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ECW2731Weeks 7 & 8
Weeks 7 & 8
Competition, market structures and
business decisions
ECW2731Weeks 7 & 8
Examination structure
1. Exam duration 120 minutes writing time 2. Reading time 10 minutes 3. Total number of questions 5 4. Students must attempt all questions 5. Use of calculators is permitted
Please note, original hand written notes or computer printouts or photocopies are not permitted in the exam this year.
ECW2731Weeks 7 & 8
Examination structure
Section 1. (Microeconomic theory from the Managerial Perspective) – attempt
Q 1-4Four theoretical questions. May include discussion of examples. Brief
answers are expected including definitions and diagrams where approporiated and/or specifically asked for.
Section 2. (Research Question) –attempt only one question 5 or 6
5. “Discuss possible impact of the introduction of carbon emission trading scheme in Australia on the following industries:
Electricity generationCar manufacturing and importTourism and hospitalityForestry
6. Apply question 5 to any country of your choice.
ECW2731Weeks 7 & 8
Weeks 7-8Competition, market structures and business decisions
Weeks 7-8Competition, market structures and business decisions
Structure
ManagerialEconomics
ManagerialEconomics
Weeks 5 - 6Production and Costs
Weeks 5 - 6Production and Costs
Week 2Basic economics principles: demand and supply.
Week 2Basic economics principles: demand and supply.
Week1Introduction. The nature of managerial economic decision making
Week1Introduction. The nature of managerial economic decision making
Week 9Pricing strategies and practices
Week 9Pricing strategies and practices
Week 10Business and Government.
Week 10Business and Government.
Week 11Capital budgeting
Week 11Capital budgeting
Week. 12
Research question
Business and current economic situation.
Week. 12
Research question
Business and current economic situation.
Weeks 3-4Demand analysis and estimation
Weeks 3-4Demand analysis and estimation
ECW2731Weeks 7 & 8
What is the market Structure What is the market Structure
Competition, market structures and business decisions
Competition, market structures and business decisions
How does competition affect business decisions in different
market structures?
How does competition affect business decisions in different
market structures?
Perfect competition; monopoly; oligopoly; monopolistic
competition
Perfect competition; monopoly; oligopoly; monopolistic
competition
Competitive strategies. Competitive strategies.
Measurement of market structures Measurement of market structures
Market strategies in different market structures.
Market strategies in different market structures.
Non-price competition.Non-price competition.
Multinational companies. Vertical and horizontal coordination.
Multinational companies. Vertical and horizontal coordination.
Learning objectives Learning objectives
ECW2731Weeks 7 & 8
Competition, market structures and business decisionsCompetition, market structures and business decisions
ReadingReading
Hirschey, Chapters 10, 12, 13, & 14
ECW2731Weeks 7 & 8
7
Table 10.1 Characteristics of Market Types
Marketstructure
Examples
Number of
producers
Type of product
Power of firm over price
Barriers to
entry
Non-price competition
Perfect competitio
n
Parts of agriculture are
reasonably close
Many Standardized None Low None
Monopolistic
competition
Retail trade Many Differentiated Some LowAdvertising and
product differentiation
OligopolyComputers,
oil, steelFew
Standardized or
differentiatedSome High
Advertising and product
differentiation
Monopoly Public utilities OneUnique product
Consider-able
Very high
Advertising
ECW2731Weeks 7 & 8
Competition, market structures and business decisionsCompetition, market structures and business decisions
Market structures Market structures
What is the market structure?
• The competitive environment in the market for any product is the market structure faced by the firm– Is measured in terms of
• the number of the actual buyers and sellers plus potential entrants
• Barriers to entry and exit
• Capital requirements
• Price vs Non-price competition
• Etc
– Potential entrants pose a sufficiently credible threat of entry to affect price/output decisions of incumbents
ECW2731Weeks 7 & 8
Factors that Shape the Competitive Environment
• Product Differentiation– R&D, innovation, and advertising are important in
many markets.
• Production Methods– Economies of scale can preclude small-firm size.
• Entry and Exit Conditions– Barriers to entry and exit can shelter incumbents
from potential entrants.
• Buyer Power– Powerful buyers can limit seller power.
