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1. Monopolistic
Competition
Monopolistic competition satisfies
the following conditions:
-
like perfect competition in that there is a large number
of sellers so that the actions of one producer have no significant
effect on rivals;
-
like monopoly and oligopoly in that each seller faces a
negatively sloped demand curve for a 'distinctive' product; and,
-
each seller possesses some market power depending on the
elasticity of demand.
Under monopolistic competition, independence of producers
results from the 'attachment' of certain consumers to specific producers.
This affects price but to a lesser extent than under monopoly. In the
long-run, price equals average costs but marginal revenue equals marginal
cost. In theory monopolistic competition is considered inefficient because
price is higher and quantity supplied lower than under perfect
competition.
Monopolistic competition occurs in a market in which
product differentiation exists and which exhibits elements of both perfect
competition and monopoly. There are a large number of sellers of close
substitutes that are not exactly the same. Under these conditions it is
difficult to determine exactly what is the industry. Using the Chamberlain
Solution, it is assumed:
-
firms producing such differentiated goods can be
clustered into product groups;
-
the number of firms in the group is sufficiently large so
that each firm operates as if its actions had no effect on its rivals;
and,
-
demand and cost curves are the same for all firms in the
group.
Given that each firm's product is slightly different it
faces a negatively sloped demand curve or what is called a 'market niche'.
In effect, the industry demand curve is disaggregated into market
segments. The position of the demand
curve depends, however, on the price of other firm's output. Thus an
increase in the prices of rivals will shift the firm's demand curve up to
the right; a decrease would cause a shift to the left. In the short-run
equilibrium will be reached where marginal cost equals marginal revenue,
i.e. profit maximizing. In the long-run, however, firms are able to change
the scale of product and enter or leave the industry. Therefore
long-run equilibrium is reached where long-run average cost is tangent to
the demand curve and where marginal cost is equal to marginal revenue,
i.e. firms are maximizing profits. But because price is equal to
average cost, economic profits are zero. At this point there is no
incentive to entry and equilibrium is established (P&B 4th Ed. Fig.
14.2; 5th Ed. Fig. 13.2; 7th Ed
Fig. 14.1 &
Fig. 14.3;
R&L 13th Ed
Fig. 11-2).
2.
Oligopoly
Oligopoly satisfies the following conditions:
-
a small number of large firms that dominate the industry;
-
a competitive fringe of smaller firms; and,
-
actions of a producer perceptible to rivals, i.e.
interdependency of sellers whereby action of one results in reaction of
others.
In perfect competition and monopoly there exists a
determinant solution to a firm's price and output decision-making. When
there are only a few sellers, however, each firm recognizes that its best
choice depends on choices made by rivals. There are dozens of alternative
oligopoly pricing theories and some economists claim there is no
determinant solution. In an oligopolistic market there is usually price
stability because of the interdependence of sellers. Interdependence
results in 'game playing' behavior whereby suppliers act like players in a
game acting and reacting to the moves of their competitors. Competition
tends to take place on a secondary level of: product differentiation;
technological innovation; and, diversification, i.e. producing more than
one commodity. In theory, oligopoly is considered inefficient because
price is higher and quantity lower than under perfect competition.
a) Cournot Solution
The Cournot Solution proposes that firms choose an output
that will maximize profits assuming the output of rivals is fixed. The
solution concludes that there is a determinant and stable price-quantity
equilibrium that varies according to the number of sellers. In effect each
firm makes assumptions about its rival's output that are tested in the
market. Adjustment or reaction follows reaction until each firm
successfully guesses the correct output of its rivals.
A much more sophisticated and complex solution known as the
'Nash-Cournot'
equilibrium was proposed by
John Forbes Nash, the protagonist of the movie 'A Beautiful Mind'.
b)
Sweezy Kinked Demand Curve Solution
The Sweezy solution postulates that oligopolists face two
subjectively determined demand curves that assume:
A key assumption is that rivals will choose the alternative
least favorably to the initiator. If initiator raises p, rivals will not
follow; if lowers price everyone follows. The result is p will be
relative rigid in the face of moderate changes in cost or demand (P&B 4th Ed. Fig.
14.6; 5th Ed. Fig. 13.6;
7th Ed Fig. 15.2;
R&L 13th Ed not displayed).
c) Non-Price Competition
If price is rigid, there is no 'price competition'.
