Unit 4 Overview: Imperfect Competition
6 min read•december 21, 2022
Unit 4 Overview: Imperfect Competition
Unit 4 is hard.
Unit 4 is confusing.
Unit 4 earns 5s.
-a Micro Haiku
Do not push into Unit 4 until you are comfortable with Unit 3, especially 3.7. Don't be afraid to go back and review Perfect Competition graphs and concepts before proceeding into . Make sure you have memorized Unit 3 cost calculations and graphs in the short-run and long run. Plan to take your time in Unit 4. It's well worth your time and effort to get this right because this section WILL appear on the SAQs. Remember to click on the section hyperlinks for a more detailed explanation of the topics.
Unit 3 covered perfectly competitive markets. However, unit 4 turns that on its head by removing some of the assumptions of perfect competition. What happens when there aren't many firms? What happens when barriers to entry exist? What happens when there are differentiated products? Different answers to these questions will give rise to our main market structures in this unit:
1. Monopolies / /
2.
3.
4.1 Introduction to Imperfectly Competitive Markets
4.1 reminds you of your friendly, perfect competition market structures, and then it breaks it. While the perfect competition market structure allows everyone to play on the playground, market structures put up fences and charge for admission with Barriers to Entry (geography, common use, government, and economies of scale).
There's a legitimate reason why you can open up a competing waste disposal company to compete against the municipal company, but it means you won't make that sweet profit either. 4.1 is going to give you the characteristics of market structures. In general, firms can sometimes make a long-run if there is less competition because firms get to be "" and can utilize tactics (such as advertising).
The big takeaway is that all of the imperfect market structures are inefficient. There will always be with one big exception (4.3).
Graphs Learned:
None...yet.
4.2 Monopolies
And here we go… A monopoly is a market structure where there is only one firm producing a product. The firm IS the Industry! They keep the competition out with super high barriers to entry and can earn in the long run. In some cases, a monopoly is the result of a government decision. You don't want a ton of power plants producing because that will impact the environment. Thus, the government may award a company a natural monopoly to keep costs low. We'll be revisiting this idea in Unit 6. Sometimes, the government can create a monopoly by awarding an individual or company a , and they become the sole producer of a unique product.
What keeps a monopolist from charging outrageous prices? For example, Luxottica has a monopoly on eyeglasses frames and is the price maker, yet most people can still afford glasses. The price-makers set the prices higher than they could be (glasses are expensive!), but not so expensive that most people can't have them. Because at the end of the day, the monopolist still needs you to buy their product, which means the MR line will not equal the Demand curve.
MR. DARP has been chopped in two! We now have MR and DARP. If glasses become too expensive, consumers will find substitutes or go without, so the monopolist produces just enough to maximize profit (MR=MC), BUT they raise the price from the profit maximization point to the Demand curve! This means a regular monopoly will be both productively inefficient AND allocatively inefficient.
Graphs Learned:
Monopoly (take your time on this!)
Natural Monopoly (revisited in Unit 6)
4.3 Price Discrimination
When we go to buy something, we typically have a price range in mind. When you go to a food truck to buy a taco, you know that the taco could be as low as $2 and as high as $10. If you see the price is $12.95, you'll walk away from the truck and leave them a lousy review on Yelp! What if the monopolist could see into your mind and know the upper limits of what you are willing to pay and adjust the price before you arrived? You walk up to the truck and see the taco will cost you $10. You aren't happy about it, but you get the taco, and the monopolists receive the profit.
The described happens in specific industries because everyone pays a different price for the same good. Pretty cool trick, right? To pull it off, the monopolist must keep a few rules.
Go to have a monopoly- otherwise, people can easily go to your competitor.
You have to be able to segregate your market (i.e., make purchase negotiations private). No one knows the price the other person paid.
The item can't be resold.
Price will equal D, which means no . The big loss is the consumer surplus. A price discriminating monopoly will not have any consumer surplus!
Graphs Learned:
Price discriminating monopoly
4.4 Monopolistic Competition
While the name would suggest monopoly, this market structure functions closer to perfect competition than the other imperfect market structures. These industries are still inefficient , yet they have lower barriers to entry, differentiated products and will break even in the long run. They have aspects of both perfect competition AND monopolies. Think fast-food burgers, for example.
