1. Slides by Alex Stojanovic
ECONOMICS
ELEVENTH EDITION
LIPSEY &
CHRYSTAL
Chapter 9
IMPERFECT
COMPETITION
Slides by
Alex Stojanovic

2. Learning Outcomes
Concentration of production varies between industries, but firms in all intermediate industry types have some power to influence price
In industries where there are many producers but of different products, free entry will tend to eliminate profits in the long run
Where there is a small group of dominant producers (oligopoly), strategic interaction is important because the market form of one is affected by what its rivals do
Insights into the choices available and the nature of outcomes can be achieved using game theory
Oligopoly can be associated with pure profits in the long run if there are barriers to entry

3. [i] Equilibrium of a Typical Firm in Monopolistic CompetitionMC
£ per unit
ATC Es ps D MR qs
Output
[I]. Short-run equilibrium

4. (i) Short run equilibrium for a firm in monopolistic competition
A typical monopolistically competitive firm is shown in short-run equilibrium is at point ES.
Output is qs, where MC = MR, price is ps.
Profits are the blue area.

5. [ii] Equilibrium of a Typical Firm in Monopolistic CompetitionMC
£ per unit
ATC EL pL pc D MR qL qc
Output
[ii]. Long-run equilibrium

6. (ii) Long run equilibrium of a firm in monopolistic competition
Here the firm is in long-run equilibrium at point EL.
Entry of new firms has pushed the existing firm’s demand curve to the left until the curve is tangent to the firm’s ATC curve at output qL.
Price is pL, and total costs are just being covered.
Excess capacity is qC-qL.
If the firm did produce at capacity, its costs would fall from pL per unit of output to pC.

7. The Oligopolist’s Dilemma: to Co-operate or to Compete
A’s output
One-half
monopoly
output
Two-thirds
monopoly
output
monopoly
One-half
output 20 20 15 22
B’s output
Two-thirds
monopoly
output 22 15 17 17

8. The Oligopolist’s Dilemma: to Co-operate or to Compete
The figure gives a payoff matrix for a two-firm duopoly game.
A’s production is indicated across the top.
Its profits (in millions of pounds) are shown in the yellow circles within each square.
B’s production is indicated down the left side.
Its profits (in millions of pounds) are shown in the green circles within each square.
For example, the top right square tells us that if B produces one-half, while A produces two-thirds, of the output that a monopolist would produce:
A’s profits will be £22 million
while B’s will be £15 million

9. The Oligopolist’s Dilemma: to Cooperate or to Compete
If A and B co-operate, each produces one-half the monopoly output, and earns profits of £20 million as shown in the upper left box.
In this co-operative solution, either firm can raise its profits by producing two-thirds of the monopoly output, provided that the other firm does not do the same.
Now let A and B behave non-cooperatively.
A reasons that whether B produces either one-half or two-thirds of the monopoly output, A’s best output is two-thirds.
B reasons similarly.
As a result, they reach the non-cooperative equilibrium.
Here each produces two-thirds of the monopoly output, and each makes less than it would if the two firms co-operated.

10. The Prisoner’s Dilemma
John’s plea
Innocent
Guilty
J light sentence
W light sentence
J no sentence
W severe sentence
Innocent
William’s
plea
J severe sentence
W no sentence
J medium sentence
W medium sentence
Guilty

11. The Prisoner’s Dilemma
Two prisoners are interrogated separately.
They are told:
if they both plead innocent, they will get a light sentence.
If one pleads innocent while the other pleads guilty, the one who claims innocence will get a heavy sentence while the other will be let off.
If both plead guilty, they will both get a medium sentence.
The pay off matrix shows these conditions.

12. The Prisoner’s Dilemma
Both prisoners reason as follows
(1) if the other pleads innocent I am better off to plead guilty and get off.
(2) if the other pleads guilty I am better off to plead guilty and get only a medium sentence.
So the optimal non-cooperative strategy for both is to plead guilty
This gives them a medium sentence rather than the light sentence that they would get if they were allowed to consult and agree that both would plead innocent.

13. CHAPTER 9: IMPERFECT COMPETITION
Imperfectly Competitive Market Structures
Firms in market structures other than perfect competition face negatively sloped demand curves and must administer their prices.
Monopolistic Competition
In the theory of large-group monopolistic competition, many firms compete to sell differentiated products.
Each may make pure profits in the short run. In the long run, freedom of entry shifts its demand curve until it is tangent to the ATC curve, leading to excess capacity and production at average costs above the minimum possible level.

14. CHAPTER 9: IMPERFECT COMPETITION
Oligopoly
Competitive behaviour among oligopolists may lead to a non-cooperative equilibrium.
It is self-policing in the sense that no one has an incentive to depart from it unilaterally.
The prisoner’s dilemma game is a case in point.
Oligopolistic profits can persist only if there are entry barriers.
Natural barriers include economies of large-scale production and large fixed costs of entering the market.
Artificial barriers include brand proliferation and high levels of advertising.

15. CHAPTER 9: IMPERFECT COMPETITION
Oligopoly as a Game
Small-group interaction can be analysed using a game theory framework, which sets out the available actions and the payoffs under various actions.
In a Nash equilibrium each firm is doing the best it can, given the choices that other firms have made.
A co-operative solution is likely to be the one that maximizes joint profits, but each firm will typically have an incentive to cheat, and explicit co-operation between firms may be proscribed by competition law.

16. CHAPTER 9: IMPERFECT COMPETITION
Dynamics of Oligopoly Industries
In qualitative terms the workings of the allocative system under oligopoly are similar [but not identical] to what they are under perfect competition.
Oligopolistic industries appear to have contributed much more to the technological changes that underlie the long-run growth of productivity than have perfectly competitive industries.