Market Equilibrium and Market Demand: Imperfect Competition Chapter 9
Market Structure Characteristics We characterize an industry by üThe number of firms and their size distribution üProduct differentiation üBarriers to entry üThe picture to the right concerned with two markets: 2 Ø No. 2 yellow corn: many producers/sellers (Perfect Competition) Ø Farm equipment: few manufacturers/sellers (Oligopoly) Pages 145 -148
Perfect Competition üUp to now we have been assuming the firm and market reflect conditions of perfect competition Ø Not a bad assumption for many agricultural subsectors üA large number of small firms: 2 million farms üA homogeneous product: No. 2 yellow corn üFreely mobile resources: No barriers to entry caused by patents, etc. or barriers to exit (? ? ? ) üPerfect knowledge of market conditions: Quality outlook information from government, university and private sources 3
Imperfect Competition üMany markets in which farmers buy inputs and sell their products however do not reflect perfect competition conditions üChapter 9 focuses on specific types of imperfect competitors in the farm input market ØThese firms are capable of setting prices farmers must pay for specific inputs 4
Imperfect Competition in Selling 5
Topics for Nov rd 3 ü Monopolistic Competition Ø Definition Ø Production and Pricing Decisions ü Oligopolies Ø Definition/Examples Ø Production and Pricing Decisions ü Monopolies Ø Definition/Examples Ø Production and Pricing Decisions ü Comparison of Market Structures 6 Pages 106 -107
Imperfect Competition in Selling üUnlike perfect competitors who face a perfectly elastic (horizontal) demand curve ØImperfect competitors selling a differentiated product have a downward sloping demand curve $ Firm’s demand curve under P. C. A 7 $ A Firm’s demand curve under imperfect competition B Q
Price Table 9 -1 Imperfect Quantity Total Rev. Avg. Revenue Marginal Revenue Competition 15 0 ----- 14 2 28 14 14 13 4 52 13 12 12 6 2 72 20 12 10 11 8 88 11 8 10 10 10 6 9 12 108 9 4 8 14 112 8 2 7 16 112 7 0 6 18 108 6 -2 5 20 100 5 -4 4 22 88 4 -6 3 24 72 3 -8 2 26 52 2 -10 1 28 28 1 -12 0 8 0 30 0 ----- -14 Firm faces a downward sloping demand curve → MR ≤ AR Marginal Revenue (MR) : Change in revenue from the sale of the last unit of output (ΔTR÷ΔQ) Average Revenue (AR): Total Revenue/Total output (TR÷Q) Note: Price = Average Revenue Page 149
Imperfect Competition in Selling Marginal Revenue: Change in revenue from the sale of the last unit of output 9 Page 150
Imperfect Competition in Selling Maximum Total Revenue ü Marginal revenue in this instance is also downward sloping ü MR=0 at the point where TR is at a maximum 10 Page 150
Types of Imperfect Competitors in Input Markets ü Monopolistic Competition ü Oligopoly ü Monopoly Let’s start here… 11
Monopolistic Competitors üMany sellers Ø Each firm has relatively small market share Ø Power to set prices somewhat like a monopoly Ø Face competition like perfect competition Ø Collusion is not possible given number of firms in the industry üNo barriers to entry or exit 12 Page 148 -151
Monopolistic Competitors üProduct Differentiation: Each firm makes a product that is slightly different from the products of competing firms Ø Close substitutes but no perfect substitutes Ø An attempt to ↑ price will normally results in a ↓ in volume sold üCompetition on Quality, Price, Marketing 13 Ø Quality is design, reliability, service provided to buyer and ease of access to product Ø The firm faces a downward sloping demand curve Ø Firm must market intensively: promotions, distribution, packaging, etc. Page 148 -151
Monopolistic Competitors üProduct differentiation does not necessarily mean there any physical differences among products Ø They might all be the same, but how they are sold may make all the difference 14 Page 148 -151