It is relatively affordable to open a fast-food franchise compared to opening a nuclear power plant; everyone may sell the same products, BUT they are not identical. Each company has its own spin on burgers, fries, and drinks. Some make their burger patties square, some make giant stacks of meat and cheese on them, some do a different direction and make the burger out of chicken or plant-based materials. How do you compete when your products differ? Advertise (AKA )
"I'm lovin' it!"
"Where's the beef?"
"Pizza, Pizza!"
"Eat Mor Chikin"
will be lodged in your head much longer than economics, but at least they will help you understand how this market structure functions.
Graphs Learned:
4.5 Oligopoly and Game Theory
An oligopoly's graph is so confusing that AP doesn't require you to know it. An oligopoly functions like a monopoly, but it's a small group (less than 10) of companies that make the price. It's usually a group of less than ten, and they are frenemies. They are competing against each other yet also work together in some ways to keep others out. Think of the airline industry in the USA.
There are maybe 5 to 6 airlines that all own major hubs and dominate the market. They can't directly work together to control the price. That's called collusion and is illegal in most nations. We see collusion in other markets, like the illegal drug market, where cartels work together to control prices. The we will be studying, however, are non-colliding .
Non-colluding can't directly work together to control prices, but they can make educated guesses about what the other companies will do and plan to react. This decision-making process is called Game Theory. In-game theory, we are looking to see if any of the companies have a dominant strategy. It can be tricky at first, but most micro students consider this their strongest aspect of Unit 4.
Graphs Learned:
Game Theory Matrix + Nash Equilibrium +
Key Terms to Review (15)
Advertising Jingles
: Advertising jingles are catchy tunes or songs that are used in commercials to promote a product or brand. They are designed to be memorable and create a positive association with the product.DARP (Demand, Average Revenue, Price)
: DARP is an acronym that represents the relationship between demand, average revenue, and price in microeconomics. Demand refers to the quantity of a good or service that consumers are willing and able to buy at a given price. Average revenue is the total revenue divided by the quantity sold, while price is the amount of money charged for a product or service.Deadweight Loss
: Deadweight loss refers to the economic inefficiency that occurs when the allocation of goods and services is not at the socially optimal point, resulting in a loss of total surplus.Dominant Strategies
: Dominant strategies refer to the best course of action for a player in a game, regardless of what other players do. It is the strategy that yields the highest payoff for a player, no matter what choices others make.Economic profit
: Economic profit refers to the total revenue earned by a firm minus both explicit and implicit costs. It measures the profitability of a business after considering all costs, including opportunity costs.Imperfect Competition
: Imperfect competition refers to a market structure where there are multiple sellers and buyers, but they have some degree of control over the price and quantity of goods or services. This means that firms can differentiate their products or manipulate prices to gain an advantage.Monopolistic Competition
: Monopolistic competition refers to a market structure where there are many sellers offering differentiated products that are similar but not identical. Each firm has some degree of control over its own pricing.MR (Marginal Revenue)
: Marginal revenue represents the change in total revenue resulting from selling one additional unit of a good or service. It is calculated by dividing the change in total revenue by the change in quantity sold.Natural Monopolies
: Natural monopolies occur when a single firm can efficiently serve the entire market due to high fixed costs and economies of scale. This means that it is more cost-effective for one company to provide the goods or services rather than multiple firms competing.Non-price competition
: Non-price competition refers to strategies used by firms to attract customers without changing the price of their products or services. This can include advertising, product differentiation, customer service, and other marketing techniques.Oligopolies
: Oligopolies are market structures characterized by a small number of large firms that dominate the industry. These firms have significant control over prices and can influence market outcomes.Patent
: A patent is an exclusive legal right granted by the government that gives inventors protection over their inventions or discoveries for a specific period of time. It prevents others from making, using, or selling the patented invention without permission.Price Discrimination
: Price discrimination refers to the practice of charging different prices for the same product or service based on various factors such as location, age, or willingness to pay. It allows businesses to maximize their profits by extracting more value from customers who are willing to pay higher prices.Price makers
: Price makers are firms or individuals that have the ability to set the price of a product or service in the market. They have control over the supply and demand conditions, allowing them to influence prices.Price-Discriminating Monopolies
: Price-discriminating monopolies are firms that charge different prices for their products based on individual customers' willingness to pay. They have the ability and market power to segment consumers into different groups and charge higher prices to those who are willing and able to pay more.Unit 4 Overview: Imperfect Competition
6 min read•december 21, 2022
Unit 4 Overview: Imperfect Competition
Unit 4 is hard.
