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Level 5 Economics: Theory of the Firm [3]

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Presentation on theme: "Level 5 Economics: Theory of the Firm [3]"— Presentation transcript:

1 Level 5 Economics: Theory of the Firm [3]
Imperfect Competition Economic Principles Economic Environment

2 Level 5 Economics: Theory of the Firm [3]
Learning Outcome Three Theory of the Firm: Imperfect Competition

3 Tiwai Point Aluminium Smelter – Meridian's biggest customer
Wikimedia Commons

4 Barriers to Industry Entry limit Competition
barriers to entry into a market give existing suppliers market power high capital costs / economies of scale technological expertise registration systems / licensing / examinations patents / copyrights: "Intellectual Property Rights" incl. trademarks: names and symbols (silver fern?) franchising / dealerships parallel importing – dealer networks bypassed excessive government regulations ("red tape") use of market power predatory pricing, control of inputs [examples?] S&R, S ch.6 diamonds, pounamu (NZ jade), local landline

5 Imperfect Competition
Level 5 Economics Exercise Form groups of 2 or 3. Imagine you plan to start a new business. Think of 2 industries in New Zealand or in your home country in which it would be extremely difficult for your new firm to enter the market. Are some markets within that industry easier for a new firm to enter than others?

6 Efficient and Competitive Markets
Efficient Market for a commodity Price = Minimum Average Cost = Marginal Benefit = Marginal Cost [accounting for benefits to consumers and other parties] [accounting for costs to producers and other parties] Perfectly Competitive Market is efficient, without government intervention there are no "other parties"; only consumers, producers Imperfectly Competitive Market without government help, is not efficient

7 Monopoly market with a single seller – a price-maker
absence of competitors gives monopoly firms market power the most imperfect form of competition NZ examples: NZ Bus, Auckland Airport (AIA), Vector competitive forces arise from substitutes not all substitutes are obvious; eg home renovation may be a substitute for overseas holidays labour monopolies: unions and societies Natural Monopoly where large economies of scale exist Mankiw fig 1 technical efficiencies maximised if just one firm

8 Revenue curves for perfect competition and monopoly
for perfect competition marginal revenue is constant because S&R, S fig 6.2 (reminder) each firm is too small to influence the market supply curve hence the perfectly competitive firm cannot, on its own, influence the equilibrium market price a monopolist's marginal revenue curve is downward sloping S&R, S fig 6.3 a monopolist's output is also the market's output  an increase in a monopolist's supply reduces the market price Impact on price: competition and monopoly compared.

9 Equilibrium of the Firm; Imperfect Competition
applying the MC=MR rule to establish Qe Profit () equals S&R, S fig total revenue (TR) minus total cost (TC) firms maximise profit when S&R, S fig marginal revenue (MR) equals marginal cost (MC) under imperfect competition, MR < price AR and MR slope down to the right firm's equilibrium, Imperfect Competition above-normal profits apply and persist S&R, S fig 7.12a

10 Imperfect Competition
Level 5 Economics Fig 7.12a fig 4 Mankiw Imperfect competition esp. monopoly. = price for a given Q (new fig 7.12a)

11 Imperfect Competition
Level 5 Economics Multichoice Exercise

12 Monopolistic Competition S&R, S end of ch.7
industry includes small firms commonly includes larger firms as well eg restaurants and fast food (McDonalds) product differentiation / variation S&R fig 7.18, S 7.15 eg Nike, Levis etc market leaders through successful branding marketing strategy designed to raise demand for brand and thereby to avoid price-cutting successful brand variant enjoys less elastic demand differentiation can be achieved also by levels of personal service, reputation etc. most well-known firms are monopolistic competitors

13 Oligopoly / Duopoly S&R, S end of ch.7
few sellers / two sellers [large size firms] individual firms' supply each affect price examples . high barriers to market entry lead to oligopoly oligopolist firms compete for market share each rival firm happy to supply more (as economies of scale are common), but not happy for an increase in industry supply to force prices down price competition [price wars, extreme case] works only in short-term as rivals soon respond banking, supermarkets, newspapers, energy production and retailing

14 Holding Companies & Mergers
common ownership through holding companies reduces competition eg The Warehouse Group; other examples? mergers have to be approved in NZ by the Commerce Commission Cartel: a colluding oligopoly Monopsony: single buyer Fonterra (dairy), Zespri (kiwifruit) in NZ globally, these are Monopolistic Competitors

15 Natural Monopoly when a single firm can supply the whole market while experiencing decreasing costs S&R fig 7.15 p.136, S fig 7.18 p (eg Vector) especially where large networks exist competition would force each firm to produce at an above-optimal cost (ie on the left side of the LAC curve) monopoly is not always bad natural monopolies are usually publicly owned or subject to price regulation to improve their economic efficiency high cost industries with social benefits will often only be provided by a monopoly to operate efficiently, a subsidy may be needed fig 8.2, 8.1 fig 7.14, 7.17 for price regulation

16 Contrasting effects of Perfect and Imperfect Competition
Market Concentration Ratios many industries fall between oligopoly and monopolistic competition, with market leaders monopoly = 1; perfect competition = 0 Evaluation of differences S&R, S Table 8.1 imperfect competition can be made more efficient through policy intervention competition creates marketing industry dynamic competition – rivalry – creates change Issue to think about do Google and Facebook dominate the Internet?


18 Efficient Outcome for Society
if Price (ie Average Revenue) = Marginal Cost price is the marginal benefit of a private good (T4) "price (AR) = marginal cost" is a condition for efficiency for society as a whole for a 'private good' otherwise , efficiency gains can be realised: if price > marginal cost, there will be increased net benefits if more resources are allocated to that good if price < marginal cost, there will be increased net benefits if fewer resources are allocated to that good and more resources are allocated to other goods a market is efficient if a change in the quantity produced cannot lead to efficiency gains back

19 Net Benefits Consumer (household) point of view
back Consumer (household) point of view happiness – unhappiness = individual welfare Producer (firm) point of view total revenue – total cost = profit Social point of view total benefit – total cost = societal welfare

20 Imperfect Competition
Level 5 Economics Average Revenue Curves, firms in industries with different levels of competition back 20% increase in firm’s output; what happens to price?

21 Imperfect Competition
Average Revenue Curves, Firms in Industries with different levels of competition Level 5 Economics Oligopoly Duopoly Monopoly back

22 Imperfect Competition
Level 5 Economics Average Revenues of Competitive Firms $5.00 market-clearing price (P) per item sold $3.00 Monopolistic Competition; Average Revenues for individual brands are like this. $1.00 160 170 180 190 200 210 220 230 240 250 output (Q) of individual firm back

23 from Mankiw, Principles of Economics (4e), p.315
Note KR: "Average Total Cost" here means what we call "Long-Run Average Cost" (LAC)

24 Example of a Long-Run Average Cost Curve LAC S&R ch.5
Costs of Production Level 5 Economics Example of a Long-Run Average Cost Curve LAC S&R ch.5 $ eg Dairy back return eg Superette eg large Supermarket eg small Supermarket economies of scale diseconomies of scale

25 Imperfect Competition
Level 5 Economics natural monopoly Advertisement from Auckland City Harbour News 25 August 2004 back

26 Imperfect Competition
Level 5 Economics Dynamic vs. Static Efficiency back

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