Competition, market structures and business decisionsCompetition, market structures and business decisions
Market structures Market structures
ECW2731Weeks 7 & 8
Competition, market structures and business decisionsCompetition, market structures and business decisions
Market structures Market structures
Perfect competition
Perfect competition
OligopolyOligopoly
The firm in competitive marketsThe firm in competitive markets
MonopolyMonopoly
Non-perfect competitionNon-perfect competition
Monopolistic competition
Monopolistic competition
ECW2731Weeks 7 & 8
Competition, market structures and business decisionsCompetition, market structures and business decisions
Market structures Market structures “Perfect competition” – competitive markets
Profit maximiser Identical product Very small share of the market Price-taker Produces a homogeneous product Perfect information No barriers to entry (legal, technological, or
resource) No technical progress No investment lag - Immediate implementation of
production decisions) Homogeneous goals of the owners and
managerial staff
ECW2731Weeks 7 & 8
• Examples of Competitive Markets– Agricultural commodities.– Some prominent markets for intermediate goods and
services.– Unskilled labor market.
Competition, market structures and business decisionsCompetition, market structures and business decisions
Market structures Market structures “Perfect competition” – competitive markets
ECW2731Weeks 7 & 8
• Profit Maximization Imperative– Normal profit is return necessary to attract and maintain
capital investment.– Efficient firms can earn normal profit.– Inefficient firms suffer losses.
• Role of Marginal Analysis– Set Mπ = MR – MC = 0 to maximize profits.– MR=MC when profits are maximized.
Competition, market structures and business decisionsCompetition, market structures and business decisions
Market structures Market structures “Perfect competition” – competitive markets
ECW2731Weeks 7 & 8
14
Profit maximization in a perfectly competitive market
• (see book)
• P = MC
• Marginal cost curve left of shutdown level (min. variable cost) is supply curve
• P = MR = MC = AC
• Firm produces at minimum of average costs! (optimal outcome for industry)
• In a constant-cost industry increase in supply will lead in the long term to constant prices (i.e. horizontal supply curve)
ECW2731Weeks 7 & 8
Competition, market structures and business decisionsCompetition, market structures and business decisions
Market structures Market structures “Perfect competition” – competitive markets
Marginal Cost and Firm Supply
Short-run Firm Supply– Competitive market
price (P) is shown as a horizontal line because P=MR.
– Firm’s marginal-cost curve shows the amount of output the firm would be willing to supply at any market price.
– Marginal cost curve is the short-run supply curve so long as P > AVC .
ECW2731Weeks 7 & 8
Long-run Firm SupplyMarginal cost
curve is the long-run supply curve so long as P > ATC.
In long run, firm must cover all necessary costs of production and earn a normal profit.
Competition, market structures and business decisionsCompetition, market structures and business decisions
Market structures Market structures “Perfect competition” – competitive markets
ECW2731Weeks 7 & 8
Competition, market structures and business decisionsCompetition, market structures and business decisions
Market structures Market structures “Perfect competition” – competitive markets
Long Run Normal Profit Equilibrium
With a horizontal market demand curve, MR=P.
P=MR=MC=ATC.
There are no economic profits.
All firms earn a normal rate of return.
ECW2731Weeks 7 & 8
Price, cost
Competition, market structures and business decisionsCompetition, market structures and business decisions
Market structures Market structures Perfect competition
Breakeven point
Output per time period
MC
ATC
AVC
0
D
B
per unit
Qoff peak
Q peak
Poff peak
Ppeak
Poff peak – break even price off peak. At this price the firm expects to return only variable costs and can produce quantity Qoff peak
Ppeak- break even price at peak. This is when the firm expects to return both fixed and variable costs producing
quantity Qpeak
ECW2731Weeks 7 & 8
Competitive Market Supply CurveMarket Supply With a Fixed Number
of Competitors
Supply is the sum of competitor output.
Market Supply With Entry and Exit
Entry results in more firms, increased output, a rightward shift in the supply curve, and drives down prices and profits.
Exit reduces the number of firms, decreases the quantity of output, shifts the supply curve leftward, and allows prices and profits to rise for remaining competitors.
Competition, market structures and business decisionsCompetition, market structures and business decisions
Market structures Market structures “Perfect competition” – competitive markets
ECW2731Weeks 7 & 8
Quantity per time period (millions)
10
8
6
4
2
0
Supply
50 100150200250300350400
Price per unit ($)
P = – $0.254 + $0.000025
Q
P = $40 – $0.0001Q
Demand
Competition, market structures and business decisionsCompetition, market structures and business decisions
Market structures Market structures Perfect competition
Market price determination
• Negatively sloped demand curve
• Positively sloped supply curve
ECW2731Weeks 7 & 8
Competition, market structures and business decisionsCompetition, market structures and business decisions
Market structures Market structures Monopoly
Basic Properties
• One firm in industry
• Profit-maximiser
• Faces market demand curve
• One product
• No close substitutes
• Price-maker
• No restrictions on resources
• Blockaded entry and/or exit
• Imperfect dissemination of information
• Opportunity for economic profits in long-run equilibrium.
