Imperfect competition

Imperfect competiton

Of the four market structures, all of them are classified as imperfect competition apart from perfect competition. The most common of these market structures are monopolistic competition and oligopoly.

Monopolistic competition

Monopolistic competition, combining aspects from both monopolies and competition, has distinct products so that they can set the price to wherever they want. However, these products are similar enough that there are substitutes that can play a similar role, hence the competition aspect. For example, various food chains sell burgers that are all different, yet they all still compete against each other. Characteristics of this market include:

1. Easy entry and exit
2. Zero economic profit in the long run due to the easy entry
3. Differentiated products
4. Inefficiency and deadweight loss
5. Marginal revenue is less than demand

The Mr and demand curves for monopolistic competition are the same as a monopoly with the Mr less than the demand curve.

Short run vs long run with monopolistic competition

Short run profit

In the short run, a firm will either produce at a profit or a loss. Thus, we can identify this example as a short-run graph because it is producing at a profit.

Short run losses

This example also shows a short run graph because the firm is producing at a loss

Long run

In the long run, firms will produce zero economic profit because the Atc intersects the demand curve and quantity. This happens because when firms are profiting, other firms will join the industry bringing the profit down and when firms are losing money, other firms will leave the sector bringing prices up.

Monopolistic competition vs perfect competition

Monopolistic competition has many similarities to perfect competition such as how they both have zero long-run economic profits. Differences between the two include how perfect competition is completely efficient while monopolistic competition is inefficient with deadweight loss. Perfect competition also has all identical products while there is variation in monopolistic competition. Perfect competition produces at the P=Mc, the socially optimal level, whereas monopolistic competition does not. Finally, producers in perfect competition have to price at the market price while monopolistic firms can set their price.

Excess capacity

Point A is the point where monopolistic competitive firms produce. However, point B, where the Mc intersects the Atc, is where the firm is producing at the lowest average cost. That is why there is deadweight loss present and why monopolistic competition markets are inefficient.

Oligopoly

Oligopoly, similar to the word oligarchy, means a small number of firms that have control over all of the supply of a product. To outcompete the competitors, individual firms may decide to lower their prices. To prevent this, these firms often make agreements called collusions to agree on what price and quantity to sell at. Characteristics of an oligopoly include:

A small number of firms
Collusions between firms to collectively change prices
High barriers to entry

Game theory

Game theory is a concept that allows economists to understand the optimal decisions for firms in the context of a game. A dominant strategy is a choice that is beneficial for that firm no matter what the opposition chooses. Looking at this example, the underlined numbers represent firm A while the other firm B.

When looking at what the dominant strategy is for firm B, we must recognize the possible choices for firm A. If firm A decides to maintain the price, firm B can either make 70 in profit or 0 in profit. Thus, maintaining the price is better for firm B. If firm A decides to lower the price, firm B can either make 80 or 75 in profit. 80 is higher so maintaining price is also better for firm B if firm A lowers price. Therefore, maintaining price is the dominant strategy for firm B.

Applying the same strategy we can find that firm A rather maintain its price in the case that firm B maintains its price but would rather lower the price if firm B lowers its price. Thus, firm A does not have a dominant strategy because it is split on whether to maintain or lower the price depending on what firm B will choose. However, firm A can still choose a more beneficial strategy by predicting what firm B will choose. Since the dominant strategy for firm B is to maintain the price, firm A can just ignore what will happen if firm B lowers the price. Firm A should maintain the price if firm B maintains their price so maintaining the price is more optimal for firm A.

Since both companies decided to maintain the price, the final result will be the top right corner of the game theory matrix. When two firms both choose the same cell, this is considered the Nash equilibrium.

Since both firms only consider their benefit, the choices of both firms led to firm A profiting 50 and firm B profiting 70. However, if they both decided to lower they could have both profited more with firm A profiting 300 and firm B 75. This is known as the prisoner's dilemma.

Vocabulary/Summary:

Imperfect competition: A market with either consumers or producers with the ability to alter the market price. Notably, monopolistic competition, oligopoly and monopoly.

Monopolistic competition: Firms in this market structure can change the price of their product but still have to compete with other firms that have substitutes to that good.

Oligopoly: A group of firms that have total control over the supply of a good.

Collusion: When an oligopoly comes to an agreement to change the price of their good

Excess capacity: When a monopoly firm does not produce at a point where demand equals supply

Game theory: Turns economics into the context of a game in which players have to determine what is the most optimal decision.

Dominant strategy: The choice that is beneficial for the firm no matter what the opposing player chooses.

Nash equilibrium: When two firms choose the same cell in game theory.

Prosoner's dilemma: When the Nash equilibrium is not in the cell that offers the most profit.

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