Imperfect competition with entry/exit 1 Falafel vendors on the - PDF document

P1 Sep–Oct 2012 • Timothy Van Zandt • Prices & Markets Page 1 Session 13-Bis • Imperfect competition with entry/exit Imperfect competition with entry/exit 1 Falafel vendors on the beach of Beirut 2 h c a e B Yen Ling Harry Cheng Charlie Jennie Weiwen Inês Vivek Anjum

P1 Sep–Oct 2012 • Timothy Van Zandt • Prices & Markets Page 2 Session 13-Bis • Imperfect competition with entry/exit A metaphor for product attributes … 3 Cardiovascular improvements Fewer administrations Rheumatoid arthritis market (2008) 4 Golimumab Remicade Humira Kineret Orencia Enbrel Cimzia

P1 Sep–Oct 2012 • Timothy Van Zandt • Prices & Markets Page 3 Session 13-Bis • Imperfect competition with entry/exit For fixed firms, price competition … 5 Firm A P B 50 Firm B 40 30 20 10 10 20 30 40 50 P A … or quantity competition 6 Q 2 800 600 400 200 200 400 600 800 Q 1

P1 Sep–Oct 2012 • Timothy Van Zandt • Prices & Markets Page 4 Session 13-Bis • Imperfect competition with entry/exit What does entry do to prices, volumes, var. profits? 7 Numerical example: Cournot 8 • Market demand curve: Q = 1500 − 50 P • Constant MC = 10 . Then I calculate the Nash equilibrium for any number N of firms.

P1 Sep–Oct 2012 • Timothy Van Zandt • Prices & Markets Page 5 Session 13-Bis • Imperfect competition with entry/exit Entry: prices, volumes, variable profits 9 Q = 1500 - 50P || P = 30 - Q/50 Number Total Output Profit per Price of firms Output per firm firm 1 500 20.00 500 5,000 2 667 16.67 333 2,222 3 750 15.00 250 1,250 4 800 14.00 200 800 5 833 13.33 167 556 6 857 12.86 143 408 7 875 12.50 125 313 8 889 12.22 111 247 9 900 12.00 100 200 10 909 11.82 91 165 11 917 11.67 83 139 12 923 11.54 77 118 13 929 11.43 71 102 14 933 11.33 67 89 15 938 11.25 63 78 What happens if FC falls? 10 Before entry of new firms? After entry of new firms?

P1 Sep–Oct 2012 • Timothy Van Zandt • Prices & Markets Page 6 Session 13-Bis • Imperfect competition with entry/exit All firms have Numerical example with free entry 11 same fixed cost Q = 1500 - 50P || P = 30 - Q/50 Number Total Output Profit per Price of firms Output per firm firm 1 500 20.00 500 5,000 2 667 16.67 333 2,222 3 750 15.00 250 1,250 4 800 14.00 200 800 FC 350 1000 5 833 13.33 167 556 6 857 12.86 143 408 6 3 N ∗ 7 875 12.50 125 313 8 889 12.22 111 247 12.86 15.00 P ∗ 9 900 12.00 100 200 10 909 11.82 91 165 11 917 11.67 83 139 12 923 11.54 77 118 13 929 11.43 71 102 14 933 11.33 67 89 15 938 11.25 63 78 Let’s try again, this time using insights from IC+FE 12 Q: Why do pharmaceutical companies charge so much for AIDS medicine? A: Because they have to recover R&D expenses. Higher R&D expenses do lead to higher prices, but … Not because any firm takes them into account when setting prices. Instead, because the higher R&D expenses limit entry. The resulting lack of competition is what leads to higher prices.

P1 Sep–Oct 2012 • Timothy Van Zandt • Prices & Markets Page 7 Session 13-Bis • Imperfect competition with entry/exit How does this change if … 13 an article is published extolling the virtues of eating falafel? Firm A P B 50 Firm B 40 30 20 10 10 20 30 40 50 P A How does this change if … 14 market size grows, but composition does not change, and firms have constant MC? Firm A P B 50 Firm B 40 30 20 10 10 20 30 40 50 P A

P1 Sep–Oct 2012 • Timothy Van Zandt • Prices & Markets Page 8 Session 13-Bis • Imperfect competition with entry/exit Wrap up: 15 Imperfect competition with entry and exit 1. Entry has two effects on profit: • smaller market shares • greater competitive pressure on prices 2. Higher FC ⇒ less entry ⇒ less intense competition ⇒ higher prices (Even though no firm bases pricing on its fixed cost.) 3. Increase in market volume ⇒ more entry ⇒ lower prices