MarketEquilibrium and Market Demand:
Imperfect Competition
Chapter 9
Market Structure CharacteristicsWe characterize an
industry byThe number of firms and
their size distributionProduct differentiationBarriers to entryThe picture to the right
concerned with two markets:No. 2 yellow corn: many
producers/sellers (Perfect Competition)
Farm equipment: few manufacturers/sellers (Oligopoly)
Pages 145-1482
Perfect CompetitionUp to now we have been assuming the firm
and market reflect conditions of perfect competitionNot a bad assumption for many agricultural
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
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
Topics for Nov 3rd
Monopolistic Competition Definition Production and Pricing Decisions
Oligopolies Definition/Examples Production and Pricing Decisions
Monopolies Definition/Examples Production and Pricing Decisions
Comparison of Market StructuresPages 106-1076
7
Imperfect Competition in SellingUnlike 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.
$$
8 Page 149
Price Quantity Total Rev. Avg. Revenue Marginal Revenue15 0 0 -------- -----14 2 28 14 1413 4 52 13 1212 6 72 12 1011 8 88 11 810 10 100 10 6
9 12 108 9 48 14 112 8 27 16 112 7 06 18 108 6 -25 20 100 5 -44 22 88 4 -63 24 72 3 -8
2 26 52 2 -101 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 1509
Imperfect Competition in Selling
Marginal Revenue: Change in revenue from the sale of the last unit of output
Page 150
Marginal revenue in this instance is also downward sloping
MR=0 at the point where TR is at a maximum10
Imperfect Competition in SellingMaximum Total Revenue
Types of Imperfect Competitors in Input Markets
Monopolistic Competition Oligopoly Monopoly
11
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 exit
Page 148-15112
Monopolistic Competitors
Page 148-15113
Product Differentiation: Each firm makes a product that is slightly different from the products of competing firmsClose substitutes but no perfect substitutesAn attempt to ↑ price will normally results in a ↓ in volume sold
Competition on Quality, Price, MarketingQuality is 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 148-15114
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 148-15115
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 ReputationsAppeals to vanity Snob appea
Monopolistic Competitors
Page 148-15116
Typical Monopolistic CompetitorTries to set firm apart from competition
New Product Development and Innovation Advertising
o Create consumer perception of product differentiation – real or imagined
o Attempt 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 148-15117
Monopolistic CompetitorsProduction Decision:
Determine output level where MC=MR (Why does this make sense?)
Pricing Decision: Determine where above quantity
intersects the downward sloping demand curve
Page 148-15118
Page 15019
Short run profitsThe 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
MonopolisticCompetition
Short run profits exist if: PSR > ATCSR at QSR
20
MonopolisticCompetition
Page 150
Short run loss At QSR, PSR < ATCSR
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
Page 15121
PLR = ATCLR
MonopolisticCompetition
Monopolistic Competitors
Page 148-15122
How much is the industry dominated or not dominated by few suppliersGeographical scope – national, regional, global
An industry can be almost perfectly competitive on a national scope, but almost a monopoly locally e.g. Feed Retailing
Barriers to entry and exit: industries may appear concentrated but few barriers exist to prevent entry
Monopolistic Competitors
Page 148-15123
Quantitative measures of competitionConcentration Ratio (CR): 2,4, 8, 20, etc
% of the value of total market revenue accounted for by 2, 4, 8, 20, etc. largest firms in the industry
Low CR values→ a high degree of competition High CR values → an absence of competition
Monopolistic Competitors
Page 148-15124
Quantitative measures of competitionHerfindahl-Hirschman Index (HHI): The
square of the % market share of each firm summed over the largest 50 firms in an industry or all firms if < 50 in 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
OligopoliesA few number of sellers
Each can impact market price & quantities
Interdependent in their decision making Key component in marketing strategies and
pricing behavior Match price cuts but not price increases by
fellow oligopolists Do this to maintain market share
Non-price competition between oligopolists to uniquely identify products
Pages 152-15525
OligopoliesRival oligopolists will match price cuts but
not price increases in the short run because they want to capture a larger market share
If there are differences in prices they are the result of successful product differentiation
Tend to have stable prices Changes in production and other costs not easily
passed on and may have to be absorbed
Pages 152-15526
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 under perfect competition Quantity produced is lower then perfect comp.
Pages 152-15527
OligopoliesThe dominant firm may be efficient
enough to set a lower price Eventually drive the other firms out of
the market
Pages 152-15528
OligopoliesExamples of Oligopolies
Auto manufacturers 1997 CR4 value of 97.4
Aircraft manufacturing 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
Pages 152-15529
Page 154
Demand curve DD All oligopolists move prices
together and share market
30
Demand curve ddA single firm changes
its price Curve DD is more
inelasticBelow point 1, firms
match price cutThis leads to a kinked
demand curve d1D Leads to a
discontinuous marginal revenue curve, d256
6
Remember oligopolists account for the reaction of other firms so there is no single demand curve
Page 15431
Meeting demand along the lower segment of the kinked demand curve → the firm is maintaining its market share
Page 15432
Shifting MC curves reflecting technological advances will not affect PE and QE
It does impact profits as MC drops from pt 3 to pt 4
MonopoliesOne seller in the marketEntry of other firms restricted by
patents, etc. (i.e., barrier to entry)Firm has absolute power over
setting market priceProduces a unique productIt can have economic profits in the
long run because it can set price without competition
Page 155-15633
Monopolies
Page 155-15634
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 155-15635
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 155-15636
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 155-15637
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 155-15638
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 155-15639
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
40
Page 157
Consumer surplus = sum of areas1, 4, 5, 8 and 9 (blue triangle)
Perfect Competition Case
41
Page 157
Producer surplus = to the sum of areas 2, 3, 6 and 7 (green triangle)
Perfect Competition Case
42
Page 157
Perfect Competition Case
Total economic surplus = sum of blue and green triangles =sum of areas 1 – 9
43
Page 157
CS = sum of areas 8 and 9, (new blue triangle)
Compared to P.C., consumers would be economically worse-off by areas 1, 4 and 5Paying a higher
price, PM Purchasing a smaller
quantity, QM
Monopoly Case
44
Page 157
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 + 5Economically
better-off than P.C.
