Chapter 6: Market Structure

Brickley, Smith, and Zimmerman, Managerial Economics and

Organizational Architecture, 4th ed.

Market structureobjectives

• Students should be able to

• Differentiate among the four standard market structures

• Distinguish between price takers and price searchers

Market structure

• What is a market?• All firms and individuals willing and able to

buy or sell a particular product

• What is market structure?• Defined by attributes of the market

environment

Market structures

• Perfect competition

• Monopoly

• Monopolistic competition

• Oligopoly

Perfect competitioncharacteristics

• Many buyers and sellers

• Product homogeneity

• Low cost and accurate information

• Free entry and exit

Firm demand curveperfect competition (Figure 6.1)

Firm supply

• Short run– Marginal cost curve above average

variable cost

• Long run– Long-run marginal cost curve

above long-run average cost

The firm’s short-run supply curve(Figure 6.2)

The firm’s long-run supply curve(Figure 6.3)

Shut-down Analysis

• If Price (P) > Average Cost (AC)• Stay Open (this applies to both

short run and long run)• What if Price (P) < Average Cost

(AC)?• Then we need to do more

analysis

Shut-down Analysis

• If Price (P) < Average Variable Cost (AVC)

• Shut down immediately

Shut-down Analysis

• What if Average Total Cost (ATC)> Price (P) > Average Variable Cost (AVC)?

• Short run: stay in business

• Long run: shut down

Competitive equilibrium(Figure 6.4)

Barriers to entry

Incumbent reactions

• Specific assets• Economies of scale• Excess capacity• Reputation effects

Incumbent advantages• Precommitment

contracts• Licenses and patents• Learning-curve effects• Pioneering brand

advantages

Monopoly

• Strong barriers to entry single supplier

• Profit maximization– faces market demand and sets MR=MC

• Unexploited gains from trade

Monopolistic competition

• Multiple firms produce similar products

• Firms face downsloping demand curves

• Profit maximization occurs where MC=MR

• In the limit, firms compete away economic profits

Oligopoly

• A few firms produce most market output

• Products may or may not be differentiated

• Effective entry barriers protect firm profitability

• Firm interdependence requires strategic thinking

The Nash equilibrium

• An oligopolist does the best it can, given expectations of rival behavior

• Behaviors are noncooperative• Duopolists considering a low price or a

high price must consider rival’s response

• Nash equilibrium occurs when each firm does the best it can given rival’s actions

Determining the Nash equilibrium

The classic prisoners’ dilemma

The cartel’s dilemma