Monopolistic Competitors üThe monopolistic competitor tries to set his/her product apart from the competition Ø Main method is via advertising Ø When this is done successfully, the demand curve becomes more vertical or inelastic § Buyers are willing to pay more because they believe it is much better than their other choices üBasis for product differentiation Ø Physical differences Ø Ambience Ø Appeals to vanity 15 Convenience Reputations Snob appea Page 148 -151
Monopolistic Competitors üTypical Monopolistic Competitor ØTries to set firm apart from competition § New Product Development and Innovation § Advertising o Create consumer perception of product differentiation – real or imagined o Attempt to keep demand as inelastic as possible ØSelling costs can be extremely high 16 Page 148 -151
Monopolistic Competitors üShort run profits can exist but long run profits are reduced to 0 with industry entrants üFast food industry is a good example Ø All services basically the same ØExtensive use of marketing to differentiate products/services across firms Ø Striving to produce more products and services 17 Page 148 -151
Monopolistic Competitors üProduction Decision: ØDetermine output level where MC=MR (Why does this make sense? ) üPricing Decision: ØDetermine where above quantity intersects the downward sloping demand curve 18 Page 148 -151
Monopolistic Competition Short run profits exist if: PSR > ATCSR at QSR Short run profits üThe firm produces QSR where MR=MC at E üPrices its products at PSR by reading off the demand 19 curve at quantity QSR Ø Represents consumer’s willingness to pay for QSR Page 150
Monopolistic Competition Short run loss ü At QSR, PSR 20 < ATCSR Page 150
üIn the Long Run (LR) PLR = ATCLR Ø Profits are bid away as more firms enter the market Ø Losses will no longer exist as firms leave the market üAt QLR the remaining firms are just breaking even Monopolistic Competition 21 Page 151
Monopolistic Competitors üHow much is the industry dominated or not dominated by few suppliers ØGeographical scope – national, regional, global § An industry can be almost perfectly competitive on a national scope, but almost a monopoly locally e. g. Feed Retailing ØBarriers to entry and exit: industries may appear concentrated but few barriers exist to prevent entry 22 Page 148 -151
Monopolistic Competitors üQuantitative measures of competition ØConcentration Ratio (CR): 2, 4, 8, 20, etc § % of the value of total market revenue accounted for by 2, 4, 8, 20, etc. largest firms in the industry § Low CR values→ a high degree of competition § High CR values → an absence of competition 23 Page 148 -151
Monopolistic Competitors üQuantitative measures of competition ØHerfindahl-Hirschman Index (HHI): The square of the % market share of each firm summed over the largest 50 firms in an industry or all firms if < 50 in industry § Perfect competition, HHI is small § Only 1 firm, HHI is 10, 000 = (1002) § U. S. Justice Department o HHI < 1, 000 competitive markets o HHI > 1, 800 could be considered concentrated industry worthy of Justice Dept. examination of any purchases 24 Page 148 -151
Oligopolies üA few number of sellers Ø Each can impact market price & quantities üInterdependent in their decision making Ø Key component in marketing strategies and pricing behavior Ø Match price cuts but not price increases by fellow oligopolists § Do this to maintain market share üNon-price competition between oligopolists to uniquely identify products 25 Pages 152 -155
Oligopolies üRival oligopolists will match price cuts but not price increases in the short run because they want to capture a larger market share üIf there are differences in prices they are the result of successful product differentiation üTend to have stable prices Ø Changes in production and other costs not easily passed on and may have to be absorbed 26 Pages 152 -155
