Imperfect Competition and Strategic Behavior

1
Chapter 11

• Imperfect Competition and Strategic Behavior

2
Industrial Concentration

• The concentration ratio measures economic power
  in an industry and shows the market shares of a
  specific number of the industrys largest firms.

3
Imperfect Competition

• Industries with a large number of small firms
  the theory of monopolistic competition.
• Industries with a small number of large firms
  the theory of oligopoly (which involves game
  theory).

4
Monopolistic Competition

• 1. Each firm produces one variety of the
  differentiated product. Thus, it faces a
  negatively sloped and highly elastic demand
  curve.
• 2. The industry contains so many firms that each
  one ignores competitors when making price and
  output decisions.
• 3. Firms are free to enter and exit the industry.

5
Profit Maximization for a Firm in Monopolistic
Competition
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Monopolistic Competition vs. Perfect Competition

• In contrast to perfect competition, the LR
  equilibrium in monopolistic competition does not
  minimize ATC there is excess capacity.
• This excess capacity may not mean waste if
  consumers value product variety.
• Society faces a tradeoff between product variety
  and lower cost per unit.

7
Oligopoly and Game Theory

• Oligopoly an industry containing two or more
  firms, at least one of which produces a
  significant portion of the industrys total
  output.
• An oligopolistic firm faces only a few
  competitors.
• Strategic behavior is central to their actions.

8
Game Theory

• The players are firms, their strategies are the
  price or output decisions, and their payoffs are
  profits.
• Consider a simplified duopoly in which two firms
  choose to cooperate or compete
• Cooperate produce 1/2 of the monopoly output
• yields low output and high price
• Compete produce 2/3 of the monopoly output
• yields high output and low price

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The Oligopolists Dilemma To Cooperate or to
Compete?
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Nash Equilibrium

• A Nash equilibrium is an outcome in which each
  firm is doing the best it can given what the
  other firm is doing.
• Note that for each firm, the best action is to
  compete, no matter what the other firm is
  doing.
• So in this game, the Nash equilibrium has both
  firms competing and producing the higher level
  of output.

11
Prisoners Dilemma
As output
One-half monopoly output
Two-thirds monopoly output
Cooperative Outcome
One-half monopoly output
20
20
15
22
Bs output
Nash equilibrium
Two-thirds monopoly output
22
15
17
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But notice that this outcome does not maximize
joint profits this is the classic example of
the prisoners dilemma!
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Entry Barriers

• Brand Proliferation
• Advertising
• Predatory Pricing