Imperfect Competition

1. The World of Imperfect Competition
Competition has been shown to be useful up to a certain
point and no further, but cooperation, which is the thing we
must strive for today, begins where competition leaves off.
-Franklin D. Roosevelt
Slide 1 of 49

2. In this module, we conclude our
study of firm behavior…
Slide 2 of 30
We now turn our attention to an environment between
perfect competition and monopoly…called ‘imperfect
competition’.
In this module, we’ll explore how monopolistically
competitive firms and oligopolies behave, how they
make decisions, and how they compete.
It covers a key learning outcome and if you continue to
study economics, you will see it all again.

3. Let’s turn our attention to
Monopolistically competitive firms
Perfect Competition Monopolistic Competition Oligopoly Duopoly Monopoly
This was
the topic of
Modules 8
and 9
This was
the topic of
Module 10
Market Structure
Overview
Slide 3 of 49

4. Let’s review these market structures
Perfect Competition Monopolistic Competition Oligopoly Duopoly Monopoly
Most firms are monopolistically competitive
Characteristics of monopolistic competition:
There are a relatively large number of sellers
There are a lot, but not
thousands of competitors.
Examples might include grocery
stores.
Producers do face a competitors
Widespread non-price competition exists
There are minimal barriers to entry
Imperfect competition includes all things between Perfect competition and monopoly.
Market Structure
Overview
This means that sellers are in
heavy competition and have to
keep prices low.
Examples include gas stations.
Since it is difficult to compete on
price, producers differentiate
their products to prove they are
better.
Examples include fast food
chains.
You can open a hamburger or hot
dog stand and compete with big
fast food chains.
Examples include a downtown
food truck or neighborhood food
vendor.
Slide 4 of 49

5. Types of market structures
Perfect Competition Monopolistic Competition Oligopoly Duopoly Monopoly
In this category, there are only two or a few producers.
Firms here are less numerous, but big.
Characteristics of oligopolies
and duopolies:
Market has only a few or two sellers
Examples include big box
superstores.Each firm is affected by decisions of others
Barriers to entry exist
Firms are always ‘looking over
their shoulder’ for changes in
competitor’s behavior.
Examples include the airlines.
Barriers to entry are not
insurmountable, but they are
daunting.
Examples include tobacco
companies.
“Du” means two. “Oli” means several. We’ll treat these as one group.
Market Structure
Overview
Slide 5 of 49

6. Review: Examples of
firms in different markets
Perfect Competition Monopolistic Competition Oligopoly Duopoly Monopoly
NBA,MLB,NHL,NFL
CokeandPepsi
IBMinthe1980s
Banks
CoffeeShops
SoapManufacturers
TomatoFarmer
HooverDam
DeBeersDiamonds
TVNetworksinthe1960s
Airlines
GroceryStores
Hotels
CatfishFarmer
WheatFarmer
AircraftManufacturers
Greetingcardcompanies
Cigarettemakers
CerealManufacturers
OperatingSystemproducers
Market Structure
Overview
Slide 6 of 49

7. Monopolistic competition
A large number of firms but not so many that
each firm’s output is insignificant
Monopolistic Competition
Slide 7 of 49

8. Monopolistically competitive
firms have unique characteristics
• There are a relatively large number of
sellers (i.e. dozens or more, but not thousands)
• Producers face a lot of competition
• There are minimal barriers to entry
• Producers have limited control over price
• Instead producers practice widespread
“non-price competition”
These characteristics will be
described a little later.
The next slide will provide an
example for these.
Monopolistic Competition
Slide 8 of 49

9. Lodging is a monopolistically
competitive industry
There are a large
number of sellers
A good example is the hotel industry.
There are probably hundreds of hotel
brands, big and small.
Producers face a
lot of competition
Pull off any exit in an urban area and
see how many hotel signs you see.
There are minimal
barriers to entry
Get a business license, a building,
and a sign out front and you can
compete!
Monopolistically
Competitive
Characteristic Comment
Monopolistic Competition
Sean’s B&B
Slide 9 of 49

10. So do monopolistically competitive
firms have control over their price?
With product differentiation… yes….a little.
For example, are their prices the
same?
Monopolistic Competition
Slide 10 of 49

