Imperfectly competitive markets

 Perfectly competitive markets had the features we described

earlier. Imperfectly competitive markets may not have some, or
all, of these features:
Perfect information/ Imperfect
Homogeneous Products/ Heterogenous
All sellers and buyers are price takers/ not all price takers
Sellers and buyers cannot and thus do not behave
strategically/ strategy very important
Easy entry and exit/ barriers to entry and exit
Large number of small sellers and buyers/ dominance possible
Price Makers/ Finders

 Price finder: The firm chooses the price

 Within this there could be different market
structures:
– Monopolistic competition
– Oligopoly
– Monopoly
A numerical illustration

 We will first assume a perfectly competitive market

 Assume a given firm’s Total Cost function is given by
TC = 128+69Q -14Q2+Q3
 Assume price is 60, P = 60

 What is the optimal quantity to be produced?

 Should that optimal quantity be produced?
Optimum Q
 1.Derive the MC fn:
TC = 128+69Q -14Q2+Q3
MC = 69-28Q+3Q (1)2

 2.Derive the MR fn:

In this case TR=PQ, dTR/dQ=P Therefore, MR
which is equal to dTR/dQ is = P; and P=60.
MR = 60 (2) Do it!
 3. Equate MR to MC, solve for Q (quadratic
equation) and check for the second and third order
conditions
Optimum Q TC = 128+69Q -14Q2+Q3

 1.Derive the MC fn: 69-28Q+3Q2

 2.Derive the MR fn: In this case TR=PQ
dTR/dQ=P Therefore, MR which is equal to
dTR/dQ is = P; and P=60.
 3. Equate MR to MC, solve for Q (quadratic
equation) and check for the second order condition
 So, Q = 9
 Second Order Condition Check: - 28 + 6Q =
-28 + 54 = +26
Optimum Q

 4.To check if the seller should produce this level

of Q, plug this into the Average cost function
and see if price is greater than the
Average Economic Cost (AEC). Note AEC is
nothing but ATC but signifying that cost of
capital is also included
 AEC= ??
TC = 128+69Q -14Q +Q
2 3

 If P < AEC, SHUT DOWN Point.

Optimum Q

 4.To check if the seller should produce this

level of Q, plug this into the Average cost
function and see if price is greater than the
AEC
 AEC= 38.22 < price of 60
 Economic Profits = ?
Optimum Q

 4.To check if the seller should produce this

level of Q, plug this into the Average cost
function and see if price is greater than the
AEC
 AEC= 38.22 < price of 60
 Economic Profits = (60-38.22)*9 = 196.-> 0

Note: We are looking at a perfectly competitive market.

Therefore, in equilibrium the Economic Profits will be
driven down to zero
Dynamics

 In the short run this firm is making abnormal

economic profits, a situation that cannot
sustain in a price taker scenario
 However, for now we ignore the dynamics
that will set in and lead to new P* and
optimum Q etc (though we know finally at the
equilibrium economic profits will be equal to
zero)
Price Making/ Finding Scenario

 If the same story was set in a price finding

scenario, what would be the outcome?
Price Making/ Finding Scenario

 Since this is a price finding scenario, the firm

can influence the price through its own output
decisions
 Assume the demand curve for the firm is given
by: P=132-8Q
 Assume the TC function to be the same as
before TC = 128+69Q -14Q +Q
2 3

 How much should the firm produce?

Remember!

 In a linear demand curve, MR is equal to twice

the slope of D or AR.

 Eg: P = 132 – 8Q
 So MR = ?..dTR/dQ....
 TR = 132Q – 8Q2

 MR = 132 – 16Q
Optimum Q TC = 128+69Q -14Q2+Q3

 Following the steps mentioned earlier; MC=

69-28Q+3Q2
 TR= PQ; since P= 132-8Q, we have TR=
(132-8Q)*Q =132Q-8Q2
 MR=dTR/dQ= 132-16Q
 Equating MR to MC: 69-28Q+3Q2 = 132-16Q
 Solving for Q, we have Q =7
 And Economic Profits?
Perfect versus Imperfect
Competition

 Compare the two situations:

 Perfect Competition: Q=9; P=60;Profits=196
-> 0
 Imperfect Competition: Q=7; P=76;
Profits=264
 Output is higher, Price is lower and Profits
lower for the firm in perfect competition than
in a monopoly
You!

 If you were an entrepreneur, or a business

strategist, would you prefer to be in a price-
taking position or a price-making/ finding
position?
Perfect versus Imperfect
Competition

 What in the computation is making the Profits

higher in the price finding scenario?
Graphical presentation of the
optimum output for a price finder
Perfect versus Imperfect
Competition

 It is the divergence between MR and P that

makes profits higher in an imperfectly
competitive scenario
 So, if profits are to be maximized , the seller
needs to maximize the divergence
 What is this divergence a function of?
Perfect versus Imperfect
Competition

 Flatter the demand curve smaller The

divergence between MR and price.
 In the extreme when demand is horizontal,
divergence is zero since MR is equal to price
 Therefore steeper the demand curve greater
the divergence and greater the profits
 Further smaller the absolute value of price
elasticity, steeper the demand curve
 Thus smaller the elasticity, greater the
divergence and greater the profits.