Competition among the Few

A. Behavior of Imperfect Competitors

1. Recall the four major market structures: (a) Perfect competition is found when no firm is large enough to affect the market price. (b) Monopolistic competition occurs when a large number of firms produce slightly differentiated products. (c) Oligopoly is an intermediate form of imperfect competition in which an industry is dominated by a few firms. (d) Monopolycomes when a single firm produces the entire output of an industry.


2. Measures of concentration are designed to indicate the degree of market power in an imperfectly competitive industry. Industries which are more concentrated tend to have higher levels of R&D expenditures, but on average their profitability is not higher.


3. High barriers to entry and complete collusion can lead to collusive oligopoly. This market structure produces a price and quantity relation similar to that under monopoly.


4. Another common structure is the monopolistic competition that characterizes many retail industries. Here we see many small firms, with only slight differences in the characteristics of their products (such as different locations of gasoline stations or different types of breakfast cereals). Product differentiation leads each firm to face a downward-sloping demand curve as each firm is free to set its own prices. In the long run, free entry extinguishes profits as these industries show an equilibrium in which their AC curves are tangent to their demand curves. In this tangency equilibrium, prices are above marginal costs, but the industry exhibits greater diversity of quality and service than would occur under perfect competition.


5. A final situation recognizes the strategic interplay that is present when an industry has but a handful of firms. When a small number of firms compete in a market, they must recognize their strategic interactions. Competition among the few introduces a completely new feature into economic life: It forces firms to take into account competitors' reactions to price and output decisions and brings strategic considerations into these markets.


6. Price discrimination occurs when the same product is sold to different consumers at different prices. This practice often occurs when sellers can segment their market into different groups.

B. Game Theory

7. Economic life contains many situations with strategic interaction among firms, households, governments, or others. Game theory analyzes the way that two or more parties, who interact in an arena such as a market, choose actions or strategies that jointly affect all participants.


8. The basic structure of a game includes the players, who have different possible actions or strategies, and the payoffs, which describe the various possible profits or other benefits that the players might obtain under each outcome. The key new concept is the payoff table of a game, which displays information about the strategies and the payoffs or profits of the different players for all possible outcomes.


9. The key to choosing strategies in game theory is for players to think about their opponent's goals as well as their own, never forgetting that the other side is doing the same. When playing a game in economics or any other field, assume that your opponent will choose his or her best option. Then pick your strategy to maximize your benefit, always assuming that your opponent is similarly analyzing your options.


10. Sometimes a dominant strategy is available—one that is best no matter what the opposition does. More often, we find a Nash equilibrium (or noncooperative equilibrium), in which no player can improve his or her payoff as long as the other player's strategy remains unchanged.

C. Public Policies to Combat Market Power

11. Monopoly power often leads to economic inefficiency when prices rise above marginal cost, costs are bloated by lack of competitive pressure, and product quality deteriorates.


12. Economic regulation involves the control of prices, production, entry and exit conditions, and standards of service in a particular industry. The normative view of economic regulation is that government intervention is appropriate when there are major market failures. These include excess market power in an industry, an inadequate supply of information for consumers and workers, and externalities such as pollution. The strongest case for economic regulation comes in regard to natural monopolies. Natural monopoly occurs when average costs are falling for every level of output, so the most efficient organization of the industry requires production by a single firm.


13. Antitrust policy, prohibiting anticompetitive conduct and preventing monopolistic structures, is the primary way that public policy limits abuses of market power by large firms. This policy grew out of legislation like the Sherman Act (1890) and the Clayton Act (1914). The primary purposes of antitrust policy are (a) to prohibit anticompetitive activities (which include agreements to fix prices or divide up territories, price discrimination, and tie-in agreements) and (b) to break up illegal monopoly structures. In today's legal theory, such structures are those that have excessive market power (a large share of the market) and also engage in anticompetitive acts.


14. Legal antitrust policy has been significantly influenced by economic thinking during the last three decades. As a result, antitrust policy now focuses almost exclusively on improving efficiency and ignores earlier populist concerns with bigness itself.