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McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia Chapter 12: Imperfect Competition.

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Presentation on theme: "McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia Chapter 12: Imperfect Competition."— Presentation transcript:

1 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia Chapter 12: Imperfect Competition

2 12-2 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia Objectives After studying this chapter, you will be able to:  Define and identify monopolistic competition  Explain how price and output are determined in a monopolistically competitive industry  Explain why advertising and branding costs are high in a monopolistic competition  Define and identify oligopoly  Explain two traditional models of oligopoly

3 12-3 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia Fliers, Coupons, and Specials  Supermarkets like Coles and Woolworth and department stores like K-Mart and Target advertise each week’s specials to tell us that they have the best product at the best price.  Firms in these markets are neither price takers like those in perfect competition, nor are they protected from competition by barriers to entry like a monopoly.  How do such firms choose the quantity to produce and price?

4 12-4 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia What is Monopolistic Competition?  Monopolistic competition is a market with the following characteristics:  A large number of firms.  Each firm produces a differentiated product.  Firms compete on product quality, price, marketing and branding.  Firms are free to enter and exit.

5 12-5 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia Monopolistic Competition  Large Number of Firms  The presence of a large number of firms has three implications:  Small market share  Can ignore other firms  Collusion is impossible

6 12-6 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia Monopolistic Competition  Product Differentiation  Firms in monopolistic competition practice product differentiation, which means that each firm makes a product that is slightly different from the products of competing firms.

7 12-7 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia What is Monopolistic Competition?  Competing on Quality, Price, Marketing and Branding  Product differentiation enables firms to compete in four areas:  Quality.  Price  Each firm has a downward-sloping demand curve for its own product.  Marketing through advertising and packaging  Branding through name, sign or symbol

8 12-8 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia What is Monopolistic Competition?  Entry and Exit  There are no barriers to entry in monopolistic competition, so firms cannot earn an economic profit in the long run.  Identifying Monopolistic Competition  All four features of monopolistic competition must be present.  Examples of Monopolistic Competition  Audio and video equipment, computers, frozen foods, petrol stations.

9 12-9 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia What is Monopolistic Competition?  Imperfect competition, not monopolistic competition  When a brand becomes a dominant, the brand itself becomes a barrier to entry, as entry of new firms may not drive down its price  Brand names that are incredibly successful include, Coco- Cola, Heinz, and Kellogg’s

10 12-10 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia Price and Output in Monopolistic Competition  Short-Run Output and Price Decision  Produces the profit maximising quantity at which its marginal revenue equals its marginal cost (MR = MC).  Price is determined from the demand curve for the firm’s product and is the highest price the firm can charge for the profit-maximising quantity.

11 12-11 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia Economic profit Quantity (French Connection jackets per day) Price & cost (dollars per French Connection jacket) D MR Economic Profit in the Short Run ATC MC Profit maximising quantity Price greater Than average Total cost Figure 12.1

12 12-12 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia Price and Output in Monopolistic Competition  Profit Maximising Might be Loss Minimising  A firm might face a level of demand for its product that is too low for it to make an economic profit.  A firm could maximise profit or minimise loss by producing the output at which marginal revenue equals marginal cost

13 12-13 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia Economic loss Quantity (French Connection jackets per day) Price & cost (dollars per French Connection jacket) D MR Economic Profit in the Short Run ATC MC Profit maximising (loss-minimising quantity Price less than average total cost Marginal revenue = marginal cost Figure 12.3

14 12-14 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia Price and Output in Monopolistic Competition  Long Run: Zero Economic Profit  In the long run, economic profit induces entry. If firms incur economic losses, exit will occur.  Entry continues as long as firms in the industry earn an economic profit—as long as (P > ATC).  Price and quantity fall with firm entry until P = ATC and firms earn zero economic profit.  If firms were incurring economic losses, exit of firms will occur until all firms earn zero economic profit

15 12-15 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia Quantity (French Connection jackets per day) Price & cost (dollars per French Connection jacket) D MR Output and Price in the Long Run ATC MC Profit maximising quantity Price = average total cost Marginal revenue = marginal cost Figure 12.3

16 12-16 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia Price and Output in Monopolistic Competition  Monopolistic Competition and Perfect Competition  Two key differences:  Excess Capacity  A firm has excess capacity if it produces below its efficient scale.  Markup  Markup is the amount by which price exceeds marginal cost

17 12-17 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia Quantity (French Connection jackets per day) Price & cost (dollars per French Connection jacket) D MR Excess Capacity and Markup ATC MC PriceExcess capacity Efficient scale Markup Marginal cost 50 Monopolistic Competition Figure 12.4(a)

18 12-18 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia AR = MR Price = Marginal cost Perfect Competition 0 Excess Capacity and Markup Quantity (jackets per day) Price and costs (dollars per jacket) ATC MC Quantity = efficient scale Figure 12.4(b)

19 12-19 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia Price and Output in Monopolistic Competition  Is Monopolistic Competition Efficient?  Firms charge price in excess of marginal cost.  Therefore, the market structure is inefficient.  However, consumers gain variety.  The loss in efficiency must be weighed against the gain of greater product variety.