Unit 4 is confusing.
Unit 4 earns 5s.
-a Micro Haiku
Do not push into Unit 4 until you are comfortable with Unit 3, especially 3.7. Don't be afraid to go back and review Perfect Competition graphs and concepts before proceeding into . Make sure you have memorized Unit 3 cost calculations and graphs in the short-run and long run. Plan to take your time in Unit 4. It's well worth your time and effort to get this right because this section WILL appear on the SAQs. Remember to click on the section hyperlinks for a more detailed explanation of the topics.
Unit 3 covered perfectly competitive markets. However, unit 4 turns that on its head by removing some of the assumptions of perfect competition. What happens when there aren't many firms? What happens when barriers to entry exist? What happens when there are differentiated products? Different answers to these questions will give rise to our main market structures in this unit:
1. Monopolies / /
2.
3.
4.1 Introduction to Imperfectly Competitive Markets
4.1 reminds you of your friendly, perfect competition market structures, and then it breaks it. While the perfect competition market structure allows everyone to play on the playground, market structures put up fences and charge for admission with Barriers to Entry (geography, common use, government, and economies of scale).
There's a legitimate reason why you can open up a competing waste disposal company to compete against the municipal company, but it means you won't make that sweet profit either. 4.1 is going to give you the characteristics of market structures. In general, firms can sometimes make a long-run if there is less competition because firms get to be "" and can utilize tactics (such as advertising).
The big takeaway is that all of the imperfect market structures are inefficient. There will always be with one big exception (4.3).
Graphs Learned:
None...yet.
4.2 Monopolies
And here we go… A monopoly is a market structure where there is only one firm producing a product. The firm IS the Industry! They keep the competition out with super high barriers to entry and can earn in the long run. In some cases, a monopoly is the result of a government decision. You don't want a ton of power plants producing because that will impact the environment. Thus, the government may award a company a natural monopoly to keep costs low. We'll be revisiting this idea in Unit 6. Sometimes, the government can create a monopoly by awarding an individual or company a , and they become the sole producer of a unique product.
What keeps a monopolist from charging outrageous prices? For example, Luxottica has a monopoly on eyeglasses frames and is the price maker, yet most people can still afford glasses. The price-makers set the prices higher than they could be (glasses are expensive!), but not so expensive that most people can't have them. Because at the end of the day, the monopolist still needs you to buy their product, which means the MR line will not equal the Demand curve.
MR. DARP has been chopped in two! We now have MR and DARP. If glasses become too expensive, consumers will find substitutes or go without, so the monopolist produces just enough to maximize profit (MR=MC), BUT they raise the price from the profit maximization point to the Demand curve! This means a regular monopoly will be both productively inefficient AND allocatively inefficient.
Graphs Learned:
Monopoly (take your time on this!)
Natural Monopoly (revisited in Unit 6)
4.3 Price Discrimination
When we go to buy something, we typically have a price range in mind. When you go to a food truck to buy a taco, you know that the taco could be as low as $2 and as high as $10. If you see the price is $12.95, you'll walk away from the truck and leave them a lousy review on Yelp! What if the monopolist could see into your mind and know the upper limits of what you are willing to pay and adjust the price before you arrived? You walk up to the truck and see the taco will cost you $10. You aren't happy about it, but you get the taco, and the monopolists receive the profit.
The described happens in specific industries because everyone pays a different price for the same good. Pretty cool trick, right? To pull it off, the monopolist must keep a few rules.
Go to have a monopoly- otherwise, people can easily go to your competitor.
You have to be able to segregate your market (i.e., make purchase negotiations private). No one knows the price the other person paid.
The item can't be resold.
Price will equal D, which means no . The big loss is the consumer surplus. A price discriminating monopoly will not have any consumer surplus!
Graphs Learned:
Price discriminating monopoly
4.4 Monopolistic Competition
While the name would suggest monopoly, this market structure functions closer to perfect competition than the other imperfect market structures. These industries are still inefficient , yet they have lower barriers to entry, differentiated products and will break even in the long run. They have aspects of both perfect competition AND monopolies. Think fast-food burgers, for example.
It is relatively affordable to open a fast-food franchise compared to opening a nuclear power plant; everyone may sell the same products, BUT they are not identical. Each company has its own spin on burgers, fries, and drinks. Some make their burger patties square, some make giant stacks of meat and cheese on them, some do a different direction and make the burger out of chicken or plant-based materials. How do you compete when your products differ? Advertise (AKA )
"I'm lovin' it!"
