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The Effects of Market EntryThe Effects of Market EntryThe Effects of Market EntryThe Effects of Market Entry In the absence of substantial economies of scale,
it is possible for additional firms to enter the market, driving down prices and profit.
Output decisions are based on the marginal principle:
Marginal PRINCIPLEIncrease the level of an activity if its marginal benefit exceeds its marginal cost, but reduce the level if the marginal cost exceeds the marginal benefit. If possible, pick the level at which the marginal benefit equals the marginal cost.
Marginal PRINCIPLEIncrease the level of an activity if its marginal benefit exceeds its marginal cost, but reduce the level if the marginal cost exceeds the marginal benefit. If possible, pick the level at which the marginal benefit equals the marginal cost.
The Effects of Market EntryThe Effects of Market EntryThe Effects of Market EntryThe Effects of Market Entry
There are three reasons why profit decreases for the individual firm after entry of a second firm: Lower price Lower quantity sold Higher AC of production
The Meaning of “Monopolistic The Meaning of “Monopolistic Competition”Competition”The Meaning of “Monopolistic The Meaning of “Monopolistic Competition”Competition”
Each firm is monopolistic because it sells a unique product.
The availability of close substitutes makes the firm’s demand very price elastic.
Each firm is a competitive because it sells a product that is a close but not a perfect substitute for the products sold by other firms in the market.
Short-run and Long-run EquilibriumShort-run and Long-run EquilibriumShort-run and Long-run EquilibriumShort-run and Long-run Equilibrium
As firms enter, each firm’s demand curve shifts to the left, decreasing market price, decreasing the quantity produced per firm, and increasing the average cost of production.
As long as there is profit to be made, more and more firms will enter the market.
Entry will stop once the economic profit of each existing firm reaches zero. In the long run, revenue will be just enough to cover all costs, including the opportunity cost of all inputs, but not enough to cause additional firms to enter.
Long-run Equilibrium Under Long-run Equilibrium Under Monopolistic CompetitionMonopolistic CompetitionLong-run Equilibrium Under Long-run Equilibrium Under Monopolistic CompetitionMonopolistic Competition
In this example, the marginal principle is satisfied at 55 thousand toothbrushes per minute, selling at a price of $1.35. The cost of producing each toothbrush is also $1.35. Economic profit equals zero.
Trade-offs with Monopolistic Trade-offs with Monopolistic CompetitionCompetitionTrade-offs with Monopolistic Trade-offs with Monopolistic CompetitionCompetition
Trade-offs with Monopolistic CompetitionTrade-offs with Monopolistic CompetitionTrade-offs with Monopolistic CompetitionTrade-offs with Monopolistic Competition
Monopolistic competition brings good news and bad news relative to the monopoly outcome:
The key feature of an oligopoly is that firms act strategically. Firms are interdependent—the actions of one firm affect the profits of the other firms in the market.
Oligopoly and Pricing DecisionsOligopoly and Pricing DecisionsOligopoly and Pricing DecisionsOligopoly and Pricing Decisions
Economists use concentration ratios to measure the degree of concentration, or just how few firms exist in a market.
For example a four firm concentration ratios is the percentage of total output in the market produced by the largest four, i.e., a 93% concentration ratio for cigarettes indicates that the largest 4 firms produced 93% of the total output.
In a cartel arrangement, two firms act as one. In this case, they split the market output—each serving 75 passengers per day, and charge $400 per ticket.
The firms also split the profit. Each firm earns$7,500 = [(400-300) x 150]/2.
Cartel and Duopoly Outcomes in the Game TreeCartel and Duopoly Outcomes in the Game TreeCartel and Duopoly Outcomes in the Game TreeCartel and Duopoly Outcomes in the Game Tree
Cartel and Duopoly Outcomes in the Game TreeCartel and Duopoly Outcomes in the Game TreeCartel and Duopoly Outcomes in the Game TreeCartel and Duopoly Outcomes in the Game Tree
Retaliation for UnderpricingRetaliation for UnderpricingRetaliation for UnderpricingRetaliation for Underpricing
Duopoly price: Jill also lowers price; abandons the idea of cartel profits, and settles for duopoly profits which are better than the profits when she is underpriced by Jack.
Tit-for-tat: Jill chooses whatever price Jack chose the preceding month.
Tit-for-Tat Response to UnderpricingTit-for-Tat Response to UnderpricingTit-for-Tat Response to UnderpricingTit-for-Tat Response to Underpricing
After Jack lowers price, profits sink to the duopoly level. Jack increases price in the fourth month, which restores the cartel pricing in the fifth month.
Jill chooses whatever price Jack chose the preceding month.
Avoiding the Dilemma: Guaranteed Avoiding the Dilemma: Guaranteed Price MatchingPrice MatchingAvoiding the Dilemma: Guaranteed Avoiding the Dilemma: Guaranteed Price MatchingPrice Matching
To eliminate the incentive for underpricing, one firm can guarantee that it will match its competitor’s price.
How will Jack respond to Jill’s price-matching policy?
Choose the high price: Jack matches Jill’s high price in which case both will earn maximum (cartel) profits.
Choose the low price: if Jack chooses the low price, Jill will match the low price and both firms will earn minimum (duopoly) profits. Therefore, Jack has no reason to choose the low price.
The Entry-deterrence StrategyThe Entry-deterrence StrategyThe Entry-deterrence StrategyThe Entry-deterrence Strategy Mona can prevent Doug from entering by incurring a
large investment and committing herself to serving a large number of customers at a low price.
What is more profitable, entry deterrence or the passive duopoly outcome?
Brief History of Antitrust LegislationBrief History of Antitrust LegislationBrief History of Antitrust LegislationBrief History of Antitrust Legislation
1890 Sherman Act: made it illegal to monopolize a market or to engage in practices that resulted in a restraint of trade.
1914 Clayton Act: outlawed specific practices that discourage competition, including tying contracts, price discrimination for the purpose of reducing competition, and stock-purchase mergers that would substantially reduce competition.
1914 Federal Trade Commission: established to enforce antitrust laws.
1936 Robinson-Patman Act: prohibited selling products at “unreasonably low prices” with the intent of reducing competition.
1950 Celler-Kefauver Act: outlawed asset-purchase mergers that would substantially reduce competition.
1980 Hart-Scott-Rodino Act: extended antitrust legislation to proprietorships and partnerships.
Breaking Up MonopoliesBreaking Up MonopoliesBreaking Up MonopoliesBreaking Up Monopolies
A trust is an arrangement under which the owners of several companies transfer their decision-making powers to a small group of trustees. Firms in a trust act as a single firm.
The label “antitrust” comes from early cases involving the breakup of trusts.
A merger occurs when two firms combine their operations.
Because a merger decreases the number of firms in a market, it is likely to lead to higher prices.
A possible benefit from a merger is that the new firm could combine production, marketing, or administrative operations, and thus produce its products at a lower average cost.
New guidelines developed by the Justice Department and the Federal Trade Commission allow companies involved in a proposed merger to present evidence that the merger would reduce costs and lead to lower prices, better products, or better service.
The analysis of proposed mergers today focuses less on counting the number of firms in a market, and more on how a merger would affect price.