COMPETITION 1 E Distinguish the characteristics of a perfect competitive firm and a monopoly E Graphically show profit and loss in a perfect and imperfect market E Discuss the profit maximising behaviour of firms in a perfect and imperfect market E Compare perfect competition against a monopoly in terms of price and output decisions and efficiencies. E Introduce how an imperfect market structure such as an oligopoly use game theory to make price and output decisions. Objectives of this lecture are to: Perfect and Imperfect Competition 2 Market: Refers to an institution where buyers and sellers of a particular good or service come together. Price serves as the language of the market Market structure: Is the characteristics under which a market operates and it allows market classification Markets 3 Characteristics of PC are: 1 Many buyers and sellers 1 No barriers to entry and exit 1 Price taker 1 Homogenous products 1 Profit maximiser Characteristics of monopoly are: + Only one supplier + Very high barriers to entry + Price maker + Profit maximiser + Firms D curve = Market D curve
Perfect and Imperfect Competition 4 Imperfect Competition: Monopoly BARRIERS TO ENTRY Artificial
Patents Legislations Natural
Economies of Scale High Fixed Cost 5 PRICE TAKER: 1 No market power 1 Perfectly elastic demand curve or horizontal demand curve 1 Each unit sold at the same price 1 MR=AR=P=D
1 Total revenue is linear PRICE TAKER VS PRICE MAKER PRICE MAKER: eHas market power eDownward sloping demand curve eOnly increases Q by decreasing P eMR < AR and eAR = P = D eTotal revenue increases at a decreasing rate 6 Market Power A firms ability to set a price that is greater than the marginal cost without losing its entire share of the market. 7
Q P TR AR MR 1 10 10 10 NA 2 10 20 10 10 3 10 30 10 10 4 10 40 10 10 5 10 50 10 10
Each unit sold at the same market price PRICE TAKER: Perfect Competition 8 Since P = AR = MR wTotal revenue is linear PRICE TAKER: Perfect Competition 9 TR ($) Q(Tens) 150 15 TR PRICE TAKER: Perfect Competition 10 P=AR=MR=DEMAND Since price is constant, the demand curve of a firm in perfect competition is horizontal (i.e. perfectly elastic). PRICE TAKER: Perfect Competition 11 P Q(Hundreds) 10 S D Q(Tens) P 15 10 D 10 20 Market Firm D=P=MR=AR PRICE TAKER: Perfect Competition 12 To increase Q sold, Price has to decrease Q P TR AR MR 1 10 10 10 na 2 9 18 9 8 3 8 24 8 6 4 7 28 7 4 5 6 30 6 2 PRICE MAKER: Monopoly 13 eMR < AR eTR increases at a decreasing rate eAR = P = D eDemand and marginal revenue are downward sloping eMarginal revenue is below the demand curve
PRICE MAKER: Monopoly 14 Q(Tens) TR TR PRICE MAKER: Monopoly 15 MR/ MC Q(000) AR=D MR PRICE MAKER: Monopoly 16 D Demand Comparisons Quantity Price Monopoly View Quantity Price Competitive View D 17 All firms in any market structures are profit maximisers
PROFIT MAXIMISERS 18 Profit Maximisation and Output Decisions
Profit maximising firms will produce a quantity where the gap between TR and TC is the greatest or Marginal Revenue = Marginal Cost 19 Quantity produced where the gap between TR and TC is at its maximum Q(000) Q(000) TR/TC Profit/ Loss 9 9 12 12 4 4
TR TC Profit maximising quantity Perfectly Competitive Firm 20 MR/ MC P=MR=AR=D MC 5 8 10
MR > MC Q MR < MC Q Q(000) Perfect Competitive Firm (Profit maximisation) 9 Profit maximising quantity Profit maximising point, MC=MR 21 Q(Tens) Q(Tens) TR/TC Profit/ Loss TR TC
TR TC Quantity produced where the gap between TR and TC is at its maximum
Profit Maximising Quantity
Monopoly (Profit maximisation) 23 8 MR/ MC Q(000) AR=D MR 10 Profit Maximising Quantity (MC=MR) MR > MC Q
MR < MC Q
MC 9 5 8 Monopoly (Profit maximisation) 24 Profit Maximisation and Output Decisions NOTE: Marginal cost and marginal revenue may not be equal at a given quantity because we use discrete quantities.
