; Imperfect Competition
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Imperfect Competition


  • pg 1
									Imperfect Competition
 Types  of imperfect competition
 Oligopoly and its characteristics
 Collusion and cartels
 Equilibrium for an oligopoly
 Game theory and the economics of
     Prisoners’ Dilemma
 Public   policy toward oligopolies
              Imperfect Competition
   Based on the number of sellers and product type

    Perfect            Imperfect Competition

           Oligopoly             Monopolistic Competition
 Oligopoly is a market structure in which only a
  few sellers offer similar or identical products
 A key feature of oligopoly is the tension
  between cooperation and self-interest
 Duopoly is a limited case of oligopoly with two
 Cooperation among oligopolists results in
 Collusion is an agreement among firms in a
  market about quantities to produce or prices to
Quantity   Price   TR= Total Profit
0          120     0
10         110     1100
20         100     2000
30         90      2700
40         80      3200
50         70      3500
60         60      3600
70         50      3500
80         40      3200
90         30      2700
100        20      2000
110        10      1100
120        0       0
 Collusion  results in a cartel
 A cartel is a group of firms acting in unison and
  the market functions like a monopoly
 However, cartels are not easy to form and
  sustain in the absence of a binding agreement
 Self-interest in the form of profit motive
  translates into cornering the larger share of the
 Where is the equilibrium for an oligopoly?
 Nash equilibrium is a situation in which economic
  actors interacting with one another each choose their
  best strategy given the strategies the others have
 Due to the presence of the Nash equilibrium
  oligopolists stop short of producing output where
 When firms in an oligopoly individually choose
  production to maximize profit, they produce a
  quantity of output greater than the level produced by
  monopoly and less than the level produced by
 At this equilibrium, the oligopoly price is less
  than the monopoly price but greater than the
  competitive price
 Impact of the number of sellers on the
  oligopoly market:
    The output effect

    The price effect

 The larger the number of sellers the smaller
  the price effect and in such an event oligopoly
  may approach a competitive market
                 Game theory
 Game    theory is a study of how people behave
  in strategic situations
 Prisoners’ dilemma is a particular game
  between two captured prisoners that illustrates
  why cooperation is difficult to maintain even
  when it is mutually beneficial
 The sentence that each prisoner receives
  depends on his/her decision (whether to
  confess or to not confess) and on the decision
  made by the other prisoner
                         Game theory
                         P.1’s Decision
         Prisoner #1 Confess                        Not Confess
P.2’s    (P.1)
Decision Prisoner #2
         Confess     P.1 and P.2 get eight          P.1 gets 20 years
                     years each                     P.2 goes free

          Not            P.1 goes free              P.1 and P.2 get
          Confess        P.2 gets 20 years          one year each

    Dominant strategy is to confess and it is the Nash equilibrium.
     Application of Prisoner's Dilemma to Oligopoly
                         Jack’s (J) Decision

Mary’s     Jack and      High production        Low production
(M)        Mary          (40L)                  (30 L)
           High          J & M get $1600        J gets $1500 profit
           production    profit each            M gets $2000 profit
           (40 L)

           Low           J gets $2000 profit    J gets $1800 profit
           production    M gets $1500 profit    M gets $1800 profit
           (30 L)

   Dominant strategy is to produce 40 L each. This equilibrium quantity
   is called the Nash equilibrium.
      The Prisoners’ Dilemma and Welfare
 Depending on the circumstances, a non-
 cooperative equilibrium could lead to loss of
     Overuse of common property resources
 However,  lack of cooperation is desirable from
  welfare point of view if the oligopolists would
  reach a monopoly outcome with cooperation
  (reduction in total surplus)
 Oligopolists can solve prisoner’s dilemma if the
  game is repeated more than once.
       Public Policy Toward Oligopolies

 Policy aims to induce firms to compete rather
  than cooperate
 Canada’s Competition Act subjects the
  following activities to criminal prosecution:
     Bid-rigging
     Price discrimination
     Resale price maintenance
     Predatory pricing
  Controversies over Competition Policy
 Resale    price maintenance
     Does not reduce competition
     One of the mechanisms to solve free-rider problem
 Predatory    pricing
     Is not a profitable business strategy
 Tying
     Is it a form of price discrimination?
     Efficiency effects of tying are ambiguous
       • The Microsoft Case
        Priosoner’s Dilemma
 http://www.miskatonic.org/pd.html
 http://www.miskatonic.org/cgi-bin/pd.cgi

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