Econ Last Frontier

Front 1

Given goods

Back 1

Are an extreme case of inferior goods for which few if any substitutes exist

Front 2

Veblen goods

Back 2

High luxury- higher price means higher demand

Front 3

Elastic demand

Inelastic demand

Back 3

ED > 1

ED <1

Front 4

Cross price elasticity

Back 4

-1 < XD < 0 - complement

1 > XD > 0 - substitute

Front 5

What is oligopoly

Back 5

Small number of large competing firms - sometimes just two 'duopoly'.

These firms supply similar or identical but differentiated products and each has sufficient market power to not be a price taker

Front 6

Why is the demand curve of a firm not the demand curve of the industry?

Back 6

Inter-firm rivalry - Each firm knows that any action may lead to competitors responding - oligopolistic firms are interdependent and so behave strategically

Front 7

The oligpolist's dilemna

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Oligopolistic behaviour is essentially strategic, firms have to choose whether to compete or co-operate

They will earn more profits if they cooperate but it is harder when there are more than two competing firms

Front 8

The kinked oligopoly

Back 8

Behaviour in oligopoly is strategic but, primarily focuses on output rather than price competition. This is because oligopolies face a kinked demand curve

If an oligopolist raises its price, its unlikely other firms will follow. The firm demand curve will therefore be relatively price elastica above the equilibrium price. A price rise leads to a fall in sales and TR

If an oligopoly lowers its price, other firms will follow. The firm's demand curve is therefore that of the industry which is therefore relatively price inelastic below the equilibrium price.

A price fall leads to increased sales but a fall in TR.

Front 9

The Assumptions of Imperfect (Monopolistic) Competition

Back 9

Most economic activities are not characterized by monopoly, oligopoly, and perfectly competitive competition.

The most common is imperfect competition - sometimes referred to as monopolistic competition.

The defining characteristic of imperfect competition is that firms produce and sell differentiated (i.e. branded) goods such that they are not price-takers.

Front 10

Assumptions of Imperfect Competition

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4 key assumptions of imperfect competition:

1. Each firm produces just one variety or brand of the product.

2. There are so many firms that they can ignore rivals' reactions

3. There is freedom of entry and exit

4. New entrants take market share from all other firms equally (symmetry).

Front 11

Implications of the ImperfectlyCompetitive Assumptions

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Each firm faces a downward sloping Demand curve that is relatively elastic because of the wide availability of substitutes from other firms.

Each firm makes its on demand and cost decisions, without considering the responses of other firms

If existing firms earn profits, new firms will enter and share the market equally.

Front 12

Firms Create Their Own DistinctiveProducts

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In imperfectly competitive markets, each firm decidesthe key characteristics of their product, which is justone variety of the good in the market.

Differentiation, through branding,advertising etc., means that each product can be soldat a different price in spite of the availability ofsubstitutes. In other words, goods and services are notperfect substitutes, such that the cross-elasticity ofdemand is less than one: XD < 1.

Front 13

‘Non-Price’ Competition

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Several types of firm behaviour take place underimperfect competition that are not present in eitherperfect competition or monopoly.

Many imperfectly competitive industries feature heavyadvertising expenditures and competition based uponquality. This enables firms to shift their own Demandcurve to the right (and possibly the industry curve too)

Front 14

Imperfectly Competitive Markets:

Implications

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The characteristics of imperfectly competitive markets have two important effects:

- Less is sold and at a higher price than in Perfect Competition (Demand is relatively inelastic)

- Production is not at the lowest point on the ATC, the least-cost (most efficient) level of output

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Equilibrium in Imperfectly Competitive Markets

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Firms are profit maximisers and they therefore produce MR = MC. Because the Demand curve of firms in imperfectly competitive markets is downward sloping (relatively inelastic), the MR curve also slopes downwards - as price p falls, all goods are sold at the lower price.

Nevertheless, the AC and MC curves may be identical to those under perfectly competitve conditions.

Front 16

Short-Run Equilibrium in ImperfectCompetition

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In an imperfectly competitive market, firms alsoproduce at their profit maximising level of output,where MR = MC, and set price according to theposition of the Demand curve. This price setting processis identical to that of monopoly and oligopoly.

n the short-run, it is therefore possible for imperfectlycompetitive firms to earn Abnormal profits.

The short-run equilibrium diagram is exactly the same asfor Monopoly and Oligopoly.

Front 17

Long-Run Equilibrium in ImperfectlyCompetitive Markets

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In the long-run however, just as under perfectlycompetitive conditions, new firms have an incentive toenter the industry (free entry and exit). Any increase inIndustry supply shifts the Demand curve of each firm tothe left and so reduces the price that they receive.

In this way, firms’ Abnormal profits are competed awayby the entry of new firms, leaving only Normal profits inlong-run equilibrium (at point E).

Note that: p > MC

Front 18

Product Differentiation & Advertising

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A key feature of imperfect competition is productdifferentiation, including branding and advertising. Theprincipal reasons for advertising:

To attract more buyers: it provides consumers withinformation about products; competition increases –firms aim to shift their own Demand curve to theright

It enables firms to charge p > MC: firms can chargea higher price for differentiated products.

To signal quality: firms can signal product quality andconsumers can act on this information.

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Product Differentiation & Advertising

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A critique of advertising however, suggests that it mayalso have other effects:

It impedes competition: it persuades consumers thatproducts are more different than they really are(reducing demand cross-elasticities

•It creates brand loyalty: consumers are lessconcerned with price differences between similargoods (increases the price mark-up).

• It manipulates consumers: the psychological effectsof creating new (unnecessary) desires.