ECW2731Weeks 7 & 8
• Examples of Monopoly– Electricity utilities, – Gas – Water– Public Tramsport– Telecommunications
Competition, market structures and business decisionsCompetition, market structures and business decisions
Market structures Market structures Monopoly
ECW2731Weeks 7 & 8
23
Monopoly graph
ECW2731Weeks 7 & 8
Competition, market structures and business decisionsCompetition, market structures and business decisions
Market structures Market structures Monopoly
Profit Maximization in Monopoly Markets• Price/Output Decisions
• A monopoly firm is the market.
• Market and firm demand curve slopes downward.
• Monopoly demand curve is always above the marginal revenue curve, P = AR > MR.
• Monopoly position allows above-normal profits.P > AC in long-run
equilibrium.
• Set Mπ = MR - MC = 0 to maximize profits.
• MR=MC at optimal output.
ECW2731Weeks 7 & 8
Competition, market structures and business decisionsCompetition, market structures and business decisions
Market structures Market structures Monopoly
Social Costs of Monopoly• Monopoly Underproduction
Monopolists produce too little output.
Monopolists charge prices that are too high.
• Deadweight Loss from MonopolyMonopoly markets creates
a loss in social welfare due to the decline in mutually beneficial trade activity.
There is also a wealth transfer problem associated with monopoly.
Under monopoly, consumer surplus is transferred to producer surplus.
ECW2731Weeks 7 & 8
Social Benefits From Monopoly
• Economies of ScaleMonopoly is sometimes the natural result of vigorous
competitive forces.In natural monopoly, LRAC declines continuously and one
firm is most efficient.Some real-world monopolies are government-created or
government-maintained.
• Invention and InnovationPublic policy sometimes confers explicit monopoly rights to
spur productivity.
Competition, market structures and business decisionsCompetition, market structures and business decisions
Market structures Market structures Monopoly
ECW2731Weeks 7 & 8
Monopoly Regulation
• Dilemma of Natural MonopolyMonopoly has the potential for efficiency.Unregulated monopoly can lead to economic profits and
underproduction.
ECW3830 COMPETITION AND REGULATION
Competition, market structures and business decisionsCompetition, market structures and business decisions
Market structures Market structures Monopoly
ECW2731Weeks 7 & 8
28
Monopolists produce less, price higher than firms in competitive equilibrium
MR = P(1 + 1/)
• Situation is inefficient, insofar as the sum of consumer and producer surplus is concerned– What is producer and consumer surplus?
• Monopolist has to take demand conditions explicitly into account
• Why is no other firm entering the market???
ECW2731Weeks 7 & 8
29
Other aspects of monopoly
• “Natural monopoly” if minimum of average cost occurs only at very high output level (minimum efficient scale) ==> there is only place for one firm in the market!
• Measure of monopoly power (markup of price over cost):
P MCmarkup
MC
ECW2731Weeks 7 & 8
30
Sources of monopoly power• Natural monopoly (public utilities best example, railway tracks),
economies of scale,
• Capital requirements on production or big sunk costs on entry
• Patents (17 years), trade secrets (Coke)
• Exclusive or unique assets (minerals, talent)
• Locational advantage (popcorn shop in cinema – but in general you pay rent for these advantages)
• Regulation (TV, taxi, telephone in the past)
• Collusion by competitors
ECW2731Weeks 7 & 8
Competition, market structures and business decisionsCompetition, market structures and business decisions
Market structures Market structures In the “real life”
• A typical firm, if it is not a small one, is not owner-managed
• Separation of ownership, long-term strategic and short-run current control (shareholders, board of directors, brunch managers) implies the segregation of objectives;
• Natural, economic and legal barriers
• Diversification (non-homogenous product, more than one kind of activity)
• Technical progress
• Different criteria for different time horizons (short-run operation vs long-run planning.
