1. The Theory of the Firm Intro to Competition Theory 4 major theoretical frameworks: Perfect competition monopoly monopolistic competition oligopoly (including duopoly) Most info from Blink & Dorton or Tragakes

2. Intro to Perfect Competition Assumptions: Industry has a very large # of firms. – Each firm is so small that they: can’t alter its own output to affect the industry’s output can’t affect the price of the product (firms are “price takers”) Firms produce exact same products – One firm does not produce better goods – No brand names, no marketing to differentiate Firms completely free to enter & leave industry – No barriers to entry All producers and consumers have a perfect knowledge of the market. – Prices, costs of producing, quality of products, etc.

3. Perfect Competition in the Real World DOES NOT EXIST! But…closest examples are often in agriculture

4. Agricultural Markets and Perfect Competition Case Study: Wheat in the European Union There are some large wheat farms in the EU, but they are very small in relation to the whole wheat-growing industry. An individual farm could increase its output many times over without have any noticeable effect on total supply of wheat in the EU. A single farm is not able to affect the price of wheat in the EU, since it cannot shift the industry supply curve. The farm has to sell at whatever the industry price is. In addition wheat is wheat, and so there is no way to tell one farm’s wheat from another.

5. Intro to Monopoly The (one) firm IS the industry! Barriers to entry exist (New firms can’t enter) – Examples Economies of scale Branding/Advertising Legal barriers (patents, licenses, copyrights, etc.) – Gov’t may only allow one firm Control of essential resources – Leads to what kind of profits in the long run? ABNORMAL!

6. The Extent of Monopoly Power Key Qs Can the firm set its own prices w/o worrying about other firms? Can the firm keep others out of the industry? Are there no adequate substitutes? – e.g. Underground railway in a city maybe only one, but it competes against buses, taxis, etc.

7. Intro to Monopolistic Competition Supposed to be more realistic (between 2 extremes of monopoly/perfect competition) Key Characteristics – Fairly large # of (small) firms – No barriers to entry Free to enter and leave whenever – Substantial control over market price If a firm raises price, doesn’t lose all sales (perfect c.) but loses more sales than the monopolist – Slightly differentiated products Physical, quality, location, services, advertising differences Which are similar to perfect competition?

8. Intro to Monopolistic Competition Examples – Shoes – Clothing – Detergent – Computer – Publishing – Furniture – Italian restaurants – Mechanics – Jewelers

9. How is Monopolistic Competition different to Perfect Competition ? The most significant difference from perfect competition, is that in monopolistic competition, there is product differentiation.

10. How is the market structure different? Although it may appear to be a small difference from the assumptions of perfect competition, this leads to a markedly different market structure. As the products are differentiated there will some extent of brand loyalty.

11. We’ll stop here today!

12. Intro to Oligopoly: Assumptions Large proportion of industry’s output is shared by a small number of firms. – Industry may or may not have many firms. But only a few DOMINATE! – What is a small #? Varies. – Key indicator: Concentration Ratio Shows % of market share held by x # of firms Most common: CR 4 and the CR 8 – How many firm in each example?

13. Intro to Duopoly: 2 firms dominate an industry This is still part of oligopoly theory!

14. Intro to Oligopoly: Assumptions (Already mentioned): Dominance by small # of firms Importance of interdependence – Leads to dilemma: COMPETE or COLLUDE ? Differentiated or homogeneous products

15. TIME FOR SOME CONCENTRATION RATIO QUESTIONS!

16. What would CR 1 = 100% be? A monopoly! What would CR 4 = 0% be? Perfect competition (or perhaps monopolistic competition)

17. Our Friend Wikipedia Looks @ the UK How would the concentration ratio be expressed?

18. Concentration Ratios (not sure which country…US?)

19. R & D in various types of industries

20. Classifying Competition in Specific Industries Where do you think each fits? Why? Oil industry Global airline industry US airline industry Social media industry Bottled water industry

21. Before we discuss allocative efficiency, a few reminders: Consumer Surplus – “the highest price consumers are willing to pay for a good minus the price actually paid” Producer Surplus – “the price received by firms for selling their goods minus the lowest price that they are willing to accept in order to produce the good”

22. Allocative Efficiency

23. Efficiencies ALLOCATIVE EFFICIENCY Marginal benefit of what consumers receive is = to marginal cost for producers. MC = AR MC = P MSB = MSC – Marginal social benefit = marginal social cost Nothing is wasted in society (no pos./neg. externalities) Perfect competition leads to allocative efficiency in BOTH the SHORT RUN & LONG RUN PRODUCTIVE EFFICIENCY Production takes place at minimum average total cost. Firms produce @ the lowest possible cost. Production of 1 good uses the least amount of resources possible. MC = ATC MC = AC In long run, P = ATC. Perfect competition leads to productive efficiency in ONLY the LONG RUN but not necessarily in the SHORT RUN.