"Where's the beef?"
"Pizza, Pizza!"
"Eat Mor Chikin"
will be lodged in your head much longer than economics, but at least they will help you understand how this market structure functions.
Graphs Learned:
4.5 Oligopoly and Game Theory
An oligopoly's graph is so confusing that AP doesn't require you to know it. An oligopoly functions like a monopoly, but it's a small group (less than 10) of companies that make the price. It's usually a group of less than ten, and they are frenemies. They are competing against each other yet also work together in some ways to keep others out. Think of the airline industry in the USA.
There are maybe 5 to 6 airlines that all own major hubs and dominate the market. They can't directly work together to control the price. That's called collusion and is illegal in most nations. We see collusion in other markets, like the illegal drug market, where cartels work together to control prices. The we will be studying, however, are non-colliding .
Non-colluding can't directly work together to control prices, but they can make educated guesses about what the other companies will do and plan to react. This decision-making process is called Game Theory. In-game theory, we are looking to see if any of the companies have a dominant strategy. It can be tricky at first, but most micro students consider this their strongest aspect of Unit 4.
Graphs Learned:
Game Theory Matrix + Nash Equilibrium +
Key Terms to Review (15)
Advertising Jingles
: Advertising jingles are catchy tunes or songs that are used in commercials to promote a product or brand. They are designed to be memorable and create a positive association with the product.DARP (Demand, Average Revenue, Price)
: DARP is an acronym that represents the relationship between demand, average revenue, and price in microeconomics. Demand refers to the quantity of a good or service that consumers are willing and able to buy at a given price. Average revenue is the total revenue divided by the quantity sold, while price is the amount of money charged for a product or service.Deadweight Loss
: Deadweight loss refers to the economic inefficiency that occurs when the allocation of goods and services is not at the socially optimal point, resulting in a loss of total surplus.Dominant Strategies
: Dominant strategies refer to the best course of action for a player in a game, regardless of what other players do. It is the strategy that yields the highest payoff for a player, no matter what choices others make.Economic profit
: Economic profit refers to the total revenue earned by a firm minus both explicit and implicit costs. It measures the profitability of a business after considering all costs, including opportunity costs.Imperfect Competition
: Imperfect competition refers to a market structure where there are multiple sellers and buyers, but they have some degree of control over the price and quantity of goods or services. This means that firms can differentiate their products or manipulate prices to gain an advantage.Monopolistic Competition
: Monopolistic competition refers to a market structure where there are many sellers offering differentiated products that are similar but not identical. Each firm has some degree of control over its own pricing.MR (Marginal Revenue)
: Marginal revenue represents the change in total revenue resulting from selling one additional unit of a good or service. It is calculated by dividing the change in total revenue by the change in quantity sold.Natural Monopolies
: Natural monopolies occur when a single firm can efficiently serve the entire market due to high fixed costs and economies of scale. This means that it is more cost-effective for one company to provide the goods or services rather than multiple firms competing.Non-price competition
: Non-price competition refers to strategies used by firms to attract customers without changing the price of their products or services. This can include advertising, product differentiation, customer service, and other marketing techniques.Oligopolies
: Oligopolies are market structures characterized by a small number of large firms that dominate the industry. These firms have significant control over prices and can influence market outcomes.Patent
: A patent is an exclusive legal right granted by the government that gives inventors protection over their inventions or discoveries for a specific period of time. It prevents others from making, using, or selling the patented invention without permission.Price Discrimination
: Price discrimination refers to the practice of charging different prices for the same product or service based on various factors such as location, age, or willingness to pay. It allows businesses to maximize their profits by extracting more value from customers who are willing to pay higher prices.Price makers
: Price makers are firms or individuals that have the ability to set the price of a product or service in the market. They have control over the supply and demand conditions, allowing them to influence prices.Price-Discriminating Monopolies
: Price-discriminating monopolies are firms that charge different prices for their products based on individual customers' willingness to pay. They have the ability and market power to segment consumers into different groups and charge higher prices to those who are willing and able to pay more.
Resources
© 2024 Fiveable Inc. All rights reserved.
AP® and SAT® are trademarks registered by the College Board, which is not affiliated with, and does not endorse this website.