11. So do monopolistically competitive
firms have control over their price?
Monopolistic Competition
Monopolistically competitive firms are not price
takers like perfectly competitive firms.
But their prices typically don’t
differ by much
Gas
$3.79 /gal
Gas
$3.81 /gal
Slide 11 of 49

12. So instead of competing on price,
they compete on product characteristics
Monopolistically competitive
firms engage in heavy “non
price competition”.
That means they try to
convince you (mainly through
advertising) that their product
is different (or more
specifically, better!)
This is called “Product
Differentiation”.
Safety Ratings
Here are some examples of product
differentiation.
These firms have advertised heavily to
differentiate their product. Can you match them?
Monopolistic Competition
Maytag
Have it
your way!
Safety!
Slide 12 of 49
Product differentiation is a
key aspect of this market
structure.
For your business proposal,
you’ll probably have to show
how you plan to differentiate
your goods and services!

13. How can numerous firms
differentiate relatively similar products
• Emphasize product attributes
– Physical or qualitative differences are emphasized
• Emphasize superior service
– Firms set themselves apart by providing good service
• Provide the best location
– Being closer to a customer offers a competitive edge
• Incorporate brand name and packaging
– A name you know or trust
– An association with a person
These are all
elements of
“Non Price
Competition”
Monopolistic Competition
Gas
$3.81 /gal
Slide 13 of 49

14. Individual exercise
Take 5 minutes and think of three firms
that advertise heavily as they try to
differentiate their product
Monopolistic Competition
This shouldn’t be hard unless
you don’t watch TV, don’t read
magazines, and don’t listen to
the radio!
Slide 14 of 49

15. Key Characteristics of
Monopolistic Competition
Monopolistic Competition
Let’s discuss this
characteristic next.
Slide 15 of 49

16. The monopolistically competitive
firm's demand curve is highly elastic
Monopolistic Competition
We saw that a perfectly
competitive firm faces a
perfectly elastic demand curve.
We saw that a
Monopolist faces
the industry
demand curve.
A monopolistically
competitive firm
faces a highly elastic
demand curve.
Note that the slope of this demand curve falls somewhere
between that faced by a perfectly competitive firm and that
faced by a monopolist!
Slide 16 of 49

17. Why the highly
elastic demand curve?
Monopolistically competitive
firms face a highly elastic
demand curve because they
face a lot of competition.
Notice how a slight increase
in price causes large declines
in quantity demanded.
With a lot of competition, that
is what these firms see. If
they raise price, customers
go to their competitors!
Monopolistic Competition
Slide 17 of 49

18. How do monopolistically
competitive firms maximize profit?
Again, continue to expand production as
long as MR>MC then stop when MR=MC
Monopolistic Competition
With no units produced, profit will be
-$55, which are the fixed costs.
With one unit produced, profit will be
-$8, but MR>MC so expand
production.
With two units produced, profit will be
$38, but MR>MC so expand
production.
With 7 units produced, profit will be
$182, and MR=MC. This firm should
stop there.
With output above 7 units, MC>MR.
This firm should not produce these
units - they cost more to make than
they bring in!
Slide 18 of 49

19. Profit maximization,
seen graphically
Monopolistic Competition
Profit maximization is found where MR=MC. But what
price will this firm charge?
Like monopolists, price will be as high as the market
will bear. Follow the MR=MC point up to the demand
curve
Remember though, just like in perfect competition,
these economic profits are going to lure new suppliers
in. With little barriers to entry, what is stopping them?
Slide 19 of 49
Here we see a decision based on marginal benefit (revenue) – marginal cost
analysis for an imperfectly competitive firm. In this case is it for a monopolistically
competitive firm. That is a key learning outcome!

