- Microeconomics
Perfect Competition - Agricultural & Applied Economics
Equilibrium and
Market demand:.
Imperfect Competition
Market Structure Characteristics
We characterize an industry by
The number of firms and their size distribution
Product differentiation
Barriers to entry
The picture to the right concerned with two markets:
No. 2 yellow corn: many producers/sellers (Perfect
Competition)
Farm equipment: few manufacturers/sellers
(Oligopoly) Pages 145-148
Perfect Competition
Up to now we have been assuming the firm and market reflect conditions of perfect competition
Not a bad assumption for many agricultural subsectors
A large number of small firms: 2 million farms
A homogeneous product: No. 2 yellow corn
Freely mobile resources: No barriers to entry caused by patents, etc. or barriers to exit (???)
Perfect knowledge of market conditions:
Quality outlook information from government, university and private sources
Many markets in which farmers buy inputs and sell their products however do not reflect perfect competition conditions
Chapter 9 focuses on specific types of imperfect competitors in the farm input market
These firms are capable of setting prices farmers must pay for specific inputs
Imperfect Competition in Selling
Topics for nov 3, monopolistic competition.
Production and Pricing Decisions
Oligopolies
Definition/Examples
Comparison of Market Structures
Pages 106-107
Unlike perfect competitors who face a perfectly elastic (horizontal) demand curve
Imperfect competitors selling a differentiated product have a downward sloping demand curve
$ Firm’s demand curve under P.C.
Firm’s demand curve under imperfect competition
Price Quantity Total Rev. Avg. Revenue Marginal Revenue
15 0 0 ------------
Table 9-1 Imperfect
Competition
Firm faces a downward sloping demand curve →
Marginal Revenue
(MR) : Change in revenue from the sale of the last unit of output
(ΔTR÷ΔQ)
Average Revenue
(AR): Total
Revenue/Total output (TR÷Q)
Note : Price =
Marginal Revenue: Change in revenue from the sale of the last unit of output
Maximum Total Revenue
Marginal revenue in this instance is also downward sloping
MR=0 at the point where TR is at a maximum
Types of Imperfect Competitors in Input Markets
Let’s start here…
Monopolistic Competitors
Many sellers
Each firm has relatively small market share
Power to set prices somewhat like a monopoly
Face competition like perfect competition
Collusion is not possible given number of firms in the industry
No barriers to entry or exit
Page 148-151
Product Differentiation: Each firm makes a product that is slightly different from the products of competing firms
Close substitutes but no perfect substitutes
An attempt to ↑ price will normally results in a ↓ in volume sold
Competition on Quality, Price, Marketing
Quality is design, reliability, service provided to buyer and ease of access to product
The firm faces a downward sloping demand curve
Firm must market intensively: promotions, distribution, packaging, etc.
Product differentiation does not necessarily mean there are any physical differences among products
They might all be the same, but how they are sold may make all the difference
The monopolistic competitor tries to set his/her product apart from the competition
Main method is via advertising
When this is done successfully, the demand curve becomes more vertical or inelastic
Buyers are willing to pay more because they believe it is much better than their other choices
Basis for product differentiation
Physical differences Convenience
Appeals to vanity
Reputations
Typical Monopolistic Competitor
Tries to set firm apart from competition
New Product Development and Innovation
Advertising o Create consumer perception of product differentiation
– real or imagined o Attempt to keep demand as inelastic as possible
Selling costs can be extremely high
Short run profits can exist but long run profits are reduced to 0 with industry entrants
Fast food industry is a good example
All services basically the same
Extensive use of marketing to differentiate products/services across firms
Striving to produce more products and services
Production Decision:
Determine output level where
MC=MR ( Why does this make sense?
Pricing Decision:
Determine where above quantity intersects the downward sloping demand curve
Monopolistic
Short run profits exist if:
Short run profits
The firm produces Q
Prices its products at P where MR=MC at E
SR by reading off the demand curve at quantity Q
Represents consumer’s willingness to pay for Q
SR Page 150
Short run loss
In the Long Run (LR)
Profits are bid away as more firms enter the market
Losses will no longer exist as firms leave the market
LR the remaining firms are just breaking even
How much is the industry dominated or not dominated by few suppliers
Geographical scope – national, regional, global
An industry can be almost perfectly competitive on a national scope, but almost a monopoly locally e.g. Feed Retailing
Barriers to entry and exit: industries may appear concentrated but few barriers exist to prevent entry
Quantitative measures of competition
Concentration Ratio (CR): 2,4, 8, 20, etc
% of the value of total market revenue accounted for by 2, 4, 8, 20, etc. largest firms in the industry
Low CR values→ a high degree of competition
High CR values → an absence of competition
Herfindahl-Hirschman Index (HHI): The square of the % market share of each firm summed over the largest 50 firms in an industry or all firms if < 50 in industry
Perfect competition, HHI is small
Only 1 firm, HHI is 10,000 = (100 2 )
U.S. Justice Department o HHI < 1,000 competitive markets o HHI > 1,800 could be considered concentrated industry worthy of Justice Dept. examination of any purchases
A few number of sellers
Each can impact market price & quantities
Interdependent in their decision making
Key component in marketing strategies and pricing behavior
Match price cuts but not price increases by fellow oligopolists
Do this to maintain market share
Non-price competition between oligopolists to uniquely identify products
Pages 152-155
Rival oligopolists will match price cuts but not price increases in the short run because they want to capture a larger market share
If there are differences in prices they are the result of successful product differentiation
Tend to have stable prices
Changes in production and other costs not easily passed on and may have to be absorbed
Price leadership strategy
A particular firm dominates the market
Controls the largest share of the market
Other industry firms more efficient in operation, marketing, etc.
