Table 5.1 reflects the four major categories of market structures and their characteristics.
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Table 5.1 industry Structure Characteristics
Free entry and exit
Barriers come entry
Perfect compete is ~ above one end of the sector structure spectrum, with countless firms. The word, “numerous” has special definition in this context. In a perfectly competitive industry, each firm is so tiny relative to the industry that that cannot affect the price of the good. Each perfectly competitive firm is a price taker. Therefore, numerous firms method that every firm is so small that it is a price taker.
Monopoly is the other too much of the sector structure spectrum, through a single firm. Monopolies have syndicate power, or the capacity to readjust the price the the good. Monopoly power is additionally called industry power, and is measure up by the Lerner Index.
This chapter defines and also describes two intermediary market structures: monopolistic competition and oligopoly.
Monopolistic Competition = A industry structure defined by a distinguished product and freedom that entry and exit.
Monopolistically competitive firms have one characteristic that is like a syndicate (a identified product gives market power), and one characteristic the is prefer a competitive for sure (freedom of entry and also exit). This type of market structure is common in market-based economies, and a trip to the grocery keep reveals large numbers of identified products: toothpaste, laundry soap, breakfast cereal, and so on.
Next, we define the industry structure oligopoly.
Oligopoly = A sector structure defined by obstacles to entry and also a couple of firms.
Oligopoly is a fascinating sector structure due to interaction and interdependency between oligopolistic firms. What one firm go affects the other firms in the oligopoly.
Since monopolistic competition and oligopoly space intermediary market structures, the following section will evaluation the properties and also characteristics that perfect competition and also monopoly. These characteristics will provide the defining qualities of monopolistic competition and also oligopoly.
5.1.2 testimonial of Perfect Competition
The perfect competitive sector has 4 characteristics:
(1) Homogenous product,
(2) large number the buyers and sellers (numerous firms),
(3) freedom of entry and exit, and
(4) Perfect information.
The possibility of entry and exit that firms occurs in the lengthy run, since the variety of firms is fixed in the quick run.
An equilibrium is identified as a point where over there is no tendency to change. The ide of equilibrium have the right to be prolonged to encompass the short run and long run.
Short run Equilibrium = A suggest from which over there is no tendency to adjust (a steady state), and also a fixed number of firms.
Long operation Equilibrium = A suggest from which over there is no propensity to change (a secure state), and also entry and also exit of firms.
In the quick run, the variety of firms is fixed, conversely, in the long run, entry and also exit of firms is possible, based upon profit conditions. We will compare the short and long run for a competitive certain in number 5.1. The two panels in number 5.1 room for the firm (left) and industry (right), v vastly different units. This is emphasized by utilizing “q” because that the firm’s calculation level, and also “Q” for the industry output level. The graph mirrors both quick run and long run equilibria because that a perfectly competitive firm and industry. In short run equilibrium, the firms encounters a high price (PSR), produces amount QSR at PSR = MC, and earns confident profits πSR.
Figure 5.1 brief Run and also Long run Equilibria for a perfectly Competitive Firm
Positive profits in the brief run (πSR > 0) lead to entry of various other firms, together there are no obstacles to entry in a vain industry. The entrance of brand-new firms move the supply curve in the sector graph from it is provided SSR to supply SLR. Entry will occur until profits are driven to zero, and long run equilibrium is reached at Q*LR. In the lengthy run, financial profits room equal come zero, so there is no impetus for entrance or exit. Each firm is earning exactly what it is worth, the opportunity expenses of every resources. In lengthy run equilibrium, revenues are zero (πLR = 0), and also price equates to the minimum typical cost point (P = min AC = MC). Marginal prices equal average expenses at the minimum average price point. In ~ the long run price, supply equals need at price PLR.
5.1.3 evaluation of Monopoly
The features of syndicate include: (1) one firm, (2) one product, and also (3) no entry (Table 5.1). The syndicate solution is shown in figure 5.2.
