Chapter-10 Olig & Monopoly Comp

Oligopoly and Oligopoly and Monopolistic Monopolistic Competition Competition Chapter 10

The Nature of Imperfect Competition

Three major factors of imperfectly competitive markets are;Economies of scale, barriers to entry, strategic interaction

Cost: When the minimum efficient size of operation for a firm occurs at a sizeable fraction of industry output, only a few firms can profitably survive and oligopoly is likely to result.

Barriers to entry: When there are large economies of scale or government restrictions to entry, they will limit the number of competitors in an industry.

Strategic interaction: When only a few firms operate in a market, they will soon recognize their interdependence. Strategic interaction occurs when each firm’s business depends upon the behavior of its rivals.

THEORIES OF IMPERFECT COMPETITION

Collusive Oligopoly;The degree of imperfect competition in a market is influenced not just by the number and size of firms but by their behavior. When only a few firms operate in a market, they see what their rivals are doing and react.

Strategic Interaction is a term that describes how each firm’s business strategy depends upon its rivals’ business behavior.When there are only a small number of firms in a market, they have a choice between cooperative and non-cooperative behavior.

Firms act in a cooperative mode when they try to minimize Firms act in a cooperative mode when they try to minimize competition. When firms in an oligopoly actively cooperate competition. When firms in an oligopoly actively cooperate with each other, they engage in with each other, they engage in collusioncollusion. .

Collusion Collusion is a situation in which two or more firms jointly set is a situation in which two or more firms jointly set their prices or outputs, and divide the market among them-their prices or outputs, and divide the market among them-selves or make other business decisions jointly.selves or make other business decisions jointly.

A A cartelcartel is an organization of independent firm, producing is an organization of independent firm, producing similar products, that work together to raise prices and similar products, that work together to raise prices and restrict output.restrict output.

Firms are often tempted to engage in Firms are often tempted to engage in tacit or implied tacit or implied collusioncollusion, which occurs when they refrain from competition , which occurs when they refrain from competition without explicit agreement. When firms tacitly collude, they without explicit agreement. When firms tacitly collude, they often quote identical high prices, pushing up profits and often quote identical high prices, pushing up profits and decreasing the risk of doing business.decreasing the risk of doing business.

Maximum profit of collusive oligopolist

Obstacles Hinder In Effective CollusionObstacles Hinder In Effective Collusion

Collusion is illegalCollusion is illegal Firms may cheat on the agreement by Firms may cheat on the agreement by

cutting their prices to selected customers cutting their prices to selected customers thereby increasing their market sharethereby increasing their market share

The growth of international trade means The growth of international trade means that many companies face intensive that many companies face intensive competition from foreign firm as well as competition from foreign firm as well as domestic companies.domestic companies.

Monopolistic competition

It resembles perfect competition in three ways;• There are many buyers and sellers• Entry and exit are easy• Firms take other firms’ prices as given

The distinction is that the products are identical in perfect competition, while under monopolistic competition they are differentiated..

In the long-run equilibrium for monopolistic competition, prices are above marginal costs but economic profits are driven to zero

Rivalry among the few

Competition among the few introduces a completely new feature into economic life; it forces firms to take into account competitors’ reaction to price and output deviates and brings strategic considerations into their markets.

PRICE DISCRIMINITION

When firms have a market power, they can sometimes increase their profits through price discrimination. Price discrimination occurs when the same product is sold to different consumer for different prices.Price discrimination often improves economic welfare. Monopolies raise their price and lower their sales to increase profits. In doing so, they capture the market for eager buyers but lose the market for reluctant buyers. By charging different prices for those willing to pay high prices and those willing to pay only lower prices, monopolist can increase both its profits and consumer satisfaction.

40 20

Assume MC = zero

At same price Total Profit = (20 x 40) + (20 x 20) = Rs. 1200

At differentiated price Total Profit = (30x 30) + (15 x 30) = Rs. 1350

INNOVATION AND INFORMATIONBehavior of large corporationsDivorce of ownership and control:Owners are shareholders but Salaried Managers control the corporation.• Conflicts between Managers and Stock holders a) Top managers may vote themselves large salaries stock options, expense accounts, bonuses, free apartments, expensive artwork, and generous retirement pensions at the stock holders’ expense.

b) A conflict of interest may arise in connection with retained earnings. The managers of a company have a tendency to hold profits and use them to expand the size of the company instead of paying them out as dividends or buying back shares

Information & innovation.

Economic theory tends to glorify perfect competition as the most efficient market structure. Imperfect competitors, by contrast, set prices too high, earn profits and neglect product quality. Joseph Schumpeter argued that:

“The essence of economic development is innovation and that monopolists in-fact are the

wellsprings of innovation in a capitalist economy”

The economics of information

Entrepreneur or innovator: the person who introduces “new combination” in the form of new products or methods of organization. Innovations result in temporary supernormal innovational profits, which are eventually eroded away by imitators.Information is a fundamentally different commodity from normal goods as, markets in information are subject to severe market failure because information is costly to produce but cheap to reproduce.The inability of firms to capture the full monetary value of their inventions is called inappropriability.

