SAYRE | MORRIS
Seventh Edition
CHAPTER 11
Imperfect Competition
Alanna Holowinsky, Red River College
© 2012 McGraw-Hill Ryerson Limited
11-1
CHAPTER 11
Imperfect Competition
Learning Objectives:
LO1: Understand the importance and effects of product
differentiation, including advertising
LO2: Understand the differences between the two types of
imperfect competition
LO3: Explain why monopolistically competitive firms tend to
have excess capacity and are unlikely to earn long-run
economic profits
© 2012 McGraw-Hill Ryerson Limited
11-2
CHAPTER 11
Imperfect Competition
Learning Objectives:
LO4: understand the main characteristics of oligopoly
markets
LO5: understand why large firms are often tempted to collude
and form cartels
LO6: understand price leadership and why oligopolistic firms
are reluctant to change prices very often
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LO1
Imperfect Competition
• A market structure in which producers are
identifiable and have some control over price
• Two forms:
1. Monopolistic Competition
2. Oligopoly
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LO1
Imperfect Competition
Product Differentiation
• Attempt to distinguish a firm’s products from
those of its competitors
• Firms often compete on basis other than price
• Logos, symbols, brand names, location, service,
product development
• Often involves extensive advertising
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LO1
Advertising
Benefits of Advertising
•
•
•
•
Provides the consumer with vital information
Enhances competition between firms
Lowers the prices of products
Finances magazines and television shows
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LO1
Advertising
Criticisms of Advertising
• Mostly not informative and wasteful
• Encourages concentration within industries
• Raises prices to the detriment of consumers
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LO1
Self-Test
Assume that two firms dominate the running-shoes industry. One
of them hires a high-profile sports figure to endorse its product by
appearing in its advertising.
a)
What would you expect the other firm to do in response,
and why?
b)
After the second firm has reacted in the way you said it
would above, what do you think the relative share of the market
that each firm enjoyed would be?
c)
Given your answer in b) above, what might these two
firms be tempted to do?
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11-8
LO1
Self-Test
Assume that two firms dominate the running-shoes industry. One
of them hires a high-profile sports figure to endorse its product by
appearing in its advertising.
a) What would you expect the other firm to do in response, and
why?
Game theory analysis suggests that the other firm would be
forced to respond with a new advertising campaign possibly
using another high profile sports figure.
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11-9
LO1
Self-Test
Assume that two firms dominate the running-shoes industry. One
of them hires a high-profile sports figure to endorse its product by
appearing in its advertising.
b) After the second firm has reacted in the way you said it would
above, what do you think the relative share of the market that
each firm enjoyed would be?
Relative market share between the two firms probably
would not change much from what it was initially.
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11-10
LO1
Self-Test
Assume that two firms dominate the running-shoes industry. One
of them hires a high-profile sports figure to endorse its product by
appearing in its advertising.
c) Given your answer in b) above, what might these two firms be
tempted to do?
The two firms would be tempted to come to an (illegal)
agreement avoiding expensive adverting campaigns in the
future.
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LO2
Types of Imperfect Competition
Monopolistic Competition
• a market in which many firms sell a
differentiated product and have some control
over price
Oligopoly
• a market dominated by a few large firms
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LO2
Measuring Industry Concentration
Concentration Ratio
•
The percentage of an industry’s total sales that
is controlled by the largest few firms
• 4-firm concentration ratio: % of sales revenue
by 4 largest firms in industry
• If < 40% may be monopolistic competition
• If > 40% likely oligopoly
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LO2
4 Firm Concentration Ratios
Industry
1990
2005
Motor Vehicles
87.2%
Petroleum
75.6
99.9
Tobacco
98.8
99.8
Cement
72.0
99.7
Fertilizers
56.7
99.4
Tires
86.2
99.3
Breweries
90.6
99.2
Sugar and Confectionary
47.8
98.7
Household Appliances
61.6
98.5
Coffee and Tea
76.5
97.8
Sporting and Athletic Goods
22.7
92.8
Wineries
48.5
92.2
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100.0%
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LO2
Self-Test
The grummit industry consists of 10 companies.
Company
Sales $m:
A
$22
B
$6
C
$17
D
$12
E
$8
F
$15
Next 4 (total)
$12
a) Calculate the 4-firm
concentration ratio for
this industry.
b) What type of market does
this industry operate in?
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LO2
Self-Test
The grummit industry consists of 10 companies.
