Imperfect competition with exit/entry Session 13 Imperfect - PowerPoint PPT Presentation

Imperfect competition with exit/entry Session 13 • Imperfect competition Slide 1 P1 Sep–Oct 2012 • Timothy Van Zandt • Prices & Markets

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

A metaphor for product attributes … Cardiovascular improvements Fewer administrations Session 13 • Imperfect competition Slide 3 P1 Sep–Oct 2012 • Timothy Van Zandt • Prices & Markets

Rheumatoid arthritis market (2008) Golimumab Remicade Humira Kineret Orencia Enbrel Cimzia Session 13 • Imperfect competition Slide 4 P1 Sep–Oct 2012 • Timothy Van Zandt • Prices & Markets

For fixed firms, price competition … Firm A P B 50 Firm B 40 30 20 10 10 20 30 40 50 P A Session 13 • Imperfect competition Slide 5 P1 Sep–Oct 2012 • Timothy Van Zandt • Prices & Markets

… or quantity competition Q 2 800 600 400 200 200 400 600 800 Q 1 Session 13 • Imperfect competition Slide 6 P1 Sep–Oct 2012 • Timothy Van Zandt • Prices & Markets

What does entry do to prices, volumes, var. profits? Session 13 • Imperfect competition Slide 7 P1 Sep–Oct 2012 • Timothy Van Zandt • Prices & Markets

Numerical example: Cournot • Market demand curve: Q = 1500 − 50 P • Constant MC = 10 . Then I calculate the Nash equilibrium for any number N of firms. Session 13 • Imperfect competition Slide 8 P1 Sep–Oct 2012 • Timothy Van Zandt • Prices & Markets

Entry: prices, volumes, variable profits 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 Session 13 • Imperfect competition Slide 9 P1 Sep–Oct 2012 • Timothy Van Zandt • Prices & Markets

What happens if FC falls? Before entry of new firms? After entry of new firms? Session 13 • Imperfect competition Slide 10 P1 Sep–Oct 2012 • Timothy Van Zandt • Prices & Markets

All firms have Numerical example with free entry 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 14.00 200 800 350 1000 FC 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 Session 13 • Imperfect competition Slide 11 P1 Sep–Oct 2012 • Timothy Van Zandt • Prices & Markets

Let’s try again, this time using insights from IC+FE 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. Session 13 • Imperfect competition Slide 12 P1 Sep–Oct 2012 • Timothy Van Zandt • Prices & Markets

How does this change if … 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 Session 13 • Imperfect competition Slide 13 P1 Sep–Oct 2012 • Timothy Van Zandt • Prices & Markets

How does this change if … 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 Session 13 • Imperfect competition Slide 14 P1 Sep–Oct 2012 • Timothy Van Zandt • Prices & Markets

Wrap up: 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 Session 13 • Imperfect competition Slide 15 P1 Sep–Oct 2012 • Timothy Van Zandt • Prices & Markets