In this case the profit maximising level of output is the quantity where marginal revenue is just above marginal cost
25 In the short run, if a firm is making an economic loss, the firm has two options to minimise loss. Profit Maximisation (Loss minimisation) 26 The options to minimise loss are: Produce at a loss Temporarily Shut Down Profit Maximisation (Loss minimisation) 27 A firm will produce at a loss if Price > Average variable cost
Recall: ATC= AFC + AVC If P > AVC, by producing the firm covers part of its fixed cost Profit Maximisation (Loss minimisation) 28 Firm will temporarily shut down if Price < Average variable cost
ATC= AFC + AVC If P < AVC, by producing the firm is not only unable to cover all its AVC but also faces its fixed cost Profit Maximisation (Loss minimisation) 29 Profit Maximisation and Output Decisions SUMMARY: All firms in any market structure are profit maximisers
Profit maximising firms will produce a quantity where the gap between TR and TC is the greatest or where MR = MC
Temporary shutting down in the short run if P < AVC or producing at a loss if P > AVC
Finally, a firm will leave the industry if it is making an economic loss in the long run 30 Perfect and imperfect competition
In the short run, firms in any market structure can make economic profit, normal profit or economic loss
31 Perfect Competition Q P=MR=AR=D MC
5 10 ATC Normal profit Price = ATC P 32 P Q AR=D MR Monopoly MC ATC P Q
Normal Profit Price = ATC
33 Q P=MR=AR=D MC 5 P ATC Economic profit Price > ATC 10
ATC ATC 35 P Q P=MR=AR=D MC 5 Economic loss Price < ATC ATC
10
6 Perfect Competition 36
Economic Loss Price < ATC P Q AR=D MR Monopoly MC ATC P Q ATC
37 Perfect and imperfect competition In the long run, only monopoly can make economic profit. Perfectly competitive firm can not make economic profit. This is because in a perfect competition there are no barriers to entry and in a monopoly there are very high barriers to entry. 38 Since there are no barriers to entry in perfect competition, if firms are making an economic profit, in the long run new firms will enter the market. This will increase supply and decrease the price until only normal profits are made. When normal profits are made new firms will stop entering the market. Perfect and imperfect competition 39 The next few slides will compare price and output behaviour and efficiencies of a perfectly competitive firm and a monopoly. Perfect and imperfect competition 40 P Q AR=D MR Competition vs Monopoly Q c P c
Comp. firm produces Q c WHERE MC=AR=MR and charge P c
MC P m Q m
Monopoly produces Q m where
MC=MR and charge P m
41 P Q AR=D MR Competition Vs. Monopoly Q c P c
MC P m Q m
Monopoly restricts quantity and charges a higher Price than competitive firms. 42 Perfect Competition Allocative efficiency: Producing an output level where the marginal benefit to the consumer of the last unit consumed is equal to the marginal cost faced by the firm in producing that last unit. 43 Perfect Competition Allocative efficiency: is where MARGINAL COST EQUALS MARGINAL BENEFIT. 44 P Q AR=D=MB MR Competition Vs. Monopoly Q c P c
MC P m Q m Unlike perfect competition, monopoly is not allocatively efficient. It does not produce where marginal cost equals marginal benefit
Monopoly: MB > MC
Perfect competition: MB = MC 45 Perfect Competition Productive efficiency: Producing an output level using, with the available technology, the least cost combination of inputs. 46 Perfect Competition PC firms are productively efficient because the long run output level is at the minimum point of the long run average cost curve. 47 P Q AR=D=MB MR Competition Vs. Monopoly Q c P c
MC P m Q m
LRAC Unlike perfect competition, monopoly is not productively efficient. It does not produce at the minimum point of the long run average cost curve. Monopoly: LRAC
Perfect Competition: Minimum LRAC 48 p Small number of producers. p Price maker p High barriers to entry p High degree of interdependency Oligopoly Characteristics of an oligopoly: 49
Interdependency results in a firm making a decision after considering the reaction of other firms. Oligopoly 50 Game theory: The study of how people make decisions in situations where attaining their goals depends on their interactions with others; in economics, the study of the decisions of firms in industries where the profits of each firm depend on its interactions with other firms. LEARNING OBJECTIVE 2 Using Game Theory to Analyse Oligopoly 51 It recognises the characteristic of mutual interdependence in an oligopoly Game theory is a method of analysing strategic behaviour Oligopoly 52 Key characteristics of all games: Rules that determine what actions are allowable. Strategies that players employ to attain their objectives in the game. Payoffs that are the results of the interaction among the players strategies.