Company
Sales $m:
A
$22
B
$6
C
$17
D
$12
E
$8
F
$15
Next 4 (total)
$12
a) Calculate the 4-firm
concentration ratio for
this industry.
71.7% ($66/$92)
b) What type of market does
this industry operate in?
Oligopoly (it is higher
than the 40%)
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LO3
Monopolistic Competition
Characteristics
•
•
•
•
Many small firms acting independently
Freedom of entry
Products are differentiated
Each firm has some control over price
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LO3
Monopolistic Competition
• May have economic profit in the short run
• In the long run, the representative firm in a
monopolistically competitive market makes only
normal profits
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Monopolistically Competitive
Equilibrium (SR)
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LO2
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Monopolistically Competitive
Equilibrium (SR)
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LO2
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LO2
Self-Test
Assume that a representative firm in monopolistic
competition is experiencing economic losses. What
series of events will occur to return this firm to its
long-run equilibrium?
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LO2
Self-Test
Assume that a representative firm in monopolistic
competition is experiencing economic losses. What
series of events will occur to return this firm to its
long-run equilibrium?
Some firms within the industry will go out of
business (exit). Graphically, this would shift the
demand curve faced by each of the remaining firms
to the right so that it once again became tangent to
the average cost curve.
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LO2
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LO3
Appraisal of Monopolistic Competition
• produces a lower output than a perfectly
competitive firm
• does not achieve productive efficiency because
the long-run equilibrium price does not equal
minimum average total cost
• charges a higher price than a perfectly
competitive firm
• does not achieve allocative efficiency because
price exceeds marginal cost
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LO3
Self-Test
a) What output will this firm produce?
b) How much excess capacity exists at this output level?
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LO3
Self-Test
a) What output will this firm produce? Q2. (where MC=MR.)
b) How much excess capacity exists at this output level?
Excess capacity of Q4 – Q2
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LO4
Oligopoly
Characteristics
• It is dominated by a few large firms.
• Entry by new firms is difficult.
• Nonprice competition between firms is widely
practised.
• Each firm has significant control over its price.
• Mutual interdependence exists between firms.
• Products can be either homogeneous or
differentiated.
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LO4
Oligopoly
Mutual interdependence
• the condition in which a firm’s actions depend, in
part, on the reactions of rival firms
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LO5
Collusion
Collusion
• an agreement among suppliers to set the price of a
product or the quantities each will produce
Game Theory
• a method of analyzing firm behaviour that
highlights mutual interdependence among firms
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LO5
Game Theory
Nash Equilibrium
• a situation where each rival chooses the best
actions given the (anticipated) actions of the
other(s)
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LO5
Game Theory
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LO5
Collusive Oligopoly
Cartel
• an association of sellers acting in unison
• for example, Organization of Petroleum Exporting
Countries (OPEC)
• able to increase prices by restricting output
• cartels work to the advantage of their members
only if there is no cheating among the participants
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LO5
Self-Test
Suppose that Spartan Inc. and Trojan Ltd, the only two firms
in the industry, have entered into a collusive agreement to
share the industry’s total profits of $50 million equally.
However, if any one of them cheats, it will increase its
profits by $10 million at a cost of $10 million to the other
firm. If they both cheat, they will each reduce their profits
by $5 million.
a) Construct a matrix showing the various options.
b) Which option will they likely chose?
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LO5
Self-Test
a) Construct a matrix showing the various options.
b) Which option will they likely chose?
Cell D. They will end up both cheating.
Spartan Inc
cheat
stick to agreement
Cell A
stick to
agreement
Cell B
$25
$35
$25
$15
Trojan Ltd
Cell D
Cell C
cheat
$15
$35
$20
$20
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LO6
Noncollusive Oligopoly
Price Leadership
• When rival firms engage in what amounts to price
fixing without overt collusion
• A leader – usually the largest or most efficient firm
– sets price, other firms follow
• Must balance the advantages of a price increase
with the risks of creating an opening for new
entrants
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LO6
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LO6
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LO6
Oligopoly
• Some believe that oligopolies are too powerful and
produce inefficiently
• Others take the view that oligopolies are at the
cutting edge of new technological development and,
in the long run, push the average costs of
production down
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CHAPTER 11 SUMMARY
Key Concepts to Remember:
•
•
•
•
The importance of product differentiation
The two types of imperfect competition –
monopolistic competition and oligopoly
Collusion and cartels
Price leadership
© 2012 McGraw-Hill Ryerson Limited
11-39