• Price-making
• Price/marketing strategies
• Imperfect information
• Investment lag
A “real” firm in a market place (compare to the “ideal” one):
ECW2731Weeks 7 & 8
34
Sources of monopoly power• Natural monopoly (public utilities best example, railway tracks),
economies of scale,
• Capital requirements on production or big sunk costs on entry
• Patents (17 years), trade secrets (Coke)
• Exclusive or unique assets (minerals, talent)
• Locational advantage (popcorn shop in cinema – but in general you pay rent for these advantages)
• Regulation (TV, taxi, telephone in the past)
• Collusion by competitors
ECW2731Weeks 7 & 8
35
What can a monopolist do?Erect strategic entry barriers
• Excessive patenting and copyright
• Limit pricing (set price below monopoly price)
• Extensive advertising to create brand name to raise cost of entry
• Create intentionally excess capacity as a warning for a price war
ECW2731Weeks 7 & 8
36
Franchising „McFood“
• A Franchiser (mother company) gets a fixed percentage of sales,
• The franchisee is the residual claimant
• What are the incentives for the two partners?
• Other problems like number of shops in a region…
• Other examples??
ECW2731Weeks 7 & 8
37
ECW2731Weeks 7 & 8
Contrast Between Monopolistic Competition and Oligopoly
• Monopolistic Competition
• Large number of sellers that offer differentiated products.
• Normal profit opportunity in long-run equilibrium.
• Oligopoly
• Few sellers.
• Economic profits are possible in long-run equilibrium.
• Dynamic Nature of Competition
• Timely market structure information is required for managerial investment decisions
Competition, market structures and business decisionsCompetition, market structures and business decisions
Market structures Market structures Oligopoly and Monopolistic Competition
ECW2731Weeks 7 & 8
Competition, market structures and business decisionsCompetition, market structures and business decisions
Market structures Market structures Мonopolistic competition
• The market consists of n mono-product firms;
• The products are viewed by the buyers as close though not perfect substitutes for one another;
• Therefore, each of the sellers is a monopolist of its particular product variant with a limited degree of monopoly power.
• Such a monopolist is enjoying a monopoly power and making economic profit during only a short period of time
• from the introduction of an unique product or technology
• until such a technology becomes available to rivals, or
• until a new “more innovative” product is introduced by a rival.
ECW2731Weeks 7 & 8
Q
Short-run Monopoly EquilibriumMonopolistically competitive firms take full advantage of short-run monopoly.
Competition, market structures and business decisionsCompetition, market structures and business decisions
Market structures Market structures Мonopolistic competition
Price
Costs
Quantity
MR Demand
MCAC
Qmc
Pmc
ECW2731Weeks 7 & 8
Long-run equilibrium same costs, lower demand and excess capacity – low output high price decision With differentiated products, P=AC at a point above minimum LRAC.P > MR = MC.
Competition, market structures and business decisionsCompetition, market structures and business decisions
Market structures Market structures Мonopolistic competition
Price
Costs
QuantityMR1
D1
MC AC
MR2
D2
Price
Costs
Quantity
MC AC
Pmc
Qmc
MRD
Entry of new firms offering product substitutes shifts the demand and MR curves)
ECW2731Weeks 7 & 8
Long-run equilibrium– high output low price decision (corresponds to perfect Competition) With homogenous products, P=AC at minimum LRAC.
This is a competitive market equilibrium with homogeneous production.
Competition, market structures and business decisionsCompetition, market structures and business decisions
Market structures Market structures Мonopolistic competition
Price
Costs
QuantityMR1
D1
MC AC
MR2
D2
Price
Costs
Quantity
MC AC
Pmc
Qmc
MRD
Qac
Pac
Long-run equilibrium same costs, lower demand and excess capacity – low output high price decision
With differentiated products, P=AC at a point above minimum LRAC.P > MR = MC.
ECW2731Weeks 7 & 8
• Oligopoly Market Characteristics
• Few sellers.
• Homogenous or unique products.
• Blockaded entry and exit.
• Imperfect dissemination of information.
• Opportunity for above-normal (economic) profits in long-run equilibrium.
• Examples of Oligopoly
• National markets for aluminum, cigarettes, electrical equipment, filmed entertainment, ready-to-eat cereals, etc.
• Local retail markets for gasoline, food, specialized services, etc.
Competition, market structures and business decisionsCompetition, market structures and business decisions
Market structures Market structures Oligipoly
ECW2731Weeks 7 & 8
Cartels and Collusion
• Overt and Covert Agreements
• Cartels operate under formal agreements.
• Powerful cartels function as a monopoly.
