The Theory of Imperfect Competition Monopolistic competition A special case of oligopoly Two key assumptions are made to get around the problem of interdependence Each firm is assumed to be able to differentiate its product from its rivals Each firm is assumed to take the prices charged by its rivals as given Copyright C 2003 Pearson Education, Inc Slide 6-16
Copyright © 2003 Pearson Education, Inc. Slide 6-16 • Monopolistic competition – A special case of oligopoly – Two key assumptions are made to get around the problem of interdependence: – Each firm is assumed to be able to differentiate its product from its rivals. – Each firm is assumed to take the prices charged by its rivals as given. The Theory of Imperfect Competition
The Theory of Imperfect Competition Are there any monopolistically competitive industries in the real world? Some industries may be reasonable approximations(e. g the automobile industry in Europe) The main appeal of the monopolistic competition model is not its realism, but its simplicity Copyright C 2003 Pearson Education, Inc Slide 6-17
Copyright © 2003 Pearson Education, Inc. Slide 6-17 • Are there any monopolistically competitive industries in the real world? – Some industries may be reasonable approximations (e.g., the automobile industry in Europe) – The main appeal of the monopolistic competition model is not its realism, but its simplicity. The Theory of Imperfect Competition
The Theory of Imperfect Competition Assumptions of the Model Imagine an industry consisting of a number of firms producing differentiated products We expect a firm To sell more the larger the total demand for its industrys product and the higher the prices charged by its rivals To sell less the greater the number of firms in the industry and the higher its own price Copyright C 2003 Pearson Education, Inc Slide 6-18
Copyright © 2003 Pearson Education, Inc. Slide 6-18 • Assumptions of the Model – Imagine an industry consisting of a number of firms producing differentiated products. – We expect a firm: – To sell more the larger the total demand for its industry’s product and the higher the prices charged by its rivals – To sell less the greater the number of firms in the industry and the higher its own price The Theory of Imperfect Competition
The Theory of Imperfect Competition A particular equation for the demand facing a firm that has these properties is Q=SX[1/m-b×(P-P) (6-5) where O is the firms sales S is the total sales of the industry n is the number of firms in the industry b is a constant term representing the responsiveness of a firm's sales to its price P is the price charged by the firm itself -p is the average price charged by its competitors Copyright C 2003 Pearson Education, Inc Slide 6-19
Copyright © 2003 Pearson Education, Inc. Slide 6-19 where: – Q is the firm’s sales – S is the total sales of the industry – n is the number of firms in the industry – b is a constant term representing the responsiveness of a firm’s sales to its price – P is the price charged by the firm itself –A particular equation for the demand facing a firm that has these properties is: Q = S x [1/n – b x (P – P)] (6-5) The Theory of Imperfect Competition –P is the average price charged by its competitors
The Theory of Imperfect Competition Market Equilibrium All firms in this industry are symmetric The demand function and cost function are identical for all rms The method for determining the number of firms and the average price charged involves three steps We derive a relationship between the number of firms and the average cost of a typical firm We derive a relationship between the number of firms and the price each firm charges We derive the equilibrium number of firms and the average price that firms charge Copyright C 2003 Pearson Education, Inc Slide 6-20
Copyright © 2003 Pearson Education, Inc. Slide 6-20 • Market Equilibrium – All firms in this industry are symmetric – The demand function and cost function are identical for all firms. – The method for determining the number of firms and the average price charged involves three steps: – We derive a relationship between the number of firms and the average cost of a typical firm. – We derive a relationship between the number of firms and the price each firm charges. – We derive the equilibrium number of firms and the average price that firms charge. The Theory of Imperfect Competition