Imperfect Markets, Imperfect Competition and Basic Model

Abstract

This paper has focused on static environments or on single-agent dynamic decision problems. Many economic policy debates, however, turn on quantities that are inherently linked to dynamic competition, such as entry and exit costs, the returns to advertising or research and development, the adjustment costs of investment, or the speed of firm and consumer training. Estimating these dynamic parameters has been seen as a major challenge, both conceptually and computationally. In the perfectly competitive markets, the firms do not perceive they have any market power. Imperfect competition is a market situation where individual firms have a measure of control over the price of the commodity in an industry. In these conditions we can identify a firm or e few firms that can affect the market price of their outputs. These firms can be classified as imperfect competitors. Normally, imperfect competition arises when an industry's output is supplied only by one, or a relatively small number of firms. Profit-maximizing firms in an imperfectly competitive market will charge a mark-up of price over marginal costs. The size of the mark-up depends on the price elasticity of demand and on the degree of competition, such that an increase in the number of firms reduces the mark-up. In a general equilibrium setting, imperfect competition leads to a sub-optimal outcome (a deviation between MRS and MRT). Since international trade increases market competition, as foreign firms start to compete on the domestic market and vice versa, international trade improves economic efficiency (by diminishing the deviation between MRS and MRT), the so-called pro-competitive gains from trade. A basic model for imperfect markets is given for two firms, firm 1 and firm 2. We develop a model of advertising in a differentiated duopoly in which firms first decide how much to invest in cooperative or predatory advertising and then engage in product market competition (Cournot or Bertrand).

DOI: 10.5901/mjss.2014.v5n16p706