Study Guide to Man, Economy, and State with Power and Market

128 Study Guide to Man, Economy, and State with Power and Market
the market. Moreover, in practice unions often rely on
the actual use (or at least threat) of violence to achieve
such “bargains” with management.
5. The Theory of Monopolistic or Imperfect
Competition
A. Monopolistic Competitive Price
The crucial characteristic of a “perfectly competitive”
industry is that each firm perceives the demand for
its product as a horizontal (i.e., perfectly elastic) line. Yet
this is clearly absurd; even in theory, all demand curves
must be downward sloping (though they may possess
vertical drops). Another alleged difference is that perfectly
competitive firms may disregard the response of
their competitors to their own pricing and output decisions,
whereas an oligopolist cannot. But this too is spurious:
The demand curve, by definition, relates hypothetical
prices to the quantities consumers will purchase.
If lowering the price causes rivals to react in a certain
way, the demand curve already contains this information.
B. The Paradox of Excess Capacity
Because of low entry barriers, in the long run there is
zero economic profit in a monopolistically competitive
industry; at the equilibrium output level, each firm’s
price is just equal to average total cost. But because
demand curves are downward sloping, by simple geometry
this implies that each firm will set output at a level
below that which minimizes ATC. Apparently, then,
monopolistic competition leads to aggregate inefficiencies
in production.