Lecture six © copyright ： qinwang 2013 Qinwang@mail.shufe.edu.cn SHUFE school of international...

Lecture six

© copyright ： qinwang 2013Qinwang@mail.shufe.edu.cn  

SHUFE  school of international business

Market structure and firm behavior Market structure Perfect competition and firm decision Pure monopoly and firm decision Monopolistic competition and firm decision Oligopoly and firm decision

Market structure

Market structure ： the competitiveness of the products or services 。

Market competitive analysis ： market rates; price competition; barriers to entry and barriers to exit; industrial growth rate; fixed cost and variable cost.

Influence Factors ： Number of consumers and firms Difference of product Scale economies Entry barrier and exit barrier

Market structureMarket structure::

competitive weakerhigher

Pure Competition

Monopolistic Competition

Oligopoly Monopoly

Perfect (pure) market

Many firms and consumers all making same product (homogenization) Each firm’s output small relative to total No entry and exit barrier Complete information

Example:

Pure monopoly

Market with a single seller Firm demand = market demand

No substitutionHigh entry and exit barrier

Example:Example:

Monopolistic Competition

Large number of firms sell a differentiated product Products are close (not perfect) substitutes

Market is monopolistic Product differentiation creates a degree of marke

t power Market is competitive

Large number of firms, easy entry

Example:Example:

Oligopoly market

Number of firms is small Products are same or different High barriers to entry Interdependence of firms

example:example:

Decision in pure market

（ 1 ） Price strategy（ 2 ） Short-run decision

Maximum of profit Shut-down point

（ 3 ） Long-run decision: enter or exit

Pure competition ： Firms are price-takers

Demand for a Competitive Price-Taker

Demand curve is horizontal at price determined by intersection of market demand & supply Perfectly elastic

Marginal revenue equals price Demand curve is also marginal revenue curve

(D = MR) Can sell all they want at the market price

Each additional unit of sales adds to total revenue an amount equal to price

price MC

AC

MR=P=AR

Profit-maximization Q0product

P0

0

Profit-Maximization in the Short Run

Profit = π = TR - TC

Example: A firm in pure market

Product Total cost

AC MC

2345678

22303645607796

111099101112

--869151719

If P=17 ， how many product should be supplied ？What is the Profit of per unit ？ What is the total profit ？

In the short run, the firm incurs costs that are: Unavoidable and must be paid even if output

is zero Variable costs that are avoidable if the firm

chooses to shut down In making the decision to produce or

shut down, the firm considers only the (avoidable) variable costs & ignores fixed costs

Profit-Maximization in the Short Run

Profit Margin (or Average Profit)

Level of output that maximizes total profit occurs at a higher level than the output that maximizes profit margin (& average profit) Managers should ignore profit margin (average

profit) when making optimal decisions

Average profit ( P ATC )Q

Q Q

Profit marginP ATC

Shut down

（ 3 ） if market price =P3

price

P1

P2

MC

AVC

AC

P3

Q1 Q2 Q3 product0

（ 1 ） if market price =P1

（ 2 ） if market price =P2

Q0

PLMC

LAC

AA

EARMRPe

eP

If TR<LTC, P<LAC ， exit ； if TR>LTC ， P>LAC ， then entry

Long-run decision: Entry or exit?

BA

C

2E

1E

3E1P

3P

2P

3P

1P

2P

SACSMC

Q

P

0( )Industry

Q0

P

( )Firm

Long-Run Competitive Equilibrium

All firms are in profit-maximizing equilibrium (P = LMC)

Occurs because of entry/exit of firms in/out of industry Market adjusts so P = LMC = LAC

Long-run equilibrium

Ranidae is introduced from Cuba. It grows fast and is delicious. Some farmers in south of China began to breed Ranidae in 1985, until 1992, there were about 800 farmers and with 500 mu breeding area.

Mr.Li,50 years old, began to breed Ranidae in 1986 and had earned 700,000 yuan until1992. Mr.Zhang,40 years old, earned 280000 in 1992 for selling tadpole.

In 1993, local newspaper published a wrong news: the price of Ranidae in city A is 52 yuan/kg, sales of Ranidae in City A is about 700 kg. export price of Ranidae is 260-280 yuan/kg. At that time, a lot of farmers tried to breed Ranidae. The number of farmer rised to 6471 and breeding area increased to 6021 mu. Ranidae’s price is only 16-20 yuan/kg, less than half of the cost. what should the farmers do?

Ranidae

Discussion:

Cabbage in Shanghai and Watermelon in other provinces.

Perfect(pure) market

The firm supplies its product at the minimum of its long-run cost, so it gets efficiency.

Resources are allocated efficiently between products and firms.

The total of Consumer surplus and supplier surplus are maximized.

Monopolistic competition

Price strategyPrice strategy Short-run decisionShort-run decision Long-run decisionLong-run decision

Product strategy: Product strategy: differentiation differentiation

Competitive strategyCompetitive strategy

0P

ARD

SAC

SMC

MR

Q0

、C RP

E

0Q

A

B0AC

In short-run,When SMC=MR,Profit maximum

Short-run decision

LACLMC

Q0

P

MR D

0Q

0P

0AC

Q0

P

SACSMC

MRD

0Q

0P

Q0

P

SACSMC

MR D

0Q

0P0AC

Long-run equilibrium

Market Power

Ability of a firm to raise price without losing all its sales Any firm that faces downward sloping dema

nd has market power Gives firm ability to raise price above ave

rage cost & earn economic profit (if demand & cost conditions permit)

Measurement of Market Power

Degree of market power inversely related to price elasticity of demand The less elastic the firm’s demand, the greater its

degree of market power The fewer close substitutes for a firm’s product, t

he smaller the elasticity of demand (in absolute value) & the greater the firm’s market power

When demand is perfectly elastic (demand is horizontal), the firm has no market power

Lerner index measures proportionate amount by which price exceeds marginal cost:

Equals zero under perfect competition Increases as market power increases Also equals –1/E, which shows that the index (& market power), vary inversely with elasticity The lower the elasticity of demand (absolute value), the greater the index & the degree of market power

Measurement of Market Power

Lerner index P MC

P

If consumers view two goods as substitutes, cross-price elasticity of demand (EXY) is positive The higher the positive cross-price elasticity,

the greater the substitutability between two goods, & the smaller the degree of market power for the two firms

Measurement of Market Power

Product strategy ： differentiation

Technology innovation ： higher quality, new function, new product (objective difference)

Advertising and promotion: (subjective difference)

Service strategy ： service system after sale

Discuss: advertising Giving information or inducing Benefit to Competition or concentration Promoting efficiency or waste

Optimal advertising intensity The marginal profit or contribution margin

from an additional unit of output: PCM=P-MC The marginal cost of advertising (MCA)

/MCA Ak Q

Optimal level of advertising outlays: PCM=MCA

Competitive strategy

Low cost strategy Dell’s cost leadership in PC assembly

Differentiation strategy

Focus strategy