Monopoly Case
45
Page 157
Society as a whole would be economically worse-off by areas 1+2Known as the dead
weight lossReflects the fact that
less of available resources in this market are used to provide products to consumers
Monopoly Case
46
Summary of Imperfect Competitors from a Selling Perspective
Page 15747
Imperfect Competition From the Buying Perspective
48
Types of Imperfect Competitors on the Buying Side
Monopsonistic competitionOligopsonyMonopsony
Let’s start here…
49
MonopsoniesSingle buyer in the input marketFocus is on the marginal input cost
of purchasing an addition unit of resources
Will purchase input until Marginal Value Product (MVP)=Marginal Input Cost (MIC)As long as MVP>MIC, the
monopsonist makes a profit
Page 158-16050
MonopsoniesUnder perfect competition, the firm
views the input supply curve as a horizontal lineFirm can purchase as much as desired as the
going priceFirm’s purchase does not impact inputs cost
Monopsonist is the only input buyer→Faces an upward sloping input supply
curveBuying decisions impact input prices
Page 158-16051
MonopsoniesMonopsonist must consider the marginal
input cost (MIC) when purchasing inputsMIC defined as the change in the cost of an
input as more of the input is usedLets look at a simple example
Monopsonist must pay higher prices per unit if he/she wants to purchase greater amounts of the input→MIC curve is above the input supply
curvePage 158-16052
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
53
Marginal Input Cost
Page 158-1601 2 3 4 5 6
1
3
2
4
5
678
9
10
11
$/U
nit
12
7 8 9 10Quantity/unit of time
Marginal Input Cost
Input Supply Curve
Data obtained from previous table
54
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 the addition of one unit of variable input = Marginal revenue x MPP
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?)
Page 158-16055
Page 160
MRP = MVP under perfect competition MVP=PPC x MPP
Buying Decisions by Perfect Competitors
56
Page 160
Buying Decisions by a Monopsonist
57
Monopsonist makes decisions along MRP curveDiffers from MVPMRP=MIC at APurchase QM inputs
Page 160
Buying Decisions by a Monopsonist
Resource useHigher Price paid
under P.C., PPC
Utilization higher under P.C., QPC
Price difference referred to as monopsonistic exploitation (i.e., PPC – PM)
58
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
59
Page 161
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 PMM
60
Page 161
Case #2: Perfect Competition in input purchasing and Monopoly seller Equilibrium is where MRP=Supply at C No Marginal InputCost curve → QPCM and PPCM
61
Page 161
Case #3: Monopsony in input purchasing and Perfectly Competitive sellerEquilibrium: MVP=MIC at Point EPricing off supply curve → QMPC and PMPC
62
Page 161
Case #4: Perfect Competition in both input purchasing and product salesEquilibrium: MVP=Supply at Point F→ QPC and PPC
63
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 16164
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 16165
Page 162
Various segments of the livestock industryExhibit several forms of imperfect competition.
66
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 16267
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 16368
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 16369
Page 164
Implications of a Price Ceiling
Without regulatory involvement the monopolist will Equate MR and MC
(point C)Produce QM and
charge price PM Earn a profit of A
′PMBD
Impacts of Price Ceilings
DA′
70
Page 164
With gov’t imposed price ceiling, PMAXThe demand curve
is given by PMAXEDMR is PMAXEFGMono. produces
more (Q1>QM) at a lower price (PMAX < PM)
A′D
Implications of a Price Ceiling
Impacts of Price Ceilings
71
Page 164
Monopolist’s profit falls to area IPMAXEH (turquoise box)A′
Implications of a Price Ceiling
Impacts of Price Ceilings
72
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 Corresponds to a fixed tax regardless of
output level
How can we model the impact of a lump sum tax?
Page 16573
Page 165
Implications of Lump-Sum TaxThe monopolist
equates MC=MR (pt. F)Produces QM Charges PM
Profit of APMBC
Impacts of A Lump Sum Tax
74
Page 165
Implications of Lump-Sum Tax
Impacts of A Lump Sum TaxLump-sum tax
↑ firm’s ATC from ATC1 to ATC2
↓ producer surplus from APMBC to EPMBT
Does not change output level or price
The loss in producersurplus is area AETC(blue box)75
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 Good example is the various minimum wage
laws
How can we model the impact of a minimum price policy?
Page 16576
Page 166
Implications of a Minimum Price No minimum priceMonopsonist
determines where MRP=MIC
Employ QM input unitsPays $PM/unit
Impacts of a Minimum Price
77
Page 166
Implications of a Minimum Price
Impacts of a Minimum PriceMinimum price, PF,
imposed Monopsonist’s MIC
curve would be PFDCB
The firm would use more input
78
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?
79
Chapter 10 focuses on resource use in agriculture and the environment
80