Oligopolies üPrice leadership strategy Ø A particular firm dominates the market § Controls the largest share of the market § Other industry firms more efficient in operation, marketing, etc. Ø The dominant firm first sets its price to maximize profit Ø Remaining firms set their prices based on the dominant firms pricing Ø The price set by the oligopolist seller is higher under perfect competition 27 Ø Quantity produced is lower then perfect comp. Pages 152 -155
Oligopolies üThe dominant firm may be efficient enough to set a lower price Ø Eventually drive the other firms out of the market 28 Pages 152 -155
Oligopolies üExamples of Oligopolies Ø Auto manufacturers § 1997 CR 4 value of 97. 4 Ø Aircraft manufacturing Ø Farm machinery and equipment § John Deere, J. I. Case and New Holland § 80% of 2 -wheel drive tractors § close to 90% of combines sold in the U. S. Ø Cattle slaughtering § CR 4 value increased from 39% to 67% over the 1985 -1995 period 29 Pages 152 -155
ü Demand curve DD Ø All oligopolists move prices together and share market 6 ü Demand curve dd Ø A single firm changes its price Ø Curve DD is more inelastic Ø Below point 1, firms match price cut Ø This leads to a kinked demand curve d 1 D Ø Leads to a discontinuous marginal revenue curve, d 256 Remember oligopolists account for the reaction of other firms so there is no single demand curve 30 Page 154
üMeeting demand along the lower segment of the kinked demand curve → the firm is maintaining its market share 31 Page 154
üShifting MC curves reflecting technological advances will not affect PE and QE üIt does impact profits as MC drops from pt 3 to pt 4 32 Page 154
Monopolies ü One seller in the market ü Entry of other firms restricted by patents, etc. (i. e. , barrier to entry) ü Firm has absolute power over setting market price ü Produces a unique product ü It can have economic profits in the long run because it can set price without competition 33 Page 155 -156
Monopolies $/unit ü Total revenue = area MC ATC AVC C PE B M A 0 PECQE Ø Monopolist produces quantity where MC=MR (pt A), QE Ø Uses the demand curve (pt C) when setting price PE N Demand= AR TVC MR Quantity 0 34 QE Page 155 -156
Monopolies $/unit MC A N Demand= AR TVC MR Quantity 0 35 for the monopolist is equal to area 0 NAQE, (green box) Ø=AVC x QE = 0 N x QE B M AVC üTotal variable costs C PE ATC QE Page 155 -156
Monopolies $/unit MC AVC C PE ü Total fixed costs equals B M NMBA (orange box) Ø=(ATC-AVC) x QE TFC N ATC A Demand= AR MR Quantity 0 36 QE Page 155 -156
Monopolies $/unit MC 0 MBQE (green box + orange box) Ø = area ONAQE + area NMBA B M TFC N A Demand= AR TVC MR Quantity 0 37 AVC ü Total cost is area C PE ATC QE Page 155 -156
Monopolies $/unit Economic Profit MC C PE area MPECB Ø = Total Revenue (yellow box) – Total Costs (green box + orange box) TFC A N Demand= AR TVC MR Quantity 0 38 AVC ü Monopoly economic profit = B M ATC QE Page 155 -156
Monopolies $/unit MC AVC C PE Economic M Profit ü Total fixed costs equals B NMBA (orange box) Ø=(ATC-AVC) x QE TFC A N Demand= AR TVC MR Quantity 0 39 ATC QE Page 155 -156
Comparison of Structure Results üLets compare the results we have obtained from the alternative market structures 40
Perfect Competition Case Consumer surplus = sum of areas 1, 4, 5, 8 and 9 (blue triangle) 41 Page 157
Perfect Competition Case üProducer surplus = to the sum of areas 2, 3, 6 and 7 (green triangle) Page 157 42
Perfect Competition Case üTotal economic surplus = sum of blue and green triangles Ø=sum of areas 1 – 9 Page 157 43
üCS = sum of areas 8 and Monopoly Case 9, (new blue triangle) üCompared to P. C. , consumers would be economically worse-off by areas 1, 4 and 5 ØPaying a higher price, PM ØPurchasing a smaller quantity, QM 44 Page 157
üPS = to sum of Monopoly Case areas 3, 4, 5, 6 and 7 (green area) üCompared to P. C. producers lose area 2 but gain areas 4 + 5 ØEconomically better-off than P. C. 45 Page 157