Figure 5.2 monopoly Profit Maximization
Note the long-run profits can exist because that a monopoly, since obstacles to entry halt any kind of potential entrants from joining the industry. In the following section, us will check out market frameworks that lie between the 2 extremes of perfect competition and also monopoly.5.2 Monopolistic Competition
Monopolistic vain is a market structure identified by cost-free entry and exit, choose competition, and differentiated products, choose monopoly. Distinguished products provide each firm through some market power. Advertising and also marketing of every individual product administer uniqueness that causes the demand curve the each an excellent to be downward sloping. Cost-free entry suggests that every firm competes with various other firms and also profits space equal come zero on lengthy run equilibrium. If a monopolistically competitive certain is earning positive economic profits, entry will take place until economic profits space equal come zero.
5.2.1 Monopolistic vain in the Short and also Long Runs
The need curve the a monopolistically competitive firm is downward sloping, indicating the the firm has actually a degree of industry power. Industry power derives indigenous product differentiation, because each for sure produces a various product. Each great has countless close substitutes, so market power is limited: if the price is enhanced too much, consumer will transition to competitors’ products.
Figure 5.3 Monopolistic competition in the quick Run and Long Run
Short and long operation equilibria for the monopolistically competitive certain are displayed in figure 5.3. The demand curve dealing with the firm is downward sloping, but relatively elastic due to the ease of access of nearby substitutes. The brief run equilibrium shows up in the left hand panel, and also is virtually identical to the monopoly graph. The only difference is that for a monopolistically competitive firm, the demand is reasonably elastic, or flat. Otherwise, the quick run profit-maximizing equipment is the same as a monopoly. The firm sets marginal revenue same to marginal cost, produces output level q*SR and charges price PSR. The benefit level is shown by the shaded rectangle π.
The long run equilibrium is shown in the appropriate hand panel. Entry of other firms wake up until earnings are same to zero; total revenues space equal to total costs. Thus, the need curve is tangent to the average cost curve in ~ the optimal lengthy run quantity, q*LR. The long run profit-maximizing amount is found where marginal revenue amounts to marginal cost, which also occurs in ~ q*LR.
5.2.2 financial Efficiency and also Monopolistic Competition
There space two resources of incompetent in monopolistic competition. First, dead weight loss (DWL) early to syndicate power: price is higher than marginal price (P > MC). Second, overabundance capacity: the equilibrium amount is smaller sized than the lowest expense quantity at the minimum allude on the average expense curve (q*LR minAC). These two resources of inefficiency can be watched in figure 5.4.
Figure 5.4 compare of effectiveness for Competition and Monopolistic Competition
First, over there is dead weight loss (DWL) due to market power: the price is higher than marginal price in long run equilibrium. In the right hand dashboard of number 5.4, the price in ~ the long run equilibrium quantity is PLR, and marginal price is lower: PLR > MC. This reasons dead load loss come society, because the vain equilibrium would certainly be at a bigger quantity whereby P = MC. Total dead load loss is the shaded area beneath the need curve and above the MC curve in figure 5.4.
The 2nd source of inefficiency associated with monopolistic competition is overabundance capacity. This can likewise be checked out in the ideal hand dashboard of figure 5.4, wherein the long run equilibrium amount is lower than the amount where average prices are shortest (qminAC). Therefore, the firm might produce in ~ a lower expense by raising output to the level whereby average expenses are minimized.
Given these 2 inefficiencies associated with monopolistic competition, some individuals and groups have called for government intervention. Regulation can be used to mitigate or eliminate the inefficiencies by removing product differentiation. This would an outcome in a single product rather of a huge number of nearby substitutes.
Regulation is more than likely not a great solution come the inefficiencies the monopolistic competition, for two reasons. First, the sector power that a common firm in many monopolistically competitive sectors is small. Each monopolistically competitive industry has countless firms that create sufficiently substitutable products to carry out enough vain to result in fairly low level of market power. If the that company have little levels of market power, climate the deadweight loss and also excess capacity inefficiencies are likely to be small.
