Chapter 9 · PDF file• If Weis chooses Low, what should Giant do to make the most money? Giant’s Advertising Expenditures Low Expenditures High Expenditures Weis’

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Chapter 9 Noncompetitive Markets and Inefficiency

Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 9-2

FIGURE 9.BP.1 Market Structures and Their Characteristics


Monopoly •  Monopoly Characteristics:

–  1 firm, no close substitutes, so the firm can set Price.

– Downward-sloping Demand Curve •  The monopoly’s D curve is the mkt. D curve

– Barriers to Entry: factors keep out competitors


Barriers to Entry

•  Economies of Scale (Natural Monopoly): –  More efficient to be big –  Declining LRAC curve, better to have only 1 firm

•  Exclusive Ownership of a Unique Resource –  Alcoa & Bauxite, Diamonds & DeBeers

•  Govt. Granted Monopoly –  Franchises granted to cable co., electric co., post office

•  Patents & Copyrights –  Monopoly on a drug formula (AZT), operating system (Windows),

etc. •  The existence of Barriers to entry means that a monopolist

CAN earn economic profit in long run


Profit Max. for a Monopolist: produce as long as MR�MC, but MR�P

Perfect Competition, MR=P Monopoly, P>MR

P Q TR MR P Q TR MR

10 1 10 10 10 1 10 10

10 2 20 10 9 2 18 8

10 3 30 10 8 3 24 6

10 4 40 10 7 4 28 4

10 5 50 10 6 5 30 2

10 6 60 10 5 6 30 0


•  When P is fixed, P=MR •  When P� as Q�, P=MR at Q=1, and then

P>MR –  As the firm lowers prices to sell more units,

•  each unit makes you more $, •  but you lose some money by lowering P

–  2nd unit sells when P=$9; MR is only $8 b/c the firm had to lower P by $1 to sell another unit => make $9 more, lose $1 from lower prices

–  3rd unit sells if P=$8; but MR is $6. •  Profit Max now occurs where MR=MC, not where

P=MC.

Price & Marginal Revenue


D & MR under Perfect Competition vs. Monopoly

D=MR

D

MR

P P

Q Q

Perfect Competition Monopoly


FIGURE 9.3 A Monopoly Firm in equilibrium earning an economic profit (shaded area)


Table illustrating a monopolist

Q TC MC ATC P TR MR

0 5 12

1 9 10

2 10 8

3 12 6

4 16 4

5 25 2

6 39 0


Table illustrating a monopolist

Q TC MC ATC P TR MR

0 5 12 0

1 9 4 9 10 10 10

2 10 1 5 8 16 6

3 12 2 4 6 18 2

4 16 4 4 4 16 -2

5 25 9 5 2 10 -6

6 39 14 6.5 0 0 -10


Graph of the same monopolist

-15

-10

-5

0

5

10

15

20

0 1 2 3 4 5 6 7

Q

ATC

D

MR

MC


Another Monopoly Example. 1. Computer TR.

Q P TR MR TC MC

0 20 28 1 19 39 2 18 48 3 17 55 4 16 64 5 15 75 6 14 88 7 13 104 8 12 124 9 11 149

10 10 181


2. Computer MR=ΔTR/ΔQ

Q P TR MR TC MC

0 20 0 28 1 19 19 39 2 18 36 48 3 17 51 55 4 16 64 64 5 15 75 75 6 14 84 88 7 13 91 104 8 12 96 124 9 11 99 149

10 10 100 181


3. Compute MC

Q P TR MR TC MC

0 20 0 28 1 19 19 19 39 2 18 36 17 48 3 17 51 15 55 4 16 64 13 64 5 15 75 11 75 6 14 84 9 88 7 13 91 7 104 8 12 96 5 124 9 11 99 3 149

10 10 100 1 181


4. Determine the Profit Maximizing Level of Output and Compute Profit or Loss

Q P TR MR TC MC

0 20 0 28 1 19 19 19 39 11 2 18 36 17 48 9 3 17 51 15 55 7 4 16 64 13 64 9 5 15 75 11 75 11 6 14 84 9 88 13 7 13 91 7 104 16 8 12 96 5 124 20 9 11 99 3 149 25

10 10 100 1 181 32


Profit Max. Q = 5; TR = TC so the monopolist earns a normal profit

Q P TR MR TC MC

0 20 0 28 1 19 19 19 39 11 2 18 36 17 48 9 3 17 51 15 55 7 4 16 64 13 64 9 5 15 75 11 75 11 6 14 84 9 88 13 7 13 91 7 104 16 8 12 96 5 124 20 9 11 99 3 149 25

10 10 100 1 181 32


FIGURE 9.4 (a) A Monopolist Incurring an Economic Loss


FIGURE 9.4 (b) A Monopolist Earning a Normal Profit


TABLE 9.1 Monopoly Revenue and Cost


FIGURE 9.1 Monopoly Demand and Marginal Revenue


FIGURE 9.2 Monopoly Demand, Marginal Revenue, Average Cost, and Marginal Cost


FIGURE 9.5 Long-Run Equilibrium for the Monopolist


FIGURE 9.6 Monopoly—Output Restriction and High Price


Monopolistic Competition

Characteristics: •  Easy Entry and Exit

– No significant barriers to entry – No long term economic profits

•  Large number of firms – Firms can be small or large, but not dominant

•  Products are close but not perfect substitutes (product differentiation) – Non-price competition (advertising)


Entry and Exit in Monopolistic Competition

•  Economic profits encourage more firms to enter – This creates more substitutes for existing brands – Decreasing the demand curve for existing firms – This process continues until firms earn a normal

profit


Monopolistic Competitor Earning an Economic Profit

D

LAC LMC

MR

P

Q

D2

More substitutes → D shifts down and gets flatter

●

MR2

●

MR2 Starts out touching D and intersects MC directly below the tangency point.

