasing and Monopolist seller of product Equilibrium: MRP = MIC at Point A Pricing off input supply curve gives QMM and CMM
MVP
A
Use MR not output price (PY) due to being a monopolist (i.e., single seller of output) MRP = MR*MPP
I don’t display the MVP curve as not relevant for monopolist
Page 16167
Input SupplyPC
Input Quantity
$
QPCM
CPCM
MRPMVP
C
Case #2: Perfect Competition in input purchasing and Monopoly seller Equilibrium is where MRP=Supply at C No Marginal InputCost curve → QPCM and PPCM
Input price determined by input market Take input price as given
Page 16168
MIC
InputSupplyM
Input Quantity
$
QMPC
CMPC D
Case #3: Monopsony in input purchasing and Perfectly Competitive sellerEquilibrium: MVP=MIC at Point EPricing off supply curve → QMPC and PMPC at point D
E
We use MVP instead of MRP curve given P.C. seller
MVP = PY x MPP
Page 16169
Input SupplyPC
Input Quantity
$
QPC
CPC
F
Case #4: Perfect Competition in both input purchasing and product salesEquilibrium: MVP=Supply at Point F→ QPC and PPC
Input price determinedby input market
MVP = PY x MPP We use MVP instead of MRP curve given P.C. seller
Monopsonistic CompetitorsMany firms buying resources Ability to differentiate services to
producersDifferentiated services includes
distribution convenience and location of facilities, willingness to provide credit or technical assistance
P and Q determined same as monopsonist
Page 16170
OligopsoniesA few number of buyers of a resourceProfit earned will depend on elasticity
of supply for resource (less elastic than monopsonistic competition)
Each oligopsonist knows fellow oligopsonists will respond to changes in price or quantity it might initiate
P and Q determined same as monopsonist
Page 16171
Governmental RegulationVarious approaches have been used to
counteract adverse effects of imperfect competition in the marketplace Legislative acts passed by Congress, including
the Sherman Antitrust and Clayton Acts Price ceilings Lump-sum Tax Minimum price or floors
Page 16272
Legislative ActsSherman Antitrust Act of 1890
Prohibited monopoly and other restrictive business practices
Packers and Stockyards Act of 1921 Reinforced anit-trust laws regarding
livestock marketingCapper-Volstead Act of 1922
Exempted cooperatives from anti-trust lawsRobinson-Patman Act
Prohibited price discrimination practicesAgricultural Marketing Agreement Act
Established agricultural marketing ordersPage 16373
Impacts of Price CeilingsRegulatory agencies such as the Federal
Trade Commission can impact monopoly effects by instituting a maximum (ceiling) price FTC charged with investigating business
organizations and practices and carrying out anti-trust provisions
How can we model the impact of price ceilings?
Page 16374
Page 16575
MCATC
DemandMR
0
A
PMB
C
QM
$/unit
Quantity
Implications of a Price Ceiling
D
Without regulatory involvement the monopolist will Equate MR and MC
(pt C)Produce QM and
charge price PM Total Revenue =
0PMBQM
Total Cost = 0ADQM
Earn a profit of APMBD
Impacts of Price Ceilings
Page 16576
MCATC
Demand
0
PMB
C
QM
$/unit
Quantity
Implications of a Price Ceiling
Impacts of Price CeilingsWith gov’t imposed
price ceiling, PMAX
The demand curve is given by PMAXEH
MR is PMAXEFG Monoopolist
produces more (Q1
> QM) at a lower price (PMAX < PM)
PMAXE
F
G HQ1
IJ
Monopolist’s profit falls to area JPMAXEI (turquoise box)
Impacts of a Lump Sum TaxA regulatory agencies can impact the
level of monopoly profits by assessing a lump-sum tax May be a license fee or one-time charge This is a fixed tax regardless of output level
How can we model the impact of a lump sum tax?
Page 16577
Page 16578
MC
ATC
DemandMR
0
A
PMB
C
QM
$/unit
Quantity
Implications of a Lump Sum Tax
D
Impacts of a Lump Sum TaxThe monopolist equates
MC=MR (pt. C)Produces QM Charges PM
Profit of APMBDATC*
Lump-sum tax↑ firm’s ATC to ATC*
↓ producer surplus from APMBD to EPMBT
Does not change output level or price
E T
Per Unit Tax
Loss in PS surplus is area AETD (pink box)
Impacts of a Minimum PriceIn a monopsony, the gov’t could regulate
the price of a resource by imposing a minimum price that must be paid for that resource A good example is the minimum wage laws
How can we model the impact of a minimum price policy on how much of the input may be purchased?
Page 16579
Page 16680
MIC
Input Supply
Input Quantity
$
QM
CM
MRP
Impacts of a Minimum PriceNo minimum price Monopsonist determines
where MRP=MIC Employ QM input units Pays $CM/unit
Implications of a Minimum Price
Minimum price, CF, imposed Monopsonist’s MIC curve
would be CFDEBThe firm would use more
input, QM → QF
CF D
E
F
QF
SummaryUnlike perfect competition, imperfect
competitors have ability to influence priceMonopolistic competitors try to differentiate
their productMonopolists are the only seller in their
product market. Monopsonists are the only buyer
Oligopolies are a few number of sellers while oligopsonies are a few number of buyers.
What are the economic welfare implications of imperfect competition?
81
Chapter 10 focuses on natural resource use in agriculture and the impacts on the environment
82