üSociety as a whole would Monopoly Case 46 be economically worseoff by areas 1+2 Ø Known as the dead weight loss Ø Reflects the fact that less of available resources in this market are used to provide products to consumers Page 157
Summary of Imperfect Competitors from a Selling Perspective 47 Page 157
Imperfect Competition From the Buying Perspective 48
Types of Imperfect Competitors on the Buying Side ü Monopsonistic competition ü Oligopsony ü Monopsony Let’s start here… 49
Monopsonies ü Single buyer in the input market ü Focus is on the marginal input cost of purchasing an addition unit of resources ü Will purchase input until Marginal Value Product (MVP)=Marginal Input Cost (MIC) ØAs long as MVP>MIC, the monopsonist makes a profit 50 Page 158 -160
Monopsonies ü Under perfect competition, the firm views the input supply curve as a horizontal line ØFirm can purchase as much as desired as the going price ØFirm’s purchase does not impact inputs cost ü Monopsonist is the only input buyer Ø→Faces an upward sloping input supply curve ØBuying decisions impact input prices 51 Page 158 -160
Monopsonies ü Monopsonist must consider the marginal input cost (MIC) when purchasing inputs ØMIC defined as the change in the cost of an input as more of the input is used ØLets look at a simple example ü Monopsonist must pay higher prices per unit if he/she wants to purchase greater amounts of the input Ø→MIC curve is above the input supply curve 52 Page 158 -160
Marginal Input Cost Units of Variable Input 1 2 3 4 5 6 Total Input Cost 3. 00 7. 00 12. 00 18. 00 25. 00 33. 00 7 8 9 10 53 Price/Unit ($) 3. 00 3. 50 4. 00 4. 50 5. 00 5. 50 6. 00 6. 50 7. 00 7. 5 42. 00 52. 00 63. 00 75. 00 Marginal Input Cost ----4. 00 5. 00 6. 00 7. 00 8. 00 9. 00 10. 00 11. 00 12. 00 Page 158 -160
Marginal Input Cost 12 11 10 9 $/Unit 8 Input Supply Curve 7 6 5 4 3 Data obtained from previous table 2 1 1 54 2 3 4 5 6 7 8 9 10 Quantity/unit of time Page 158 -160
Monopsonies ü Profit maximizing monopsonist 55 ØUse variable input to the point where Marginal Input Cost (MIC) =Marginal Revenue Product (MRP) ØMRP = addition to total revenue attributed to the addition of one unit of variable input = Marginal revenue x MPP ØSo long as MRP>MIC, profits will increase with increased input use ØIf MRP<MIC, profits will ↑ by reducing the amount of input used (Why? ) Page 158 -160
Buying Decisions by Perfect Competitors ü MRP = MVP under perfect competition Ø MVP=PPC x MPP 56 Page 160
üMonopsonist makes Buying Decisions by a Monopsonist decisions along MRP curve ØDiffers from MVP ØMRP=MIC at A ØPurchase QM inputs 57 Page 160
üResource use Buying Decisions by a Monopsonist 58 Ø Higher Price paid under P. C. , PPC Ø Utilization higher under P. C. , QPC Ø Price difference referred to as monopsonistic exploitation (i. e. , PPC – PM) Page 160
Imperfect Competition on Both Sides Product Selling Input Purchasing Perspective Perfect Competition Monopolistic Monopsonistic Competition Oligopoly Oligopsony Monopoly Monopsony üCan have any combination of the above for a particular firm 59 Ø Lets look at profit maximization under specific cases Page 160
ü Case #1: Monopsonist in input purchasing and Monopolist seller of product Ø Equilibrium: MRP=MIC at Point A. Ø Pricing off input supply curve gives QMM and PMM 60 Page 161
üCase #2: Perfect Competition in input purchasing and Monopoly seller Ø Equilibrium is where MRP=Supply at C Ø No Marginal Input. Cost curve → QPCM and PPCM 61 Page 161
üCase #3: Monopsony in input purchasing and Perfectly Competitive seller üEquilibrium: MVP=MIC at Point E üPricing off supply curve → QMPC and PMPC 62 Page 161
üCase #4: Perfect Competition in both input purchasing and product sales ØEquilibrium: MVP=Supply at Point F Ø→ QPC and PPC 63 Page 161
Monopsonistic Competitors üMany firms buying resources üAbility to differentiate services to producers üDifferentiated services includes distribution convenience and location of facilities, willingness to provide credit or technical assistance üP and Q determined same as monopsonist 64 Page 161