20 12-20 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia Product Development and Marketing  Innovation and Product Development  To keep earning an economic profit, a firm in monopolistic competition must be in a state of continuous product development.  New product development allows a firm to gain a competitive edge, if only temporarily, before competitors imitate the innovation.

21 12-21 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia Product Development and Marketing  Costs versus Benefit of Product Innovation  Innovation is costly, but it increases total revenue.  Firms pursue product development until the marginal revenue from innovation equals the marginal cost of innovation.  Production development may benefit the consumer by providing an improved product.

22 12-22 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia Product Development and Marketing  Advertising  Advertising and packaging are the two principal methods firms in monopolistic competition use to differentiate their products  Firms in monopolistic competition incur heavy marketing and advertising expenditures to enhance the perception of quality differences between their product and rival products..

23 12-23 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia Advertising Expenditure

24 12-24 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia Product Development and Marketing  Selling Costs and Total Costs  Selling costs, like advertising expenditures, are fixed costs.  Advertising costs per unit decrease as production decreases.

25 12-25 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia Product Development and Marketing  Selling Costs and Demand  Advertising can increase a firm’s demand and profits.  Advertising and selling costs provide consumers with information and services that they value more highly than their cost. These activities are therefore efficient.

26 12-26 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia Quantity (French Connection jackets per day) Price & cost (dollars per French Connection jacket) D MR Advertising and the Markup ATC MC Markup is large With no advertising Demand is low but... No Firms Advertise Figure 12.7(a)

27 12-27 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia Product Development and Marketing  Using Advertising to Signal Quality  Expansive advertising signals a high quality product  A signal is an action taken by an informed person (or a firm) to send a message to uninformed person  Brand names  A brand name provides information about the quality of a product to consumers  Efficiency of advertising and brand names

28 12-28 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia What is Oligopoly?  Oligopoly is a market structure in which:  Natural or legal barriers prevent the entry of new firms  A small number of firms compete

29 12-29 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia What is Oligopoly?  Barriers to Entry  Either natural or legal barriers to entry can create oligopoly  Economies of scale and demand can form a natural barriers to entry and create oligopoly  A legal oligopoly arises when a legal barrier to entry protects the small number of firms in a market

30 12-30 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia Natural Oligopoly D Quantity (rides per day) Price and cost (dollars per ride) ATC 1 Natural Duopoly Natural oligopoly with three firms Quantity (rides per day) ATC 2 D Price and cost (dollars per ride) Efficient scale of one firm Lowest possible price = Min ATC Two firms can meet demand Efficient scale of one firm Three firms can meet demand Figure 12.8

31 12-31 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia What is Oligopoly?  Small Number of Firms  Oligopoly consists of a small number of firms each of which has a large share of the market.  Such firms are interdependent and they face a temptation to cooperate to increase their joint profit.  Examples of Oligopoly  Identify oligopoly by looking at the concentration ratios. A four-firm concentration ratio where share of total revenue exceeds 60 percent indicates oligopoly.

32 12-32 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia Two Traditional Oligopoly Models  The Kinked Demand Curve Model  The kinked demand curve model of oligopoly is based on the assumption that each firm believes that if it raises its price, others will not follow, but if it cuts its price, other firms will cut theirs.

33 12-33 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia Two Traditional Oligopoly Models  Dominant Firm Oligopoly  In a dominant firm oligopoly, there is one large firm—the dominant firm—that has a significant cost advantage over many other, smaller competing firms.  The dominant firm sets the market price and the other firms are price takers  Examples: large petrol retailer, a big video rental store in a local market

34 12-34 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia MR XD S 10 D A Dominant Firm Oligopoly Quantity (thous. of litres/week) Price (dollars per litre) Quantity (thous. of litres/week) A B A B Ten small firms and market demand Big-G’s price and output decision MC Figure 12.10

35 12-35 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia END CHAPTER 12


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