# Imperfect Competition

Document Sample

```					Imperfect Competition

A short Intro
Peter Berck
April 2006
Marginal Revenue
• When a monopolist makes one more unit
of a good he receives MR
• And it costs her MC

• Let‘s look at MR again….
Marginal Revenue
By adding 1 unit a monopolist gains
The area is 1 wide by P high = P
P(Q)             The monopolist looses

P(Q+1)            This area is the decrease in
price, which is the slope of
demand times Q.

Q     Q+1              So MR is the sum of
the two areas
MR= P + Q (slope
demand)
MR and Competition
Let Q = nq. Competitor loses just q
times slope and gains P whilst
monopolist looses Q times slope (n
times as much) and gains P. So
P(Q)
when n is big,
MR = Q/n slope+ P
is approx P.

q    Q   Q+1
For n large

•   MR = Q/n slope+ P
•   So for large n
•   MR just collapses to P
•   And that is why in competition p=mc.
Strange Case of CA El.   Figure 2.1. Instate Supply Curve for Fossil Fueled Electricity

40

38

S
36

34
\$/MWH

32

30

28

26

24
10

20

30

40

50

60

70

80

90

10

11

12

13

14

15

16

17

18

19
0

00

00

00

00

00

00

00

00

00

00

00

00

00

00

00

00

00

00

00
0

0

0

0

0

0

0

0

0

0
Capacity (MW)
Oligopoly
• N isn‘t one and it isn‘t large
• There are ―few‖ sellers
• The ‗few‘ sellers have a large incentive (a
share of monopoly profits) to collude.
• Each individual seller also has a large
incentive to cheat on the cartel
– Gets more than his share.
– Hopefully the others won‘t find out.
Major types of Organization
•   Competition
•   Monopolistic Competition
•   Oligopoly
•   Monopoly

• (from Perloff‘s Microeconomics p 425)
Competition
•   p= mc
•   Profits = 0
•   Free entry
•   Many firms
•   Price taker (mr = p)
•   Undifferentiated product
•   Ag commodities are example
Monopolistic Competition
•   mr = mc
•   Sets price
•   Free entry and so zero profits
•   Many firms
•   Probably differentiated product
•   Firms don‘t act together!
•   Possibly many consumer goods (cereal)
and maybe services like hair stylists
Zero Profit Monopoly
• Exercise: draw the standard monopoly
diagram so that the monopoly has zero
profits.
• Verify that p > mc
• Story: as more firms enter the demand
curve is shifted inward until there are no
profits and no more firm‘s enter.
Oligopoly
•   mr = mc ; sets price
•   Hard to enter
•   Few firms
•   P > mc
•   Could be differentiated
•   Automobiles in the 1950‘s and 60‘s. Steel
at the turn of the century. OPEC,
sometimes.
Monopoly
• Just one seller; no entry
• P > mc
• For a while de beers in diamonds, owners
OPEC
• OPEC is a cartel. It is an organization
whose job is to increase price over the
competitive level.
• Sometimes they can do it.
• Sometimes they can‘t.
\$ per barrel

0
10
20
30
40
50
60
70
1949

1951

1953

1955

1957

1959

1961

1963

1965

1967

1969

1971

1973

1975
Oil Price

1977

1979

1981

1983
Oil Prices

1985

1987

1989

1991

1993

1995

1997

1999

2001

2003

1In
The oil diagram explained
• In the aftermath of the Arab-Israel Yom
Kippur War in 1973, OPEC attempted an
embargo on oil sales to the US and other
supporters of Israel. At the same time,
Saudia Arabia cut its production by 35%.
The Saudi reduction in output is what is
responsible for the 1973 price increase.
Now to 1978
• In 1978 OPEC again began production controls
which were aided by the turmoil in Iran and the
Iran-Iraq war. Both Iran and Iraq were major oil
producers. Prices increased until 1981 when
they peaked at \$31.77 a barrel.
• During this period there was an increase in
output by non OPEC nations and a slow but
steady decrease in quantity demanded. Prices
then slid all the way to \$12.51 in 1986.
Three Problems
• Countries start to buy less oil. For
instance, Sweden has shifted out of oil for
heating.
• New oil is found and produced.
• Members of the cartel cheat—sell more
than they pledged to sell.
More recent history
• With the first Gulf war and the end of sales
by Iraq and Kuwait prices again increased
and subsided to \$10.87.
• From there prices have increased to close
to \$60 per barrel.
• The 2005 price spike is believed to be
from an increase in demand from India
and China.
Airlines
• Again source is Perloff, this time from a
study by Brander and Zhang.
• Quantity setting game. Two airlines that
share a city pair.
• Since two, called duopoly.
• Decide how many seats to make available
• Seats are thousand per quarter and profits
are in millions of \$
Quantity Game
qAm = 64    qAM = 48
qU = 64 4.1         5.1
4.1         3.8
qU = 48 3.8         4.6
5.1         4.6
Not the Outcome the Airlines Want
• They could collude. Many allegations that
they do exactly that.
Reduced commissions
• For instance, all the airlines together
reduced the commissions to travel agents
– ? Collusion
• Lets do lunch and screw the customer
– ? Competition
• Too many travel agents (was true)
– ? Conscious parallelism plus
• E.g. one signaled that they were going to do it and
let the rest prepare.
Current case
• EU alleges that airlines have fixed cargo
rates over the Atlantic.
– Is p > mc?
– Are there few airlines
– Is entry difficult?
– Do they have a tape recording of the lunch…
• (smoking gun.)
Can you detect cheating
• How would american know united had sold
a lot of extra seats?
– Could they distinguish it from a change in