20. Losses, shown graphically
And, just like in perfect competition, these
economic losses will drive away current
suppliers.
Monopolistic Competition
Slide 20 of 49

21. Eventually, though, only normal
profits are earned
So, economic profits will draw
competitors. With low barriers to
entry, there is little stopping them.
As competitors join, demand (and MR)
curves shift downward and profit shrinks.
Why? Because with more firms, each
firm has a smaller share of the market.
Eventually, the demand curve becomes
tangential to the ATC and all economic
profits are gone.
Monopolistic Competition
Slide 21 of 49

22. Note a distinction
$5.00
100 units
Note that as other firms enter, profit
maximizing output for a monopolistic
competitor eventually reaches a point that
is not at the lowest point of the ATC curve.
Unlike perfect competition, society does
not benefit from the guarantee that this
product will be produced at its lowest cost.
If monopolistic
competitors were
to minimize price,
they would operate
here (at the low
point of the ATC)
and fewer firms
could meet all
demand (Because
each firm would
have a higher
output).
Instead, the
industry is
overcrowded with
firms operating at
below capacity.
Industry example: How many times have you been to a hotel where there were
vacant rooms on your hall?
Monopolistic Competition
$4.75
200 units
Industry example: And how many times do you see a hotel commercial on TV
as they try to product differentiate?
Slide 22 of 49

23. Eventually, economic profits disappear
This process can be slowed by the monopolistically competitive firm so
they can enjoy economic profits as long as possible
Product differentiating and advertising!Monopolistically competitive firms want to slow this process down to
hang on to economic profits, but how can they?!?
Monopolistic Competition
Slide 23 of 49

24. Comparison
• In perfect competition there is a constant
drive to reduce prices to maintain
competitiveness
• In monopolistic competition, there is a
constant drive to maintain economic profits
“Anybody can cut prices, but it takes
brains to produce a better article.”
–P.D. Armour
Monopolistic Competition
Slide 24 of 49

25. Oligopolies and duopolies
A few firms, each of which has significant
market power
“Oli” is Greek for “Few”
Slide 25 of 49
Oligopolies &
Duopolies

26. Oligopolies and duopolies
Perfect Competition Monopolistic Competition Oligopoly Duopoly Monopoly
Let’s turn our attention from
Monopolistic Competition to
Oligopolies and Duopolies
Oligopolies &
Duopolies
Slide 26 of 49
In an oligopoly, there could be several firms…perhaps 5.
In a duopoly, there are only two.
Generally, these behave similarly so we will treat them as one group.

27. Review: Types of markets
Perfect Competition Monopolistic Competition Oligopoly Duopoly Monopoly
•Product is homogeneous
•There are many buyers and sellers
•Firms constitute a very small fraction of the market
•Firms have no control over price
•No barrier to entry
•Examples: Poured Concrete Contractors (27,149);
truck transportation (112,642)
• Single firm that produces the entire supply
of a product
•Producer does not face a competitor(s)
•Substantial barriers to entry
•Product does not have a substitute (i.e. it
is heterogeneous)
•Examples: Microsoft, Cox Communication
• Market has only a few or two sellers
•Each firm is affected by decisions of others
•Barriers to entry exist
•Examples: RJR Reynolds, Wal-Mart
• Relatively large number of sellers
•Producers do face a competitors
•Widespread non-price competition where
producers try to differentiate their products
by brand
•Minimal or no barriers to entry
•Examples: Starbucks, McDonalds
Oligopolies &
Duopolies
Slide 27 of 49

28. Review: Examples of
firms in different markets
Perfect Competition Monopolistic Competition Oligopoly Duopoly Monopoly
NBA,MLB,NHL,NFL
CokeandPepsi
IBMinthe1980s
Banks
CoffeeShops
SoapManufacturers
TomatoFarmer
HooverDam
DeBeersDiamonds
TVNetworksinthe1960s
Airlines
GroceryStores
Hotels
CatfishFarmer
WheatFarmer
AircraftManufacturers
Greetingcardcompanies
Cigarettemakers
CerealManufacturers
OperatingSystemproducers
Oligopolies &
Duopolies
Slide 28 of 49

29. Oligopolies and duopolies
also have unique characteristics
• The market has only a few or
perhaps two producers
• Producers are significantly
affected by other firm’s decisions
• There are substantial barriers to
entry
• Producers face a ‘kinked’ demand
curve This characteristic will be
described a little later.
The next slide will provide an
example for these.
Note: Du is Greek for two and oli is
Greek for several
Oligopolies &
Duopolies
Slide 29 of 49