• Collusion exists when firms reach secret, covert agreements.
• Enforcement Problem
• Cartels are typically rather short-lived because coordination problems often lead to cheating.
• Cartel subversion can be extremely profitable.
• Detecting the source of secret price concessions can be extremely difficult.
Competition, market structures and business decisionsCompetition, market structures and business decisions
Market structures Market structures Oligipoly
ECW2731Weeks 7 & 8
Competition, market structures and business decisionsCompetition, market structures and business decisions
Market structures Market structures Oligipoly
Cartels and Collusion
ECW2731Weeks 7 & 8
Competition, market structures and business decisionsCompetition, market structures and business decisions
Market structures Market structures Oligipoly
Oligopoly Output-Setting Models
• Cournot Oligopoly
• Cournot equilibrium output is found by simultaneously solving output-reaction curves for both competitors.
• Cournot equilibrium output exceeds monopoly output but is less than competitive output.
ECW2731Weeks 7 & 8
Competition, market structures and business decisionsCompetition, market structures and business decisions
Market structures Market structures Oligipoly
Stackelberg Oligopoly
• Stackelberg model posits a first-mover advantage.
• Price wars severely undermine profitability for both leading and following firms.
• Price signaling can reduce uncertainty in oligopoly markets.
• Price leadership occurs when firms follow the industry leader’s pricing policy.
ECW2731Weeks 7 & 8
Competition, market structures and business decisionsCompetition, market structures and business decisions
Market structures Market structures Oligipoly
Stackelberg Oligopoly• Price leader sets
the price at P2
• Profit is maximised at Q1.
• The follower(s) will supply the combined output of Q4-Q1
• At P3- Follows will supply everything
At P1 – the leader will supply everything at no economic profit
ECW2731Weeks 7 & 8
Competition, market structures and business decisionsCompetition, market structures and business decisions
Market structures Market structures Oligipoly
Oligopoly Price-Setting Models• Bertrand
Oligopoly: Identical Products– The Bertrand
model focuses upon the price reactions.
– The Bertrand model predicts a competitive market price/output solution in oligopoly markets with identical products.
ECW2731Weeks 7 & 8
Competition, market structures and business decisionsCompetition, market structures and business decisions
Market structures Market structures Oligipoly
Oligopoly Price-Setting Models• Bertrand
Oligopoly: Identical Products– The Bertrand
model focuses upon the price reactions.
– The Bertrand model predicts a competitive market price/output solution in oligopoly markets with identical products.
ECW2731Weeks 7 & 8
• Types of Games– Zero-sum game: offsetting gains/losses.– Positive sum game: potential for mutual gain.– Negative-sum game: potential for mutual loss.– Cooperative games: joint action is favored.
• Role of Interdependence– Sequential games: moves in succession. – Simultaneous-move game: coincident moves.
• Strategic Considerations
Competition, market structures and business decisionsCompetition, market structures and business decisions
Market structures Market structures Game Theory Basics
ECW2731Weeks 7 & 8
Prisoner’s Dilemma
• Classic Riddle– Rational behavior can give suboptimal result.– Rationality can hamper beneficial cooperation.
• Business Application– Dominant strategy gives best result regardless of moves by
other players. – Secure strategy gives best result assuming the worst
possible scenario.
• Broad Implications
Competition, market structures and business decisionsCompetition, market structures and business decisions
Market structures Market structures Game Theory Basics
ECW2731Weeks 7 & 8
Nash Equilibrium
• Nash Equilibrium Concept– Neither player can improve their payoff through a unilateral
change in strategy.– Nash equilibrium concept is broader than the concept of a
dominant strategy equilibrium.– Every dominant strategy equilibrium is also a Nash
equilibrium.– Nash equilibrium can exist where there is no dominant
strategy equilibrium.
• Nash Bargaining
Competition, market structures and business decisionsCompetition, market structures and business decisions
Market structures Market structures Game Theory Basics
ECW2731Weeks 7 & 8
Infinitely Repeated Games
• Role of Reputation– Infinitely repeated games occur over and over again without
boundary or limit.– Firms receive sequential payoffs that shape current and
future strategies.– Reputations for high quality give consumers confidence for
repeat transactions.
• Product Quality Games– In a one-shot game, poor quality can fool customers.– In an infinitely repeated game, poor quality is shunned by
customers.