Intellectual property rights

Intellectual property rights give the owner, special protection against the material’s being copied and used by others without compensation to the owner or original creator.By creating copy rights government encourages artists and investors to invest time, effort and money in the creative process. •By allowing inventors to have monopolies on their intellectual property, the government increases the degree of appropriability and thereby increases the incentive for people to invent useful new products.

The dilemma of the internetThe dilemma of the internetMany new information technologies have up-Many new information technologies have up-front or sunk cost and virtually zero marginal front or sunk cost and virtually zero marginal costs. With the low cost of electronic costs. With the low cost of electronic information systems like the internet, it is information systems like the internet, it is technologically possible to make most of the technologically possible to make most of the information available to everyone, information available to everyone, everywhere at essentially zero marginal cost.everywhere at essentially zero marginal cost.

Perfect competition cannot survive here Perfect competition cannot survive here because a price equal to zero marginal cost because a price equal to zero marginal cost will yield zero revenue and therefore no will yield zero revenue and therefore no viable firms.viable firms.

The economics of new information economy The economics of new information economy highlights the conflict between efficiency highlights the conflict between efficiency and incentives. On one hand, all information and incentives. On one hand, all information might be provided free. Free provision looks might be provided free. Free provision looks economically efficient because the price economically efficient because the price would be equal to marginal cost which is would be equal to marginal cost which is zero. zero. ButBut a zero price on intellectual a zero price on intellectual property would reduce or destroy the profit property would reduce or destroy the profit incentives to produce because creators incentives to produce because creators would reap no return or profits from their would reap no return or profits from their creative activity.creative activity.

A balance sheet on imperfect competitionA balance sheet on imperfect competition

Economics of competitionEconomics of competition

The cost of inflated prices and insufficient The cost of inflated prices and insufficient outputoutput

Imperfect competitors reduceImperfect competitors reduce output and raise output and raise price, thereby producing less than would be price, thereby producing less than would be forthcomingforthcoming in a perfectly competitive industry.in a perfectly competitive industry.

Measuring the waste from imperfect Measuring the waste from imperfect competitioncompetition

If the industry could be competitive, then the If the industry could be competitive, then the equilibrium would be reached at the point where equilibrium would be reached at the point where MC = P MC = P

The efficiency loss from monopoly is The efficiency loss from monopoly is some-time called some-time called deadweight lossdeadweight loss. . This term refers to the loss of This term refers to the loss of economic welfare arising from economic welfare arising from distortion in prices and output such distortion in prices and output such as those due to monopoly, taxation, as those due to monopoly, taxation, tariffs or quotas.tariffs or quotas.

Intervention strategiesIntervention strategies

The first three policy measures form the core of modern policies The first three policy measures form the core of modern policies toward big business:toward big business:

1.1.The major method for combating market power is the use of The major method for combating market power is the use of anti-anti-trust policytrust policy. These are laws that prohibit certain kinds of behavior . These are laws that prohibit certain kinds of behavior or curb certain market structures.or curb certain market structures.

2.2.Anticompetitive abuses can be avoided by Anticompetitive abuses can be avoided by encouraging encouraging competitioncompetition whenever possible. There are many government whenever possible. There are many government policies that can promote vigorous rivalry even among large firms. policies that can promote vigorous rivalry even among large firms. It is particularly crucial to reduce barriers to entry into all lines of It is particularly crucial to reduce barriers to entry into all lines of businesses.businesses.

3.3.Economic regulationsEconomic regulations allow specialized regulatory agencies to allow specialized regulatory agencies to oversee the prices, output, entry and exit of firm s in regulated oversee the prices, output, entry and exit of firm s in regulated industries such as public utility and transportation.industries such as public utility and transportation.

Regulations tell businesses what to do and how to price products. It Regulations tell businesses what to do and how to price products. It is in effect, government control without government ownership.is in effect, government control without government ownership.

The next three strategies are seldom used in modern The next three strategies are seldom used in modern market economiesmarket economies

Government ownership Government ownership of monopolies has been of monopolies has been approached widely, for some natural monopolies like approached widely, for some natural monopolies like water, electricity, gas. It is thought that efficient water, electricity, gas. It is thought that efficient production requires a single seller.production requires a single seller.

Price control Price control on most goods and services have been on most goods and services have been used in war time, partly as a way of containing inflation, used in war time, partly as a way of containing inflation, partly as a way of keeping down prices in concentrated partly as a way of keeping down prices in concentrated industries.industries.

Taxes Taxes have sometimes been used to alleviate the income-have sometimes been used to alleviate the income-distribution effects. By taxing monopolies, a government distribution effects. By taxing monopolies, a government can reduce monopoly profits, thereby softening some can reduce monopoly profits, thereby softening some unacceptable effects of monopoly. unacceptable effects of monopoly.