30. The hotel industry is an example of a
monopolistically competitive market
A few large firms
dominate the
industry
An overwhelming portion of the
industry’s output is produced by only
a few firms. Many soft drinks are
produced by either Coke or Pepsi
Producers are
significantly
affected by
decisions of others
Imagine what airfare prices out of
Norfolk (ORF) would do if Southwest
stop providing service.
There are
substantial barriers
to entry
Generally speaking, how have the
mom and pop hardware stores done
against the big box stores? Not too
well.
Oligopolistic or
Duopolistic
Characteristic Comment
Oligopolies &
Duopolies
Hardware
Slide 30 of 49

31. Oligopolists and duopolists have a
unique relationship with competitors
• Like a monopolist, an oligopolist (or duopolist)
has significant pricing power. They are “price
makers”
• Unlike monopolists, they must consider what
their rivals are doing with regard to the price.
Pricing and output decisions
must include a strategic
component
Oligopolies &
Duopolies
Slide 31 of 49

32. An example of mutual
dependence: Game theory
Analyze the following table.
Assume your company’s costs will be $60 million in this year.
Select a pricing strategy for your company given the information
below. Do you set prices high or low?
Oligopolies &
Duopolies
Slide 32 of 49

33. An example of mutual
dependence: Game theory (part II)
I suspect you chose a low price. You can’t risk only earning $40 million (i.e.
losing $20 million) if you pick a high price and your competitor picks a low price.
Neither can your competitor, so you both wind up pricing your product low.
This is a good example of mutual dependence in pricing decisions.
Oligopolies &
Duopolies
Slide 33 of 49

34. Collusion: the great
temptation for oligopolists
If you and your competitor had a
meeting and both agreed to set prices
high, then you could operate here and
make more money.
That is called
“collusion” and it
is illegal!
Oligopolies &
Duopolies
Slide 34 of 49

35. Oligopolists and duopolists face
a kinked demand curve
Mutual dependence also causes
the oligopolist and duopolist’s
demand curve to take a unique
shape.
We call in “kinked” because it has
a bend in it.
The next few slides will explore
this idea.
What is my
competitor
going to do?
Oligopolies &
Duopolies
Slide 35 of 49

36. Cheating
First some assumptions
Assume you are a business owner in
an industry with three firms- yours
and two others.
Assume you are all charging $90 for
the one good that you all produce.
Assume you are considering
increasing the price by $10
$90
+$10
Assume you do not collude with your
competitors
Oligopolies &
Duopolies
Slide 36 of 49

37. What if firms don’t match
your price increase?
If your rivals do not match all your price
changes then you face a more elastic
demand curve
1,000
$90
1,500
In this case, a $10 increase in
price, which is unmatched by
your rivals, causes a large drop
in the quantity demanded of your
good as consumers switch to the
cheaper good!
$100
$90
Oligopolies &
Duopolies
Slide 37 of 49

38. What if firms do match
your price increase?
$100
$90
1,400
1,500
If your rivals do match your price
changes, then you face a more
inelastic demand curve
If your rivals do
match your price
changes, then the
same increase in
price does not
cause a similar
decline in quantity
demanded.
Since all three
competitors have
increased price by
$10, customers
cannot switch to
another producer’s
product to save
money.
Oligopolies &
Duopolies
Slide 38 of 49

39. So, will your oligopolistic competitors
match your price change or not?
$90
It depends on the direction
of the price change!
For price reductions, rivals
will likely match price
changes for fear that they
will lose customers to a
rival’s lower price!
Do not
Match
Do Match
Oligopolies &
Duopolies
Slide 39 of 49

40. So, will your oligopolistic competitors
match your price change or not?
$90
For price increases, rivals
will likely not match price
changes in order to steal
new customers from you!
Do not
Match
Do Match
Oligopolies &
Duopolies
Slide 40 of 49

41. Therefore, oligoplists operate with
a “kinked” demand curve
Oligopolists face this
portion of the demand
curve where price
changes are not
matched
Oligopolists face this
portion of the demand
curve where price
changes are matched
Therefore, this is
the oligopolist’s
demand curve
Notice the bend or
“kink” in the demand
curve
Oligopolies &
Duopolies
Slide 41 of 49

42. So what does that mean for the
oligopolists’ marginal revenue curve?
Recall that there were two MR
curves for the different scenarios
Similar to demand, the
oligopolist faces portions of
each MR curve
$90
Where price
increases are
not matched,
an oligopolist
faces portions
of MR1
Where price
increases are
matched, an
oligopolist
faces portions
of MR2
The Oligopolist’s MR curve
Oligopolies &
Duopolies
Slide 42 of 49

