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Dr. Harry Hillman Chartrand, PhD

©

Cultural Economist & Publisher

Compiler Press

Chief Economist

Cultural Econometrics

h.h.chartrand@compilerpress.ca

215 Lake Crescent

Saskatoon, Saskatchewan

Canada, S7H 3A1
Tele/Fax
306-244-6945

Curriculum Vitae

 

Launched  1998

 

 

Microeconomics

5.0 Competition

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:

  • rivals will maintain their prices; and, 

  • rivals will exactly match any price change. 

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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