The dominant firm first sets its price to maximize profit
Remaining firms set their prices based on the dominant firms pricing
The price set by the oligopolist seller is higher under perfect competition
Quantity produced is lower then perfect comp.
The dominant firm may be efficient enough to set a lower price
Eventually drive the other firms out of the market
Examples of Oligopolies
Auto manufacturers
1997 CR4 value of 97.4
Aircraft manufacturing
Farm machinery and equipment
John Deere, J.I.Case and New Holland
80% of 2-wheel drive tractors
close to 90% of combines sold in the U.S.
Cattle slaughtering
CR4 value increased from 39% to 67% over the 1985-1995 period
Demand curve DD
All oligopolists move prices together and share market
Demand curve dd
A single firm changes its price
Curve DD is more inelastic
Below point 1, firms match price cut
This leads to a kinked demand curve d1D
Leads to a discontinuous marginal revenue curve, d256
Remember oligopolists account for the reaction of other firms so there is no single demand curve
Meeting demand along the lower segment of the kinked demand curve → the firm is maintaining its market share
Shifting MC curves reflecting technological advances will not affect P
It does impact profits as MC drops from pt 3 to pt 4
One seller in the market
Entry of other firms restricted by patents, etc. (i.e., barrier to entry)
Firm has absolute power over setting market price
Produces a unique product
It can have economic profits in the long run because it can set price without competition
Page 155-156
Total revenue = area
Monopolist produces quantity where
MC=MR (pt A),
Uses the demand curve
(pt C) when setting price P
Total variable costs for the monopolist is equal to area
, (green box)
Total fixed costs equals
NMBA (orange box)
=(ATC-AVC) x Q
Total cost is area
+ orange box)
= area ONAQ
+ area NMBA
Monopoly economic profit = area MP
= Total Revenue (yellow box) – Total Costs (green box + orange box)
Comparison of Structure Results
Lets compare the results we have obtained from the alternative market structures
Perfect Competition Case
Consumer surplus = sum of areas
1, 4, 5, 8 and 9 (blue triangle)
Producer surplus = to the sum of areas 2, 3,
6 and 7 (green triangle)
Total economic surplus
= sum of blue and green triangles
=sum of areas 1 – 9
Monopoly Case
CS = sum of areas 8 and
9, (new blue triangle)
Compared to P.C., consumers would be economically worse-off by areas 1, 4 and 5
Paying a higher price, P
Purchasing a smaller quantity, Q
PS = to sum of areas 3, 4, 5, 6 and
7 (green area)
Compared to P.C. producers lose area
2 but gain areas 4
Economically better-off than
Society as a whole would be economically worse-off by areas 1+2
Known as the dead weight loss
Reflects the fact that less of available resources in this market are used to provide products to consumers
Summary of Imperfect Competitors from a Selling Perspective
From the Buying Perspective
Types of Imperfect Competitors on the Buying Side
Monopsonistic competition
Monopsonies
Single buyer in the input market
Focus is on the marginal input cost of purchasing an addition unit of resources
Will purchase input until Marginal
Value Product (MVP)=Marginal
Input Cost (MIC)
As long as MVP>MIC, the monopsonist makes a profit
Page 158-160
Under perfect competition, the firm views the input supply curve as a horizontal line
Firm can purchase as much as desired as the going price
Firm’s purchase does not impact inputs cost
Monopsonist is the only input buyer
→Faces an upward sloping input supply curve
Buying decisions impact input prices
Monopsonist must consider the marginal input cost (MIC) when purchasing inputs
MIC defined as the change in the cost of an input as more of the input is used
Lets look at a simple example
Monopsonist must pay higher prices per unit if he/she wants to purchase greater amounts of the input
→MIC curve is above the input supply curve
Marginal Input Cost
Variable Input
Total Input
1 2 3 4 5 6 7 8 9 10
Quantity/unit of time
Input Supply Curve
Data obtained from previous table
Profit maximizing monopsonist
Use variable input to the point where
Marginal Input Cost (MIC) =Marginal
Revenue Product (MRP)
MRP = addition to total revenue attributed to the addition of one unit of variable input
= Marginal revenue x MPP
So long as MRP>MIC, profits will increase with increased input use
If MRP<MIC, profits will ↑ by reducing the amount of input used (Why?)