Competition, market structures and business decisionsCompetition, market structures and business decisions
Market structures Market structures Game Theory Basics
ECW2731Weeks 7 & 8
Finitely Repeated Games
• Uncertain Final Period– Finitely repeated games have limited duration. – With end point uncertainty, a finitely repeated game mirrors
an infinitely repeated game.
• End-of-game Problem– Enforcing end-of-game performance is difficult.– Solution: simply extend the game!
• First-mover Advantages– Benefits earned by the player able to make the initial move
in a sequential move or multistage game.
Competition, market structures and business decisionsCompetition, market structures and business decisions
Market structures Market structures Game Theory Basics
ECW2731Weeks 7 & 8
Competition, market structures and business decisionsCompetition, market structures and business decisions
Competitive strategies in Imperfectly competitive markets
Competitive strategies in Imperfectly competitive markets
Not all industries offer the same potential for sustained profitability;
Not all firms are equally capable of exploring the profit potential that is available.
An effective competitive strategy in imperfectly competitive markets must be founded on the firms competitive advantage.
Not all industries offer the same potential for sustained profitability;
Not all firms are equally capable of exploring the profit potential that is available.
An effective competitive strategy in imperfectly competitive markets must be founded on the firms competitive advantage.
ECW2731Weeks 7 & 8
Competition, market structures and business decisionsCompetition, market structures and business decisions
Competitive strategies in Imperfectly competitive markets
Competitive strategies in Imperfectly competitive markets
A competitive advantage is a unique or rare ability to create, distribute or service valued by customers.
It is a business-world analogue to what economists call comparative advantage or when one nation or region of the country is better suited to the production of one product than to the production of some other product
Above-normal rate of return require a competitive advantage that cannot easily be copied
In production;
In distribution; or
In marketing
A competitive advantage is a unique or rare ability to create, distribute or service valued by customers.
It is a business-world analogue to what economists call comparative advantage or when one nation or region of the country is better suited to the production of one product than to the production of some other product
Above-normal rate of return require a competitive advantage that cannot easily be copied
In production;
In distribution; or
In marketing
ECW2731Weeks 7 & 8
Competition, market structures and business decisionsCompetition, market structures and business decisions
Competitive strategies in Imperfectly competitive markets
Competitive strategies in Imperfectly competitive markets
Reasons for competitive advantage: Access to a unique resource
(Exclusive) Access to a mineral deposit
(Exclusive) Access to a material Efficient energy source Unique climatic condition Unique technology Unique (specially qualified or very talented) labour
force; or Access to a unique market
A university bookshop The rice market in Japan etc
Reasons for competitive advantage: Access to a unique resource
(Exclusive) Access to a mineral deposit
(Exclusive) Access to a material Efficient energy source Unique climatic condition Unique technology Unique (specially qualified or very talented) labour
force; or Access to a unique market
A university bookshop The rice market in Japan etc
ECW2731Weeks 7 & 8
Competition, market structures and business decisionsCompetition, market structures and business decisions
Non-price competition.Non-price competition.
Product differentiationProduct differentiation
Product differentiation refers to the increase in time of the number of
product categories suppled and the number of items in each category
Product differentiation refers to the increase in time of the number of
product categories suppled and the number of items in each category
Historically, a step from oligopolistic to monopolistic competition
Historically, a step from oligopolistic to monopolistic competition
ECW2731Weeks 7 & 8
Competition, market structures and business decisionsCompetition, market structures and business decisions
Non-price competition.Non-price competition.
Product differentiationProduct differentiation
A simple model of the reason for product differentiation
Price
QuantityQ
P
P*
• Considers constant quantity as well as non-changing AC and MC corresponding to this quantity
• Producing a little bit different product a firm might hope to charge a higher price
ECW2731Weeks 7 & 8
Competition, market structures and business decisionsCompetition, market structures and business decisions
Non-price competition.Non-price competition.
Barriers to entryBarriers to entry
Price
QuantityQ
P
P*
LAC
LAC*
Absolute cost advantages:
Ability of established firms to produce any given level of outputat lower unit costs than potentialentrants
Q*
ECW2731Weeks 7 & 8
Price
QuantityQ*
P
Economies of scale:
Ability of established firms
* To produce any given level of outputgreater than a certain level Q* at lower unit costs and * To restrict potential entrants who are not able to invest in that level of production
D
LAC
Competition, market structures and business decisionsCompetition, market structures and business decisions
Non-price competition.Non-price competition.