P2


•  This means fewer substitutes for remaining products

•  Increasing the demand curve for remaining firms

•  This process continues until firms earn a normal profit

Economic losses cause firms to exit


Monopolistic Competitor with an Economic Loss

D

LAC LMC

MR

P

Q

D2

Fewer substitutes → D increases and gets steeper

●

MR2

MR2 starts out touching D and intersects MC directly below the tangency point


FIGURE 9.7 Demand and Marginal Revenue for a Firm in Monopolistic Competition


FIGURE 9.8 Short-Run Equilibrium for a Firm in Monopolistic Competition


FIGURE 9.9 Long-Run Equilibrium in Monopolistic Competition


FIGURE 9.9 (continued) Long-Run Equilibrium in Monopolistic Competition


FIGURE 9.9 (continued) Long-Run Equilibrium in Monopolistic Competition


OLIGOPOLY •  Key Characteristics:

– Substantial Barriers to Entry – Dominated by a FEW LARGE FIRMS –  INTERDEPENDENCE AMONG FIRMS

•  Interdependence generates non-price competition (ads) and potentially

•  INCENTIVES TO COLLUDE, merge


Kinked Demand Curve

P

Q D

←D curve if firm raises price and rival firms do not

←D curve if firm lowers price

and rival firms match price cuts

Market P

Firms avoid raising prices (unless they think their rivals will follow suit. They avoid price cuts for fear of starting a price war. The likely outcome is adopting similar prices, and “testing” price increases to see if rival firms will follow suit (attempting Price Leadership).

Copyright © 2011 Pearson Addison-Wesley. All rights reserved.

Game Theory illustrates the interdependence of firms, and the incentives they face


Payoff matrix showing profits of two firms when both have dominant strategies

Giant’s Advertising Expenditures

Low Expenditures High Expenditures

Weis’ Advertising Expenditures

Low Expenditures

Weis Profits: $300,000 Giant Profits: $300,000


High Expenditures



A dominant strategy exists if profits are higher no matter when the rival does.

Both Weis and Giant have a dominant strategy: High Ad Expenditures.

In this case, an equilibrium solution occurs in the lower right hand cell of the payoff matrix.


Determining a Dominant Strategy




Low Expenditures



High Expenditures



For Weis, if Giant chooses Low Expenditures, which option should Weis choose?

Answer: High Expenditures, b/c $400,000>$200,000

If Giant chooses High Expenditures, Weis should choose High Expenditures, b/c $200,000>$100,000.

Weis has a dominant strategy: High Expenditures.

How to solve a payoff matrix

•  Assume one player chooses one option, then determine what the other player should do

•  Do this for all possible options to determine if either player has a dominant strategy or a consistent strategy




Low Expenditures Weis Profits: $350,000 Giant Profits: $400,000


High Expenditures Weis Profits: $300,000 Giant Profits: $200,000


•  If Weis chooses Low, what should Giant do to make the most money?




Low Expenditures Giant Profits: $400,000 Giant Profits: $500,000

High Expenditures

•  If Weis chooses High, what should Giant do to make the most money?

•  If Giant chooses Low, what should Weis do to make the most money?

•  If Giant chooses High, what should Weis do to make the most money?








This is a payoff matrix when Giant has a dominant strategy

Giant has a dominant strategy because high expenditures optimize profits no matter what decision Weis makes.

However, Weis does not have a dominant strategy. If Giant chooses low, Weis will choose low ($350,000>$300,000); if Giant chooses high, Weis will choose high ($200,000> $100,000).

The equilibrium solution depends upon the information Weis has about Giant. If Weis knows Giant’s dominant strategy, equilibrium solution will be high expenditures for both and profits will be $200,000 for Weis and $300,000 for Giant.









Collusion

•  Cartel –  Sellers join together to control output and/or prices. Illegal

in the US. –  Example 1: OPEC –  Example 2: Price fixing of Ivy League Schools –  Example 3: Coke and Pepsi agreement on which product

would be on sale which week of the year •  Price Leadership

–  Market leader establishes the price, other firms follow suit. •  Conscious parallelism

–  Firms adopt identical prices without communication.


FIGURE 9.10 Oligopoly Pricing and Output with Economies of Scale


FIGURE 9.11 A Cartel to Ensure Oligopoly Profits


FIGURE 9.12 Sample Payoff Matrix


TABLE 9.2 Share of Value of Shipments Accounted for by the Largest Companies in Selected High-Concentration Manufacturing Industries, 2002


TABLE 9.2 (continued) Share of Value of Shipments Accounted for by the Largest Companies in Selected High-Concentration Manufacturing Industries, 2002


TABLE 9.3 Share of Value of Shipments Accounted for by the Largest Companies in Selected Low-Concentration Manufacturing Industries, 2002


TABLE 9.4 Concentration Ratios for Selected Non-manufacturing Industries


TABLE 9.4 (continued) Concentration Ratios for Selected Non-manufacturing Industries


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Chapter 9 · PDF file• If Weis chooses Low, what should Giant do to make the most money? Giant’s Advertising Expenditures Low Expenditures High Expenditures Weis’