Instead, competition between oligopolists tends to take the form of what
is called 'non-price competition'. This includes product
differentiation, product innovation and game playing.
With respect to
product differentiation see my book review of:
McCracken, G.,
Culture and Consumption: New Approaches to the Symbolic Character of
Consumer Goods and Services, Indiana University Press,
Bloomington,
1988. Also see William Gibson's novel Pattern Recognition,
Berkley, 2003 for insight into the modern 'cool hunter'.
i - Product
Differentiation
Advertising is intended to persuade consumers – final or
intermediary – to buy a particular brand. Sometimes brands are
technically similarly but advertising can differentiate them in the
minds of consumers. Some brands are technically similar but
advertising can differentiate them in the consumer’s mind, e.g., Tide
vs. Cheer, effectively splitting off part of the industry demand curve
as its ‘owned’ share. In the Standard Model of economics only factual
product information qualifies as a legitimate expense. Attempting to
‘persuade’ or influence consumer taste is ‘allocatively inefficient’
betraying the principle of ‘consumer sovereignty’,
i.e., human wants, needs and desires is the root of the economic
process.
This mainstream view connects with consumer behaviour
research which calls this approach the ‘information processing’ model. A
consumer has a problem, a producer has the solution and the advertiser
brings them together. It is a calculatory process. An alternative
consumer behavior school of thought, ‘hedonics’ argues that people buy
products to fulfill fantasy, e.g., people do not buy a Rolls Royce for
transportation but rather for show (Holbrook & Hirschman 1982; Holbrook
1987). Thus product placement, i.e., placing a product in a socially
desirable context, enhances sales (McCracken 1988). In this regard the
proximity of Broadway and especially off- and off-off-Broadway (the
centre of live theatre) and Madison Ave. (the centre of the advertising
world) in New York City is no coincidence. Marketeers search the
artistic imagination for the latest ‘cool thing’, 'style', ‘wave’, etc.
Such pattern recognition is embodied in the new professional ‘cool
hunter’ (Gibson 2003). In fact peer-to-peer brand approval is an
artifact of the age.
Take the case of advertising biotechnology. The
‘advertising & marketing’ of GM products, specifically food vs.
medicine, highlights these divergent approaches. In reaching out to the
final consumer GM food advertising and marketing generally takes the
form of well researched and well meaning ‘risk assessments’. Such
cost-benefit analyses are presented to a public that generally finds
calculatory rationalism distasteful and the concept of probability
unintelligible, e.g., everyone knows the odds of winning the lottery yet
people keep on buying tickets. It would appear that the chances of
winning are over-rated. By contrast the even lower probability of losing
the GM ‘cancer’ sweepstakes are similarly over-rated. Attempts have been
made to place this question within the context of known/unknown
contingencies such as GM food safety within Kuhn’s ‘normal science’ (Khatchatourians
2002). The labeling debate also illustrates the ‘information processing’
view. At a minimum it would require all GM food products to be labeled
as such. At a maximum it would require that all GM food products be
traceable back to the actual field from which they grew.
While attempts have been made to highlight the health and
safety of GM foods little has been done to demonstrate that they ‘taste’
better. This may be the final hurdle, maybe not. Observers have noted,
however, that the GM agrifood industry has been rather inept in its
‘communication’ with the general public (Katz 2001). For whatever
reasons, to this point in the industry’s development, GM foods appear to
feed nightmares, a.k.a., Frankenfood, not fantasies in the mind of the
final consumer.
By contrast the ‘advertising & marketing’ of medical GM
products and services has fed the fantasies of millions with the hope
for cures to previously untreatable diseases and the extension of life
itself. Failed experiments do not diminish these hopes. Even religious
reservations appear more about tactics, e.g., the use of embryonic or
adult stem cells, rather than the strategy of using stem cells to cure
disease and extend life.
Given that intermediate rather than final demand
currently feeds the biotechnology sector one must also consider what
might be called ‘intermediate advertising & marketing’. Such activities
are conducted by trade associations and lobbyists. The audience is not
the consumer but rather decision makers in other industries and in
government. Such associations exist at both the national, e.g.,
BIOTECanada, and regional level, e.g.,
Ag.West Bio Inc.
Beyond advertising another technique to achieve product
differentiation in the minds of consumers is 'design'.
Robert H. Frank's economic guidebook
unlocks everyday design enigmas & on
YouTube a lecture at Google HQ
ii - Product
Innovation
With respect to product
innovation, in
lecture I will explore terms such as 'R&D', innovation and invention.