Barriers to entryBarriers to entry
ECW2731Weeks 7 & 8
Price
QuantityQ*
P*
Product differentiation advantages:
Variety of demand curvesand common LAC.
Some firms have advantage of technology or specialisation and are facing demand curves to the right of the critical one.
D1
LAC
D2D2
Competition, market structures and business decisionsCompetition, market structures and business decisions
Non-price competition.Non-price competition.
Barriers to entryBarriers to entry
ECW2731Weeks 7 & 8
Appear as the result of
• Ability to affect prices and
• Separation of ownership and managerial control
Appear as the result of
• Ability to affect prices and
• Separation of ownership and managerial control
* Managers’ aim at stability and increase in salaries*Stability may be achieved through the increase in the scale of operations*Increase in sales (not in profit) affects manager’s remuneration* Banks and retailers would prefer to deal with firms increasing the volume of sales
Competition, market structures and business decisionsCompetition, market structures and business decisions
Non-profit-maximising competition.Non-profit-maximising competition.
ECW2731Weeks 7 & 8
DMR
AC
MC
Q
P, Cost
Profit maximisingdecision
Competition, market structures and business decisionsCompetition, market structures and business decisions
Non-profit-maximising competition.
Non-profit-maximising competition.
ECW2731Weeks 7 & 8
DMR
Q
P, Cost
Profit maximisingdecision
Salesmaximisingdecision
• Increasing sales, the firm is moving to the right and downward the demand curve and, therefore, decreases price,
• The limitation is AC curve. Some profit should be earned anyway
Competition, market structures and business decisionsCompetition, market structures and business decisions
Non-profit-maximising competition.
Non-profit-maximising competition.
ECW2731Weeks 7 & 8
DMR
AC
MC
Q
P, Cost
Profit maximisingdecision
Competition, market structures and business decisionsCompetition, market structures and business decisions
Non-profit-maximising competition.
Non-profit-maximising competition.
ECW2731Weeks 7 & 8
Old sales maximising decision is a profitmaximising decision at a new level of average cost
Old profit maximisingdecision
New profit maximisingdecision
DMR
AC
MC
Q
P, Cost
Competition, market structures and business decisionsCompetition, market structures and business decisions
Non-profit-maximising competition.
Non-profit-maximising competition.
ECW2731Weeks 7 & 8
Competition, market structures and business decisionsCompetition, market structures and business decisions
Measurement of market structures Measurement of market structures
Seller concentrationSeller concentration
Seller concentration refers to the degree to which production for a particular market or or in a particular industry is concentrated in the hand of few large firms
Seller concentration refers to the degree to which production for a particular market or or in a particular industry is concentrated in the hand of few large firms
• number of firms in the market
• size distribution of firms in the market
Measurement of concentration
ECW2731Weeks 7 & 8
Competition, market structures and business decisionsCompetition, market structures and business decisions
Measurement of market structures Measurement of market structures
Seller concentrationSeller concentration
The Australian Bureau of Statistics
8140.0.55.001 Industry Concentration Statistics
ECW2731Weeks 7 & 8
Competition, market structures and business decisionsCompetition, market structures and business decisions
Measurement of market structures Measurement of market structures
Seller concentrationSeller concentration
C2542 - Paint Manufacturing in Australia KEY COMPETITORS (www.ibisworld.com.au/static/iwabout/SamIndPart.asp)
MAJOR PLAYERS
Table: Market Share
Major Player Market Share Range
Orica Limited 22.00% - 25.00% (2004)
Wattyl Limited 17.00% - 19.00% (2004)
Barloworld Australia Pty Limited
9.00% - 11.00% (2004)
Akzo Nobel Industries Limited 7.00% - 9.00% (2003)
ECW2731Weeks 7 & 8
T h e f i r m s i n t h e i n d u s t r y a r e s o r t e da c c o r d i n g t o t h e s i z e o f t h e i r o u t p u t .X i - t h e o u t p u t o f t h e f i r m
X - t h e o u t p u t o f i n d u s t r y
X
Xi
- t h e s h a r e o f t h e f i r m i n t h e i n d u s t r yo u t p u t
T h e r a t i o o f r l a g e s t f i r m s i n t h e i n d u s t r yo u t p u t
CX
X
X
X
X
X
X
Xri
i
rr
1
1 2 . . .