Second, the benefit listed by monopolistic competition is product diversity. The acquire from product diversity have the right to be large, as consumers room willing to salary for various characteristics and also qualities. Therefore, the gain from product diversity is likely to outweigh the expenses of inefficiency. Evidence for this case can be viewed in market-based economies, where there is a large amount that product diversity.
The next chapter will certainly introduce and also discuss oligopoly: strategy interactions between firms!5.3 Oligopoly Models
An oligopoly is characterized as a sector structure with couple of firms and also barriers to entry.
Oligopoly = A sector structure with few firms and also barriers come entry.
There is regularly a high level that competition in between firms, together each firm makes decisions ~ above prices, quantities, and also advertising to maximize profits. Because there space a small number of firms in one oligopoly, every firm’s benefit level counts not only on the firm’s own decisions, but also on the decisions of the other firms in the oligopolistic industry.
5.3.1 strategic Interactions
Each certain must take into consideration both: (1) various other firms’ reactions to a firm’s own decisions, and also (2) the own firm’s reactions to the various other firms’ decisions. Thus, over there is a consistent interplay between decisions and reactions come those decision by every firms in the industry. Each oligopolist must take into account these strategic interactions when making decisions. Since all that company in one oligopoly have actually outcomes that rely on the various other firms, this strategic interactions are the structure of the study and understanding the oligopoly.
For example, each vehicle firm’s sector share depends on the prices and also quantities of every one of the other firms in the industry. If Ford lowers prices loved one to other auto manufacturers, that will boost its market share at the cost of the other car companies.
When making decision that consider the possible reactions of other firms, firm supervisors usually assume that the supervisors of competing firms space rational and intelligent. This strategic interactions kind the examine of video game theory, the object of thing 6 below. Man Nash (1928-2015), an American mathematician, to be a pioneer in video game theory. Economists and also mathematicians use the principle of a Nash Equilibrium (NE) to describe a usual outcome in video game theory the is commonly used in the examine of oligopoly.
Nash Equilibrium = result where there is no tendency to change based on each individual choosing a strategy given the strategy that rivals.
In the examine of oligopoly, the Nash Equilibrium assumes the each firm renders rational profit-maximizing decisions while hold the actions of rival firms constant. This assumption is make to simplify oligopoly models, provided the potential for enormous intricacy of strategic interactions between firms. As an aside, this presumption is one of the exciting themes that the movement picture, “A Beautiful Mind,” starring Russell Crowe as man Nash. The principle of Nash Equilibrium is likewise the foundation of the models the oligopoly gift in the following three sections: the Cournot, Bertrand, and Stackelberg models the oligopoly.
5.3.2 Cournot Model
Augustin Cournot (1801-1877), a French mathematician, occurred the an initial model of oligopoly discover here. The Cournot version is a model of oligopoly in i m sorry firms develop a homogeneous good, assuming that the competitor’s output is fixed when deciding how much to produce.
A numerical example of the Cournot model follows, whereby it is assumed the there space two similar firms (a duopoly), v output provided by Qi (i=1,2). Therefore, complete industry output is equal to: Q = Q1 + Q2. Market demand is a duty of price and also given by Qd = Qd(P), therefore the station demand duty is ns = P(Qd). Note that the price depends on the industry output Q, which is the amount of both individual firm’s outputs. In this way, every firm’s output has actually an influence on the price and profits that both firms. This is the basis because that strategic interaction in the Cournot model: if one firm increases output, it lowers the price encountering both firms. The train station demand role and cost duty are given in Equation 5.1.