24. Helpful Q: In the long run in perfect competition, only what kind of profits can be made? NORMAL!!!

25. NOTE: IN EACH OF THE FOLLOWING EXAMPLES, OUTPUT IS @ EITHER THE PROFIT MAXIMIZING OR LOSS MINIMIZING POINT

26. ALLOCATIVE AND PRODUCTIVE EFFICIENCY WITH SHORT RUN PROFITS IN PERFECT COMPETITION Profit-maximizing test Where does MC = MR? Allocative efficiency test: At that point (profit-maximizing), does MC = AR? Productive efficiency test At that point (profit-maximizing), does MC = AC?

27. PRODUCTIVE AND ALLOCATIVE EFFICIENCY WITH SHORT RUN LOSSES IN PERFECT COMPETITION If a firm is making losses in the short run, they are producing at the profit maximising level of output q (where in MC=MR) and the allocatively efficient level of output q 2 (where MC=AR). However, the firm does not achieve productive efficiency q 1 (where MC=AC). ALLOCATIVE AND PRODUCTIVE EFFICIENCY WITH SHORT RUN LOSSES IN PERFECT COMPETITION Profit-maximizing test Where does MC = MR? Allocative efficiency test: At that point (profit-maximizing), does MC = AR? Productive efficiency test At that point (profit-maximizing), does MC = AC?

28. ALLOCATIVE AND PRODUCTIVE EFFICIENCY IN THE LONG RUN IN PERFECT COMPETITION Profit-maximizing test Where does MC = MR? Allocative efficiency test: At that point (profit-maximizing), does MC = AR? Productive efficiency test At that point (profit-maximizing), does MC = AC?

30. Source http://vhirsch.com/blog/wp- content/uploads/2009/09/m arket-domination.jpg Stimulus 1: What is meant by industry consolidation? What impact would this have on competition?

31. http://www.cartoonstock.com/newscartoons/cartoonists/mba/lowres/mban1698l.jpg

32. Source http://www.co2partners.com/images/c artoons/competition.jpg Stimulus 2. In practical terms how do companies outrun the competition?

33. Source: http://www.cartoonstock.com/low res/dcr0443l.jpg Stimulus 3 The expression `being one step ahead of the competition` in real term means…

34. Source: http://www.cartoonstock.com/newscartoons/cartoonists/jgr/lowres/jgrn830l.jpg Stimulus 4 What is meant by the expression `In this business it’s Dog Eat Dog?’

35. Source: http://www.fastupfront.com/pics/small-business-competition.jpg Stimulus 5 Which one of these pricing strategies do you feel is the most effective? What does the cartoon say about the existing competition?

36. Stimulus 6 Why are patents so important in highly competitive industries?

37. Stimulus 7 What do we mean by `anti-trust`? How does it relate to competition?

38. http://www.seppo.net/cartoons/albums/cartoons/global/economy/eu_vs_microsoft_04.jpg Stimulus 8 Explain the symbolism in this cartoon.

39. Source: http://www.cartoonstock.com/lowres/ssm0019l.jpg Stimulus 9. Why has Bill Gates made some lawyers very rich?

40. Stimulus 10 In the past how did Microsoft make its products incompatible with competitors? Provide examples

41. Stimulus 11 Why does absolute power corrupt absolutely in the corporate world?

42. Source http://4.bp.blogspot.com/_wgns7 r5yd8c/Sjuv_ALuu8I/AAAAAAAAH 1M/4POUXzI3b2M/s400/Dynamic +Duopoly.jpg Stimulus 12 What does this say about the relative market power in this industry? Who are the competitors to these companies? Why do they have less market share?

43. Source: http://www.stopunfaircardfees.eu/uploads///images/PaymentCard-TollPort.jpg Stimulus 13: What is the key message(s) from this cartoon?

44. Source: http://www.jaunted.com/files/6193/BransonNoBA.jpg Stimulus 14: Who is featured in this picture? What are the key issues?

45. Stimulus 15: What illegal activity may be taking place in this cartoon? Why? Would it be hard to prove? How common is this in the real business world?

46. Source: http://www.rudebarbs.com/images/antitrust.jpg Stimulus 16. Explain the message(s) from this cartoon.

47. Source: http://www.johnsonbottini.com/images/cartoon.jpg Stimulus 17 How does this cartoon relate to a previous question?

48. Source: http://tyrannybusters.org/images/home/duopoly.gif