Measurement of concentration
Competition, market structures and business decisionsCompetition, market structures and business decisions
Measurement of market structures Measurement of market structures
Seller concentrationSeller concentration
ECW2731Weeks 7 & 8Census Measures of Market Concentration
• Concentration Ratios– Group market share data are called concentration ratios.– CRi = ∑ Xi, where Xi is market share of the ith leading firm.
– CRi = 100 for monopoly.– CRi ≈ 0 for a perfectly competitive industry.
• Herfindahl-Hirschmann Index– Calculated in percentage terms, the HHI is the sum of squared
market shares for all competitors. – HHI = ∑ Xi2, where Xi2 is squared market share of the ith firm.
– HHI = 10,000 for monopoly.– HHI ≈ 0 for a perfectly competitive industry.
• Limitations of Census Information– Slow reports hinder usefulness.– National statistics obscure local markets.
ECW2731Weeks 7 & 8
N
Measurement of concentration
Diagrammatic approach
No of firms cumulated from the largest
Cu
mul
ativ
e %
of
outp
ut
100%
The curve of equaldistribution of shares of the market amongfirms
The curve of real (not equal distribution
This distance measures concentration
Competition, market structures and business decisionsCompetition, market structures and business decisions
Measurement of market structures Measurement of market structures
Seller concentrationSeller concentration
ECW2731Weeks 7 & 8
Competition, market structures and business decisionsCompetition, market structures and business decisions
Multinational companies. Vertical and horizontal coordination.Multinational companies. Vertical and horizontal coordination.
DiversificationDiversification
Vertical coordinationVertical coordination
Multinational companyMultinational company
ECW2731Weeks 7 & 8
Invest in production facilities to produce a product D
A firm X producinga good A
Buys shares of a firm Y producinga good B
Invents a new product C
Competition, market structures and business decisionsCompetition, market structures and business decisions
Multinational companies. Vertical and horizontal coordination.Multinational companies. Vertical and horizontal coordination.
DiversificationDiversification
ECW2731Weeks 7 & 8
A firm X producinga good A
Competition, market structures and business decisionsCompetition, market structures and business decisions
Multinational companies. Vertical and horizontal coordination.Multinational companies. Vertical and horizontal coordination.
Vertical coordinationVertical coordination
ECW2731Weeks 7 & 8
Invest in production facilities or buys sharesof or coordinate activities with a firm producing an input D
A firm X producinga good A
Competition, market structures and business decisionsCompetition, market structures and business decisions
Multinational companies. Vertical and horizontal coordination.Multinational companies. Vertical and horizontal coordination.
Vertical coordinationVertical coordination
ECW2731Weeks 7 & 8
Invest in production facilities or buys sharesof or coordinate activities with a firm producing an input D
A firm X producinga good A
Invest in facilities or buys shares of or coordinate activities with a firm providing professional training for employees
Competition, market structures and business decisionsCompetition, market structures and business decisions
Multinational companies. Vertical and horizontal coordination.Multinational companies. Vertical and horizontal coordination.
Vertical coordinationVertical coordination
ECW2731Weeks 7 & 8
Invest in production facilities or buys sharesof or coordinate activities with a firm producing an input D
A firm X producinga good A
Invest in facilities or buys shares of or coordinate activities with a firm providing professional training for employees
Invest in production facilities or buys sharesof or coordinateactivities with a firm using A as an input
Competition, market structures and business decisionsCompetition, market structures and business decisions
Multinational companies. Vertical and horizontal coordination.Multinational companies. Vertical and horizontal coordination.
Vertical coordinationVertical coordination
ECW2731Weeks 7 & 8
Invest in production facilities or buys sharesof or coordinate activities with a firm producing an input D
A firm X producinga good A
Invest in facilities or buys shares of or coordinate activities with a firm providing professional training for employees
Invest in production facilities or buys sharesof or coordinateactivities with a firm using A as an input
Invest in or buys sharesof or coordinate activities with a firm specialising inthe selling of product A
Competition, market structures and business decisionsCompetition, market structures and business decisions
Multinational companies. Vertical and horizontal coordination.Multinational companies. Vertical and horizontal coordination.
Vertical coordinationVertical coordination
ECW2731Weeks 7 & 8
A firm producinga good A in a home country
Establishes branches in other countries
Buys share ofanalogous firmsin other countries
Undertake vertical coordination measures abroad
Conduct diversificationpractices abroad
Competition, market structures and business decisionsCompetition, market structures and business decisions
Multinational companies. Vertical and horizontal coordination.Multinational companies. Vertical and horizontal coordination.
Multinational companyMultinational company
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