1. Imperfect Competition

2. Monopolistic Competition

3. Monopolistic competition Assumptions of monopolistic competition  many or several firms  free entry  differentiated product Equilibrium of the firm  short run  MR = MC

4. £ Q O QsQs AR  D MC AC MR PsPs AC s Short-run equilibrium of the firm under monopolistic competition

5. Monopolistic competition Assumptions of monopolistic competition  many or several firms  free entry  differentiated product Equilibrium of the firm  short run  MR = MC  long run  MR = MC; AR = AC

6. AR L  D L MR L £ Q O QLQL PLPL LRAC LRMC New firms entering the industry reduce demand for each individual firm. Price falls to P L Long-run equilibrium of the firm under monopolistic competition

7. Monopolistic competition Assumptions of monopolistic competition  many or several firms  free entry  differentiated product Equilibrium of the firm  short run  MR = MC  long run  MR = MC; AR = AC  under-utilisation of capacity in long run

8. £ Q O LRAC D L under monopolistic competition Q1Q1 Q2Q2 Under-utilisation of capacity in the long run

9. Monopolistic competition Limitations of the model  imperfect information  difficulty in identifying industry demand curve  entry may not be totally free  indivisibilities  importance of non-price competition The public interest  comparison with perfect competition

10. Q2Q2 P2P2 D L under perfect competition £ Q O P1P1 LRAC D L under monopolistic competition Q1Q1 Higher price and lower output (excess capacity) under monopolistic competition Long run equilibrium of the firm under perfect and monopolistic competition

11. Monopolistic competition Limitations of the model  imperfect information  difficulty in identifying industry demand curve  entry may not be totally free  indivisibilities  importance of non-price competition The public interest  comparison with perfect competition  comparison with monopoly

12. Imperfect Competition Oligopoly

13. Key features of oligopoly  barriers to entry  interdependence of firms  incentives to compete or to collude? Factors favouring collusion  few firms, open with each other  similar production methods; similar products  significant entry barriers  stable market  collusion is legal

14. Oligopoly Collusive oligopoly: cartels  equilibrium of the industry

15. £ Q O Industry D  AR Profit-maximising cartel

16. £ Q O Industry D  AR Industry MC Industry MR Q1Q1 P1P1 Industry profit maximised at Q 1 and P 1. Members must agree to restrict total output to Q 1. Profit-maximising cartel

17. Oligopoly Collusive oligopoly: cartels  equilibrium of the industry  allocating and enforcing quotas

18. Oil prices Cease-fire in Iran-Iraq war Yom Kippur War: Arab oil embargo Revolution in Iran Iraq invades Iran Recession in Far East Iraq invades Kuwait New OPEC quotas Worldwide recovery Worldwide slowdown Invasion of Iraq OPEC’s first quotas Continuing worries about supply and rapid growth in demand from China and India Banking turmoil and onset of recession Start of global recovery First oil from North Sea Recovery falters

19. Oil prices Cease-fire in Iran-Iraq war Yom Kippur War: Arab oil embargo Revolution in Iran Iraq invades Iran Recession in Far East Iraq invades Kuwait New OPEC quotas Worldwide recovery Worldwide slowdown Invasion of Iraq OPEC’s first quotas Continuing worries about supply and rapid growth in demand from China and India Banking turmoil and onset of recession Start of global recovery First oil from North Sea Recovery falters

20. Oligopoly Tacit collusion  price leadership  dominant firm

21. D market £ Q O S all other firms P1P1 P2P2 a b Division of the market between leader and followers D leader Leader’s demand curve = market demand minus followers’ supply Dominant firm price leadership

22. £ Q O S all other firms D market D leader PLPL MR leader MC leader QLQL QFQF QTQT f t Determination of price and output l Leader maximises profit at Q L, P L. At P L, followers supply Q F. Dominant firm price leadership

23. £ Q O MR leader AR  D leader AR  D market Assume constant market share for leader Price leader aiming to maximise profits for a given market share

24. £ Q O AR  D market MC MR leader PLPL QTQT AR  D leader QLQL l t Leader maximises profit at Q L and thus sets price of P L. Price leader aiming to maximise profits for a given market share

25. Oligopoly Tacit collusion  price leadership  dominant firm  barometric  rules of thumb Collusion and the law  the role of the Competition Commission in the UK The breakdown of collusion

26. 2 4 6 10 12 1000 MC AR MR £ Q The Industry 2000 3000 £10 is the cartel’s profit-maximising price. 8 The incentive for a firm to produce more than its quota, or undercut the cartel’s price

27. 2 4 6 8 10 12 200 400 600 MC AR MR £ Q Firm A 800 Cartel Price (= MR if price remains fixed) Firm is tempted to increase output to 600. The incentive for a firm to produce more than its quota, or undercut the cartel’s price

28. Oligopoly Non-collusive oligopoly: assumptions about rivals’ behaviour The Cournot model of duopoly  assumption that rival will produce a given quantity

29. O £ Quantity DMDM (a) Firm A’s profit-maximising position MC A D A1 Q B1 Firm A believes that firm B will produce Q B1. The Cournot model of duopoly

30. O £ Quantity MC A DMDM (a) Firm A’s profit-maximising position D A1 MR A1 Q A1 Q B1 Firm A’s profit- maximising output and price are Q A1 and P A. P A1 The Cournot model of duopoly

31. Oligopoly Non-collusive oligopoly: assumptions about rivals’ behaviour The Cournot model of duopoly  assumption that rival will produce a given quantity  profit-maximising price and output for firm A  reaction functions of firms A and B