43. Price stability is typical in
industries dominated by oligopolists
Oligopolies &
Duopolies
Because of oligopolistic
behavior (i.e. firms typically match
price cuts but not price increases),
prices are generally not changed often.
Firms are busy constantly watching each other!
Slide 43 of 49

44. Real world case study: Airlines
Between 1995
and 2006,
consumer
prices
increased by
more than
30%.
During the
same period,
airfares
increased by
about 10%.
Airlines were
scared to
change prices.
If they raised prices, they lose
customers. If they lowered prices
they could start a “price war”.
Oligopolies &
Duopolies
Slide 44 of 49

45. Here is a typical story
highlighting oligopolist behavior
U.S. airlines raise fares in domestic
markets
Fri Nov 3, 2006
• NEW YORK (Reuters) - Several major U.S. airlines have raised
fares in some markets by $5 each way, after two unsuccessful
efforts to hike prices in recent weeks.
• American, Continental, United, Northwest and Delta Airlines each
said on Friday that they raised fares in domestic markets not
served by low-cost carriers.
• If the price increase holds, it would mark the first broad fare
increase since August when tighter security measures were
implemented.
• Attempts at broad-based fare increases have failed in recent
weeks, with companies rescinding hikes twice in targeted markets
after low-cost carriers and some traditional airlines did not match
the increases.
• But unlike recent attempts to increase fares, the latest effort,
which affects more markets, is expected to hold because it is not
dependent on low-cost carriers playing along.
We are lucky to be served by a
low cost carrier! It keeps prices of
all carriers lower!
Oligopolies &
Duopolies
Slide 45 of 49

46. In some cases, oligopolists collude
If firms (secretly) agree to
match prices (i.e. collude)
they can operate on this
portion of the demand curve
$100
1,000
$120
900300
If firms collude and agree
to match price increases,
then a $20 increase here
causes a loss of only 100
customers instead of
700!
Oligopolies &
Duopolies
Slide 46 of 49

47. So why don’t firms collude?
Obstacle Comment
Number of firms It is harder for 5 firms to
collude than it is for 3 firms.
Cheating A colluding firm may agree to a
price increase then cheat, lower
prices and capture customers.
Firm entry Keeping prices high invites new
firms to enter into competition.
It is ILLEGAL!
That doesn’t stop
people though!
Oligopolies &
Duopolies
Cheating
+$10
Slide 47 of 49

48. What happens if you collude
and get caught?
Four Wisconsin road construction executives were arrested in
2004 on bid rigging and wire fraud charges for participating in
a conspiracy involving projects let by Wisconsin’s Department
of Transportation
The projects, which included public road, highway, bridge, street
and airport construction, were worth more than $100 million
to the state.
The Justice Department alleged that in telephone calls and in-
person meetings, the executives shared bid information,
discussed potential competitors and agreed to rig bids in an
attempt to allocate projects among themselves.
In the end, they pled guilty.
$30 million in fines were appropriated
3 were jailed
1 was given house arrest
All were forbidden to bid on state or federal projects forever
Oligopolies &
Duopolies
Slide 48 of 49

49. A summary of characteristics of
different market structures
We have now outlined all our market structure
characteristics. Be sure you know these. Many questions
on the next test could come directly from this table.
Slide 49 of 49

50. Credits
Slide 8 - http://www.flickr.com/photos/mpd01605/3940236658/
Slide 9 - http://www.flickr.com/photos/10542402@N06/7334081170/ and
http://commons.wikimedia.org/wiki/File:Food_Lion_University_Dr_Durham,_NC.jpg
Slide 11 and 12 - http://www.flickr.com/photos/noiseprofessor/8249316836/
http://commons.wikimedia.org/wiki/File:Burger_King_Paa_Karl_Johan.jpg
http://vipulbansal.deviantart.com/art/Volvo-logo-290965038
Slide 23 - http://commons.wikimedia.org/wiki/File:Philip_D_Armour_in_the_1880s.jpg
Slide 34 - http://www.flickr.com/photos/normantan/3217802586/
Slide 42 - http://pixabay.com/en/man-guy-chair-person-cartoon-40093/
Slide 50 of 49