Chapter 9 · Microeconomics
Decisions and Strategies for Firms in Imperfect Competition
Expand each section to revise: use the chevron to open and close. Printable in full by printing this page.
Profit in the short and long run
Supernormal profit persistence
- Monopoly and oligopoly can keep earning supernormal profit in the long run because barriers to entry protect them.
- Monopolistic competition earns only normal profit in the long run because entry is free.
Natural monopoly
- Average cost keeps declining over the range where P is at least ATC.
- One firm can supply the market more cheaply than several firms.
Kinked demand curve
- Rivals match price cuts but not price rises, giving the firm two demand elasticities.
- The resulting kink produces a vertical gap in marginal revenue, explaining price rigidity.
Growth strategies
Internal and external growth
- Internal expansion requires accumulated supernormal profit.
- Partnerships: firms cooperate without full integration.
- Merger: two firms combine to form a new entity.
- Acquisition (takeover): one firm takes over another.
- Horizontal integration: same industry and same stage, for example two social media platforms.
- Vertical integration: same industry but different stages, for example a distributor acquiring an animation studio.
Price discrimination
- Selling the same product at different prices for reasons other than cost.
- Conditions: market power, no resale between buyers, and different PEDs across sub-markets.
- Charge a higher price in the sub-market with more inelastic demand.
- Third-degree discrimination separates customers into distinct groups.
- A multi-price (discriminating) monopolist produces more output than a single-price monopolist.
- Difficulties: obtaining accurate PED data and preventing resale.
Limit vs predatory pricing
- Limit pricing sets a low price to keep potential competitors out.
- Predatory pricing cuts price to remove existing rivals from the market.
Competition and collusion
Non-price competition
- Product innovation shifts demand up.
- Process innovation lowers cost.
- High barriers to entry give firms the incentive to fund R&D.
- Marketing and branding can make demand more inelastic.
Collusion
- Explicit collusion: price fixing, production control and cartels.
- Tacit collusion: price leadership and market sharing by geography, size or customer type.
Responding to technology disruption
- Acquire the disruptive firm to absorb the threat.
- Invest in product innovation for core customers.
- Use process innovation to cut costs in response.
Evaluation Points
- Strategy choice depends on the height of barriers to entry and how contestable the market is.
- Price discrimination raises output but transfers surplus from consumers to the firm and raises equity concerns.
- Whether non-price competition is welfare-enhancing depends on whether claims are real or only imaginary differences.