Oligopsonies üA few number of buyers of a resource üProfit earned will depend on elasticity of supply for resource (less elastic than monopsonistic competition) üEach oligopsonist knows fellow oligopsonists will respond to changes in price or quantity it might initiate üP and Q determined same as monopsonist 65 Page 161
Various segments of the livestock industry Exhibit several forms of imperfect competition. 66 Page 162
Governmental Regulation üVarious approaches have been used to counteract adverse effects of imperfect competition in the marketplace Ø Legislative acts passed by Congress, including the Sherman Antitrust and Clayton Acts Ø Price ceilings Ø Lump-sum Tax Ø Minimum price or floors 67 Page 162
Legislative Acts üSherman Antitrust Act of 1890 Ø Prohibited monopoly and other restrictive business practices üPackers and Stockyards Act of 1921 Ø Reinforced Anit-trust laws regarding livestock marketing üCapper-Volstead Act of 1922 Ø Exempted cooperatives from anti-trust laws üRobinson-Patman Act Ø Prohibited price discrimination practices üAgricultural Marketing Agreement Act üEstablished agricultural marketing orders 68 Page 163
Impacts of Price Ceilings üRegulatory agencies such as the Federal Trade Commission can impact monopoly effects by instituting a maximum (ceiling) price Ø FTC charged with investigating business organizations and practices and carrying out anti-trust provisions üHow can we model the impact of price ceilings? 69 Page 163
Impacts of Price Ceilings Implications of a Price Ceiling üWithout regulatory involvement the monopolist will A′ 70 D ØEquate MR and MC (point C) ØProduce QM and charge price PM ØEarn a profit of A′PMBD Page 164
Impacts of Price Ceilings Implications of a Price Ceiling üWith gov’t imposed price ceiling, PMAX A′ 71 D Ø The demand curve is given by PMAXED Ø MR is PMAXEFG Ø Mono. produces more (Q 1>QM) at a lower price (PMAX < P M) Page 164
Impacts of Price Ceilings Implications of a Price Ceiling A′ 72 Monopolist’s profit falls to area IPMAXEH (turquoise box) Page 164
Impacts of a Lump Sum Tax üA regulatory agencies can impact the level of monopoly profits by assessing a lump-sum tax Ø May be a license fee or one-time charge Ø Corresponds to a fixed tax regardless of output level üHow can we model the impact of a lump sum tax? 73 Page 165
Impacts of A Lump Sum Tax Implications of Lump-Sum Tax üThe monopolist equates MC=MR (pt. F) ØProduces QM ØCharges PM ØProfit of APMBC Page 165 74
Impacts of A Lump Sum Tax Implications of Lump-Sum Tax üLump-sum tax Ø↑ firm’s ATC from ATC 1 to ATC 2 Ø↓ producer surplus from APMBC to EPMBT ØDoes not change output level or price 75 The loss in producer surplus is area AETC (blue box) Page 165
Impacts of a Minimum Price üIn a monopsony, the gov’t could regulate the price of a resource by imposing a minimum price that must be paid for that resource Ø Good example is the various minimum wage laws üHow can we model the impact of a minimum price policy? 76 Page 165
Impacts of a Minimum Price Implications of a Minimum Price üNo minimum price üMonopsonist determines where MRP=MIC üEmploy QM input units üPays $PM/unit 77 Page 166
Impacts of a Minimum Price Implications of a Minimum Price üMinimum price, PF, imposed Ø Monopsonist’s MIC curve would be PFDCB Ø The firm would use more input 78 Page 166
Summary üUnlike perfect competition, imperfect competitors have ability to influence price üMonopolistic competitors try to differentiate their product üMonopolists are the only seller in their product market. Monopsonists are the only buyer üOligopolies are a few number of sellers while oligopsonies are a few number of buyers. üWhat are the economic welfare implications of imperfect competition? 79
Chapter 10 focuses on resource use in agriculture and the environment 80
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