(5.1) p = 40 – QC(Qi) = 7Qi ns = 1,2
Each firm chooses the optimal, profit-maximizing output level offered the various other firm’s output. This will an outcome in a Nash Equilibrium, since each firm is hold the habits of the competitor constant. For sure One maximizes earnings as follows.
max π1 = TR1 – TC1
max π1 = P(Q)Q1 – C(Q1)
max π1 = <40 – Q>Q1 – 7Q1
max π1 = <40 – Q1 – Q2>Q1 – 7Q1
max π1 = 40Q1 – Q12 – Q2Q1 – 7Q1
∂π1/∂Q1= 40 – 2Q1 – Q2 – 7 = 0
2Q1 = 33 – Q2
Q1* = 16.5 – 0.5Q2
This equation is referred to as the “Reaction Function” of for sure One. This is as far as the math solution have the right to be simplified, and represents the Cournot equipment for for sure One. That is a reaction function since it defines Firm One’s reaction offered the output level of firm Two. This equation to represent the strategy interactions between the two firms, as alters in firm Two’s output level will result in alters in for sure One’s response. Certain One’s optimal calculation level relies on certain Two’s behavior and also decision making. Oligopolists room interconnected in both behavior and also outcomes.
The 2 firms room assumed come be identical in this duopoly. Therefore, certain Two’s reaction role will be symmetry to the firm One’s reaction duty (check this by setting up and also solving the profit-maximization equation for Firm Two):
Q2* = 16.5 – 0.5Q1
The 2 reaction functions can be used to settle for the Cournot-Nash Equilibrium. There room two equations and also two unknowns (Q1 and also Q2), for this reason a numerical solution is discovered through substitution the one equation into the other.
Q1* = 16.5 – 0.5(16.5 – 0.5Q1)
Q1* = 16.5 – 8.25 + 0.25Q1
Q1* = 8.25 + 0.25Q1
0.75Q1* = 8.25
Q1* = 11
Due come symmetry native the assumption of similar firms:
Qi = 11 i = 1,2Q = 22units p = 18 USD/unit
Profits because that each certain are:
πi = P(Q)Qi – C(Qi) = 18(11) – 7(11) = (18 – 7)11 = 11(11) = 121 USD
This is the Cournot-Nash solution for oligopoly, uncovered by each firm assuming the the various other firm hold its calculation level constant. The Cournot model deserve to be conveniently extended to much more than two firms, yet the mathematics does obtain increasingly complicated as an ext firms space added. Economic experts utilize the Cournot model due to the fact that is based upon intuitive and realistic assumptions, and the Cournot systems is intermediary between the outcomes of the two excessive market frameworks of perfect competition and monopoly.
This deserve to be checked out by fixing the numerical example for competition, Cournot, and monopoly models, and also comparing the remedies for each market structure.
In a compete industry, cost-free entry outcomes in price equal to marginal price (P = MC). In the instance of the numerical example, computer = 7. Once this vain price is substituted into the inverse need equation, 7 = 40 – Q, or Qc = 33. Earnings are discovered by resolving (P – MC)Q, or πc = (7 – 7)Q = 0. The competitive solution is provided in Equation (5.2).
(5.2) computer = 7 USD/unitQc = 33 unitsπc = 0 USD
The monopoly solution is found by maximizing earnings as a solitary firm.
max πm = TRm – TCm
max πm = P(Qm)Qm – C(Qm)
max πm = <40 – Qm>Qm – 7Qm
max πm = 40Qm – Qm2 – 7Qm
∂πm/∂Qm= 40 – 2Qm – 7 = 0
2Qm = 33
Qm* = 16.5
Pm = 40 – 16.5 = 23.5
πm = (Pm – MCm)Qm = (23.5 – 7)16.5 = 16.5(16.5) = 272.25 USD
The monopoly solution is given in Equation (5.3).
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(5.3) afternoon = 23.5 USD/unit Qm = 16.5 unitsπm = 272.5 USD
The competitive, Cournot, and syndicate solutions deserve to be compared on the very same graph for the numerical instance (Figure 5.5).