Business strategy: Actions taken by a firm to achieve a goal, such as maximising profits. LEARNING OBJECTIVE 2 Using Game Theory to Analyse Oligopoly 53 A Duopoly Game: Price competition between two firms Payoff matrix: A table that shows the payoffs that each firm earns from every combination of strategies adopted by the firms. Collusion: An agreement among firms to charge the same price, or to otherwise not compete. LEARNING OBJECTIVE 2 Using Game Theory to Analyse Oligopoly 54 Game Theory FIRM A F I R M
B
HIGH PRICE LOW PRICE H I G H
P R I C E
L O W
P R I C E
$1000 $1000 $700 $700 $300 $1500 $300 $1500 55 Game Theory Cooperative outcome: Where players in the game agree to cooperate Both firms will charge a high price and make $1000 each. Both firms will charge a high price and make $1000 each. 56 Game Theory Non-cooperative outcome: Where players do not cooperate and instead follow their own individual incentives. Both firms will charge a low price and receive $700 each. 57 Maximin strategies: Strategies chosen by players in a game to maximise their minimum expected pay-off from the game Oligopoly 58 A Duopoly Game: Price Competition between Two Firms
LEARNING OBJECTIVE 2 Using Game Theory to Analyse Oligopoly 59 Product designs Advertising Location Complementary services Non-Price Competition Some examples of non-price competition: 60 Build customer loyalty Increase customer satisfaction Maintain or increase market share Non-Price Competition If successful, non-price competition allows firms to: 61 Check Your Knowledge Q1. To maximise profit, which of the following should a firm attempt to do?
a. Maximise revenue. b. Minimise cost. c. Find the largest difference between total revenue and total cost. d. All of the above simultaneously. 62 Q1. To maximise profit, which of the following should a firm attempt to do?
a. Maximise revenue. b. Minimise cost. c. Find the largest difference between total revenue and total cost. d. All of the above simultaneously. Check Your Knowledge 63 Q2. Refer to the figure below. One of the curves in this figure is not necessary in order to determine the profit-maximizing level of output. Which curve can be discarded?
a. The marginal cost curve. b. The demand curve. c. The average total cost curve. d. All three curves must remain in place in order to determine which level of output maximizes profit.
Check Your Knowledge 64 Q2. Refer to the figure below. One of the curves in this figure is not necessary in order to determine the profit-maximizing level of output. Which curve can be discarded?
a. The marginal cost curve. b. The demand curve. c. The average total cost curve. d. All three curves must remain in place in order to determine hich level of output maximizes profit.
Check Your Knowledge 65 Q3. Refer to the figure below. Which demand curve is associated with the shutdown point? a. Demand 1 b. Demand 2 c. Demand 3 d. Demand 4 Check Your Knowledge 66 Q3. Refer to the figure below. Which demand curve is associated with the shutdown point? a. Demand 1 b. Demand 2 c. Demand 3 d. Demand 4 Check Your Knowledge 67 Q4. Which of the following terms best describes how the forces of competition will drive the market price to the minimum average cost of the typical firm?
a. Allocative efficiency. b. Productive efficiency. c. Decreasing-cost industry. d. Competitive markdown.
Check Your Knowledge 68 Q4. Which of the following terms best describes how the forces of competition will drive the market price to the minimum average cost of the typical firm?
a. Allocative efficiency. b. Productive efficiency. c. Decreasing-cost industry. d. Competitive markdown.
Check Your Knowledge 69 Q5. In which of the following situations can a firm be considered a monopoly?
a. When a firm is surrounded by other firms that produce close substitutes. b. When a firm can ignore the actions of all other firms. c. When a firm uses other firms prices in order to price its products. d. When barriers to entry are eliminated.
Check Your Knowledge 70 Q5. In which of the following situations can a firm be considered a monopoly?
a. When a firm is surrounded by other firms that produce close substitutes. b. When a firm can ignore the actions of all other firms. c. When a firm uses other firms prices in order to price its products. d. When barriers to entry are eliminated.
Check Your Knowledge 71 Q6. Refer to the figure below. How much is the amount of profit when the firm serves six subscribers per month?
a. (42 27) x 6 b. (42 30) x 6 c. (30 27) x 6 d. $42.
Check Your Knowledge 72 Q6. Refer to the figure below. How much is the amount of profit when the firm serves six subscribers per month?
a. (42 27) x 6 b. (42 30) x 6 c. (30 27) x 6 d. $42.