I will outline the
ideological controversy between perfect competition and oligopoly as
idealized outcome and driving force of change,
respectively.
See:
Schumpeter, J.A.,
Capitalism, Socialism and Democracy [1942; 1950], Harper Torchbooks, New York, 1962.
Chapter VII: The Process of
Creative Destruction
Chapter VIII - Monopolistic Practices
Prophet of Innovation: Joseph
Schumpeter and Creative Destruction - particularly important
because written by Solow, father of the 'Solow residual', i.e., Y
= (K, L, T)
Evolutionary Economics Wikpedia &
Association for Evolutionary Economics
iii - Game Playing
With respect to game playing the 'action-reaction' nature and the complexity of the
oligopoly and the rich variety of possible 'profit maximizing' outcomes
has led economics to 'spin off' a whole new field of thought called
Game Theory. Modern corporations and the military have adopted
various conceptual outputs of this field. Even the arts are involved in
that actors are often hired by businesses, governments, the military and
other institutions to 'role play' in games to hone the skills of various
personnel.
The impact upon the general public is also significant.
"Everyone plays games!"; "winners & losers"; "positive and negative sum
games". In many ways the contemporary ethos or zeitgeist is game
playing. For a brief history please see: AN OUTLINE OF THE HISTORY OF
GAME THEORY by Paul Walker
http://www.econ.canterbury.ac.nz/personal_pages/paul_walker/gt/hist.htm
In lecture, I will explore some games played by oligopolists such as
cartels, price fixing, 'patent wars' and 'copyright misuse'.
iv - Industrial Organization
IO is the brain-child of the late
Joe Bain. His seminal work - Industrial Organization - was published
in 1959 (Bain 1968). Using IO, Bain
began what has become an ongoing process within the economics profession of
linking macroeconomics (the study of the economy as a whole) to microeconomics
(consumer, producer and market theory) to better understand the way the ’real’
world works.
It
can be called ‘meso-economics’ in contrast to micro- and macro-economics.
It arguably is rooted in something called 'workable
competition'. This idea was introduced
by economist J.M. Clark in 1940. He argued that policy should make competition
"workable," not perfect. Competition was workable if, among other things: the
number of firms are as large as economies of scale permit and promotional
expenses are not excessive and advertising is strictly informative, i.e., not
interfering with consumer sovereignty. In effect all agencies that administer
competition policy employ some version of 'workable competition'.
The IO Model itself takes the industry as
the basic unit of analysis. In effect it
is a taxonomy or classification system with limited predictive power. Its essential prediction is that Basic
Condition in an industry determines its Structure that in turn determines the
Conduct of its firms that then determines the collective Performance of firms
in the industry.
The IO schema (Exhibit 1 &
1a) thus consists of four
parts. First, basic conditions
face an industry on the supply- (production) and demand-side (consumption) of
the economic equation. Second, an
industry has a Structure or organizational character, the primary elements of
which are barriers to entry, the number and size distribution of firms, product
differentiation, and the overall elasticity of demand. Third, firms in an industry tend to
follow typical patterns of Conduct or behavior in adapting and adjusting to a
specific but ever changing and evolving marketplace. Key variables in Conduct include pricing,
advertising, capacity, legal tactics and quality of output.
In policy terms, Conduct reflects the strategy of the firm in an industry.
Fourth,
an industry achieves varying levels of Performance with respect to contemporary
socio-economic-political goals defined broadly to include social performance,
allocative efficiency (profitability), technical efficiency (cost
minimization), and innovativeness.
We will also use four elemental
economic terms. First, buyers and
sellers exchange of goods and services in markets - geographic and/or
commodity-based. Second, an
enterprise is any entity engaging in productive activity - with or without the
hope of making a profit. This includes
profit, nonprofit and public enterprise as well as self-employed individuals. All enterprises have scarce resources and are
accountable to shareholders and/or the public and the courts. An enterprise is defined in terms of total
assets and operations controlled by a single management empowered by a common
ownership. Third, an industry is
a group of sellers of close-substitutes to a common group of buyers, e.g. the automobile industry. Fourth, a sector is a group of related
industries, e.g. the automobile,
airline and railway industries form part of the transportation sector. Often, as herein, ‘sector’ and ‘industry’ are
used interchangeably, for example - the biotechnology industry or sector.
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