32. O O £ Firm B’s output Quantity P A1 MC A DMDM (a) Firm A’s profit-maximising position (b) The two firms’ reaction functions D A1 MR A1 Q A1 Q B1 RARA Firm A’s output Q A1 x Firm A’s reaction function for each assumed output of B Q B1 RBRB Firm B’s reaction function for each assumed output of A The Cournot model of duopoly

33. Oligopoly Non-collusive oligopoly: assumptions about rivals’ behaviour The Cournot model of duopoly  assumption that rival will produce a given quantity  profit-maximising price and output for firm A  reaction functions of firms A and B  Cournot equilibrium

34. O O £ Firm B’s output Quantity MC A DMDM (a) Firm A’s profit-maximising position (b) The two firms’ reaction functions D A1 MR A1 Q A1 Q B1 RARA RBRB Firm A’s output Q A1 Q B1 Q Be Q Ae x e P A1 Equilibrium at point e, where the two reaction functions cross The Cournot model of duopoly

35. Oligopoly Non-collusive oligopoly: assumptions about rivals’ behaviour (cont.) The Bertrand model of duopoly  assumption that rival sets a particular price  equilibrium: price cutting until all supernormal profits are competed away Nash Equilibrium in the Cournot and Bertrand models

36. Oligopoly Non-collusive oligopoly: assumptions about rivals’ behaviour (cont.) The kinked demand curve theory  assumptions of the model  the shape of the demand and MR curves

37. £ Q O P1P1 Q1Q1 Current price and quantity give one point on demand curve. Kinked demand for a firm under oligopoly

38. £ Q O P1P1 Q1Q1 D D Assumption 1 If the firm raises its price, rivals will not Assumption 2 If the firm reduces its price, rivals will feel forced to lower theirs too. Kinked demand for a firm under oligopoly

39. £ Q O P1P1 Q1Q1 MR a b D  AR MR is discontinuous between a and b. Stable price under conditions of a kinked demand curve

40. Oligopoly Non-collusive oligopoly: assumptions about rivals’ behaviour (cont.) The kinked demand curve theory  assumptions of the model  the shape of the demand and MR curves  effect of a change in costs

41. £ Q O P1P1 Q1Q1 MC 2 MC 1 MR a b D  AR If MC is anywhere between MC 1 and MC 2, profit is maximised at Q 1. Stable price under conditions of a kinked demand curve

42. Oligopoly Non-collusive oligopoly: assumptions about rivals’ behaviour (cont.) The kinked demand curve theory  assumptions of the model  the shape of the demand and MR curves  effect of a change in costs  stable prices  limitations of the model

43. Oligopoly Oligopoly and the public interest  advantages  disadvantages  difficulties in drawing general conclusions Advertising and the public interest Oligopoly and contestable markets

44. Imperfect Competition Game Theory

45. Single move or normal-form games  alternative strategies: maximax and maximin  single dominant strategy games

46. £2.00£1.80 £2.00 £1.80 X’s price Y’s price A B C D £10m each £8m each £12m for Y £5m for X £5m for Y £12m for X Profits for firms A and B at different prices

47. Game theory Single move or normal-form games  alternative strategies: maximax and maximin  single dominant strategy games  the prisoners’ dilemma

48. Not confessConfess Not confess Confess Amanda's alternatives Nigel's alternatives A B C D Each gets 1 year Each gets 3 years Nigel gets 3 months Amanda gets 10 years Nigel gets 10 years Amanda gets 3 months The prisoners’ dilemma

49. Game Theory Single move or normal-form games  alternative strategies: maximax and maximin  single dominant strategy games  the prisoners’ dilemma  Nash equilibrium  non-dominant strategy games

50. Profit possibilities for firm X

54. Game theory Multiple move games  the importance of threats and promises  credible threats  the importance of timing  decision trees

55. Boeing decides 500 seater 400 seater A decision tree Boeing –£10m Airbus –£10m (1) Boeing +£30m Airbus +£50m (2) Boeing +£50m Airbus +£30m (3) Boeing –£10m Airbus –£10m (4) Airbus decides B2B2 Airbus decides B1B1 A

56. Game Theory Multiple move games  the importance of threats and promises  credible threats  the importance of timing  decision trees  first-mover advantage

57. Game Theory Limitations of game theory  complex games with multiple players  the role of individuals’ morals and attitudes Potential for cycles of collusion and competition

58. Imperfect Competition Price Discrimination

59. Price discrimination Meaning of price discrimination  different prices for same product produced at same cost Types of price discrimination  first degree

60. O P1P1 D 200 P Q First-degree price discrimination

61. O P1P1 D 200 P Q Additional revenue from price discrimination First-degree price discrimination

62. Price discrimination Meaning of price discrimination  different prices for same product produced at same cost Types of price discrimination  first degree  second degree  third degree

63. P Q O P1P1 D 200 Third-degree price discrimination

64. O P1P1 D P2P2 150200 P Q Additional revenue from price discrimination Third-degree price discrimination

65. Price discrimination Conditions necessary for third degree price discrimination to operate  two or more separable markets, each with different elasticities of demand  monopoly power  no (or limited) opportunity to resell the product

66. Price discrimination Profit-maximising prices and output under price discrimination  first degree

67. D = MR MC £ Q O Q1Q1 Profit-maximising output under first-degree price discrimination

68. Price discrimination Profit-maximising prices and output under price discrimination  first degree  third degree

69. OOO MR X MR Y MR T MC DYDY 5 7 2000 3000 (a) Market X (b) Market Y (c) Total (markets X + Y) 1000 9 DXDX Maximum-profit output Profit-maximising output under third degree price discrimination

70. Price discrimination Profit-maximising prices and output under price discrimination  first degree  third degree Advantages to the firm Price discrimination and the public interest  advantages  disadvantages