Buying Decisions by Perfect Competitors
MRP = MVP under perfect competition
Buying Decisions by a Monopsonist
Monopsonist makes decisions along
Differs from MVP
MRP=MIC at A
Resource use
Higher Price paid under P.C., P
Utilization higher under P.C., Q
Price difference referred to as monopsonistic exploitation
Imperfect Competition on Both Sides
Product Selling
Perspective
Input Purchasing
Monopsonistic
Oligopoly Oligopsony
Monopoly Monopsony
Can have any combination of the above for a particular firm
Lets look at profit maximization under specific cases
Case #1 : Monopsonist in input purchasing and
Monopolist seller of product
Equilibrium: MRP=MIC at Point A.
Pricing off input supply curve gives Q
60 Page 161
Case #2 : Perfect Competition in input purchasing and Monopoly seller
Equilibrium is where MRP=Supply at C
No Marginal InputCost curve → Q
Case #3 : Monopsony in input purchasing and
Perfectly Competitive seller
Equilibrium: MVP=MIC at Point E
Pricing off supply curve → Q
Case #4 : Perfect Competition in both input purchasing and product sales
Equilibrium: MVP=Supply at Point F
Monopsonistic Competitors
Many firms buying resources
Ability to differentiate services to producers
Differentiated services includes distribution convenience and location of facilities, willingness to provide credit or technical assistance
P and Q determined same as monopsonist
Oligopsonies
A few number of buyers of a resource
Profit earned will depend on elasticity of supply for resource (less elastic than monopsonistic competition)
Each oligopsonist knows fellow oligopsonists will respond to changes in price or quantity it might initiate
Various segments of the livestock industry
Exhibit several forms of imperfect competition.
Governmental Regulation
Various approaches have been used to counteract adverse effects of imperfect competition in the marketplace
Legislative acts passed by Congress, including the Sherman Antitrust and Clayton Acts
Price ceilings
Lump-sum Tax
Minimum price or floors
Legislative Acts
Sherman Antitrust Act of 1890
Prohibited monopoly and other restrictive business practices
Packers and Stockyards Act of 1921
Reinforced Anit-trust laws regarding livestock marketing
Capper-Volstead Act of 1922
Exempted cooperatives from anti-trust laws
Robinson-Patman Act
Prohibited price discrimination practices
Agricultural Marketing Agreement Act
Established agricultural marketing orders
Impacts of Price Ceilings
Regulatory agencies such as the Federal
Trade Commission can impact monopoly effects by instituting a maximum (ceiling) price
FTC charged with investigating business organizations and practices and carrying out anti-trust provisions
How can we model the impact of price ceilings?
Implications of a Price Ceiling
Without regulatory involvement the monopolist will
Equate MR and MC
M and charge price P
Earn a profit of
With gov’t imposed price ceiling, P
The demand curve is given by P
Mono. produces more (Q
) at a lower price (P
Monopolist’s profit falls to area IP
EH (turquoise box)
Impacts of a Lump Sum Tax
A regulatory agencies can impact the level of monopoly profits by assessing a lump-sum tax
May be a license fee or one-time charge
Corresponds to a fixed tax regardless of output level
How can we model the impact of a lump sum tax?
Impacts of A Lump Sum Tax
Implications of Lump-Sum Tax
The monopolist equates
MC=MR (pt. F)
Profit of AP
Implications of Lump-Sum Tax
Lump-sum tax
↑ firm’s ATC from
↓ producer surplus from AP
Does not change output level or price
The loss in producer surplus is area AETC
(blue box) Page 165
Impacts of a Minimum Price
In a monopsony, the gov’t could regulate the price of a resource by imposing a minimum price that must be paid for that resource
Good example is the various minimum wage laws
How can we model the impact of a minimum price policy?
Implications of a Minimum Price
No minimum price
Monopsonist determines where
M input units
Minimum price, P
Implications of a Minimum Price imposed
Monopsonist’s MIC curve would be
The firm would use more input
Unlike perfect competition, imperfect competitors have ability to influence price
Monopolistic competitors try to differentiate their product
Monopolists are the only seller in their product market. Monopsonists are the only buyer
Oligopolies are a few number of sellers while oligopsonies are a few number of buyers .
What are the economic welfare implications of imperfect competition?
Chapter 10 focuses on
resource use
in agriculture and the
environment
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