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Chapter 8

Imperfect competition
Sources of market imperfection
Monopoly
Price Determination Under Monopoly
Monopolistic competition
Price Determination under Monopolistic
Competition
Oligopoly
Price Determination under Oligopoly
Imperfect Competition
Is a market situation in which firms
recognize that their output decisions
affect market price.

Monopoly
A situation in which there is only one
seller in a market, who thus faces
the entire market demand curve for
the product.
Monopolist
Thus faces the entire market demand
curve for its output.

Monopoly Power
Power of a firm to affect price by its
output decisions. If the firm restricts
output, market price rise. If it
increase output, price falls.
Sources of Monopoly
Natural Monopoly
is a monopoly that arises naturally as a result
of technological conditions. In such case, the
market can support only one producer.
Legislated Monopoly
Created by the government legislation that
govern patents, licensing, or franchising
provisions, or regulations under which only one
firm is allowed to produce and market a
commodity in a specific regional and product
market.
Monopolistic Competition
Monopolistic competition is a market
structure in which there are many
firms selling differentiated products.
There are few barriers to entry.
Characteristics of Monopolistic
Competition
Four distinguishing
characteristics:
1. Many sellers that do not take into account rivals
reactions
2. Product differentiation where the goods that are
sold arent homogenous
3. *Multiple dimensions of competition make it harder
to analyze a specific industry, but these methods of
competition follow the same two decision rules as
price competition
4. Ease of entry of new firms in the long run because
there are no significant barriers to entry

16-6
Output, Price, and Profit of a
Monopolistic Competitor
A monopolistically competitive firm
prices in the same manner as a
monopolistwhere MC = MR.
But the monopolistic competitor is
not only a monopolist but a
competitor as well.
Output, Price, and Profit of a
Monopolistic Competitor
At equilibrium, ATC equals price and
economic profits are zero.

This occurs at the point of


tangency of the ATC and demand
curve at the output chosen by the
firm.
Monopolistic Competition

Price
MC

ATC
PM

MR D
0 QM Quantity
Oligopoly
Oligopoly is a market structure where
there are a small number of mutually
interdependent firms.
Each firm must take into account the
expected reaction of other firms to
its profit maximizing output decision.
Oligopoly
An oligopoly is a market structure
characterized by:
1. Few firms
2. Either standardized or
differentiated products
3. Difficult entry
Models of Oligopoly
Behavior

1. In the cartel model, the firms in the


industry (oligopolies) collude to set
a monopoly price.

2. In the contestable market model, an


oligopolistic firm with no barriers to
entry sets a competitive price.
Price determined under
Oligopoly
1. Interdependent Pricing
2. Price Wars
3. Price Leadership
4. Formal Agreement: Cartel
1. Interdependent Pricing
Each firm in an oligopolistic industry
keeps a close eye on the activities of
other firms in the industry. Because
oligopolistic firms engage in
competition among the few,
decisions made by one firm
invariably affect others.
2. Price Wars
Some economists assume that an oligopolistic
is able to predict the counter moves of his
rivals, and they provide a determinant
solution to the price and output problem
The objective of price wars:
1. To seize the major part of the total sales
2. To expand the monopoly power after
victory
3. To threaten the rivals so that they accept
its leadership
3. Price Leadership
Another approach is that the firms in
an oligopoly would accept one firm
as a leader and would follow him in
setting prices. Such a leader firm
may be dominant or low-cost firm
producing a very large proportion of
the total production and having a
great influence over the market
4. Formal Agreement: Cartel
A group of firms that collude to limit
competition in a market by
negotiating and accepting agreed
upon price and market shares.