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Market
Structures
Market
Structures
The Degree of Competition
• Classifying markets– number of firms– freedom of entry to industry– nature of product– nature of demand curve
• The four market structures– perfect competition– monopoly– monopolistic competition– oligopoly
Features of the four market structuresFeatures of the four market structures
Type ofmarket
Numberof firms
Freedom ofentry
Nature ofproduct
Examples Implications fordemand curvefaced by firm
Perfect competition
Verymany Unrestricted
Homogeneous(undifferentiated)
Cabbages, carrots(approximately)
Horizontal:firm is a price taker
Monopolistic competition
Many /several
Unrestricted Differentiated Builders,restaurants
Downward sloping,but relatively elastic
Oligopoly Few Restricted Undifferentiated
or differentiated
Cement
cars, electricalappliances
Downward sloping.Relatively inelastic(shape depends onreactions of rivals)
Monopoly One Restricted orcompletely
blocked
UniqueLocal water
company, trainoperators (over
particular routes)
Downward sloping:more inelastic thanoligopoly. Firm has
considerablecontrol over price
Features of the four market structuresFeatures of the four market structures
Type ofmarket
Numberof firms
Freedom ofentry
Nature ofproduct
Examples Implications fordemand curvefaced by firm
Perfect competition
Verymany Unrestricted
Homogeneous(undifferentiated)
Cabbages, carrots(approximately)
Horizontal:firm is a price taker
Monopolistic competition
Many /several
Unrestricted Differentiated Builders,restaurants
Downward sloping,but relatively elastic
Oligopoly Few Restricted Undifferentiated
or differentiated
Cement
cars, electricalappliances
Downward sloping.Relatively inelastic(shape depends onreactions of rivals)
Monopoly One Restricted orcompletely
blocked
UniqueLocal water
company, trainoperators (over
particular routes)
Downward sloping:more inelastic thanoligopoly. Firm has
considerablecontrol over price
Features of the four market structuresFeatures of the four market structures
Type ofmarket
Numberof firms
Freedom ofentry
Nature ofproduct
Examples Implications fordemand curvefaced by firm
Perfect competition
Verymany Unrestricted
Homogeneous(undifferentiated)
Cabbages, carrots(approximately)
Horizontal:firm is a price taker
Monopolistic competition
Many /several
Unrestricted Differentiated Builders,restaurants
Downward sloping,but relatively elastic
Oligopoly Few Restricted Undifferentiated
or differentiated
Cement
cars, electricalappliances
Downward sloping.Relatively inelastic(shape depends onreactions of rivals)
Monopoly One Restricted orcompletely
blocked
UniqueLocal water
company, trainoperators (over
particular routes)
Downward sloping:more inelastic thanoligopoly. Firm has
considerablecontrol over price
Features of the four market structuresFeatures of the four market structures
Type ofmarket
Numberof firms
Freedom ofentry
Nature ofproduct
Examples Implications fordemand curvefaced by firm
Perfect competition
Verymany Unrestricted
Homogeneous(undifferentiated)
Cabbages, carrots(approximately)
Horizontal:firm is a price taker
Monopolistic competition
Many /several
Unrestricted Differentiated Builders,restaurants
Downward sloping,but relatively elastic
Oligopoly Few Restricted Undifferentiated
or differentiated
Cement
cars, electricalappliances
Downward sloping.Relatively inelastic(shape depends onreactions of rivals)
Monopoly One Restricted orcompletely
blocked
UniqueLocal water
company, trainoperators (over
particular routes)
Downward sloping:more inelastic thanoligopoly. Firm has
considerablecontrol over price
Features of the four market structuresFeatures of the four market structures
Type ofmarket
Numberof firms
Freedom ofentry
Nature ofproduct
Examples Implications fordemand curvefaced by firm
Perfect competition
Verymany Unrestricted
Homogeneous(undifferentiated)
Cabbages, carrots(approximately)
Horizontal:firm is a price taker
Monopolistic competition
Many /several
Unrestricted Differentiated Builders,restaurants
Downward sloping,but relatively elastic
Oligopoly Few Restricted Undifferentiated
or differentiated
Cement
cars, electricalappliances
Downward sloping.Relatively inelastic(shape depends onreactions of rivals)
Monopoly One Restricted orcompletely
blocked
UniqueLocal water
company, trainoperators (over
particular routes)
Downward sloping:more inelastic thanoligopoly. Firm has
considerablecontrol over price
Features of the four market structuresFeatures of the four market structures
Type ofmarket
Numberof firms
Freedom ofentry
Nature ofproduct
Examples Implications fordemand curvefaced by firm
Perfect competition
Verymany Unrestricted
Homogeneous(undifferentiated)
Cabbages, carrots(approximately)
Horizontal:firm is a price taker
Monopolistic competition
Many /several
Unrestricted Differentiated Builders,restaurants
Downward sloping,but relatively elastic
Oligopoly Few Restricted Undifferentiated
or differentiated
Cement
cars, electricalappliances
Downward sloping.Relatively inelastic(shape depends onreactions of rivals)
Monopoly One Restricted orcompletely
blocked
UniqueLocal water
company, trainoperators (over
particular routes)
Downward sloping:more inelastic thanoligopoly. Firm has
considerablecontrol over price
The Degree of Competition
• Classifying markets– number of firms– freedom of entry to industry– nature of product– nature of demand curve
• The four market structures– perfect competition– monopoly– monopolistic competition– oligopoly
• Structure conduct performance
Perfect Competition
• Assumptions– firms are price takers
– freedom of entry
– identical products
– perfect knowledge
• Short-run equilibrium of the firm– price, output and profit
O
R
(b) Firm
Q (thousands)
O
(a) Industry
P
Q (millions)
S
D
Pe
MC
ARD = AR
= MR
Qe
AC
AC
Short-run equilibrium of industry and firm under perfect competition
Qe
P1
D1 = AR1
= MR1
AR1
O O
(a) Industry
P R
Q (millions)
S
D
(b) Firm
MC AC
AC
Q (thousands)
Loss minimising under perfect competitionLoss minimising under perfect competition
Perfect Competition
• Assumptions– firms are price takers– freedom of entry– identical products– perfect knowledge
• Short-run equilibrium of the firm– price, output and profit
• The short-run supply curve of the firm
O O
(a) Industry
P R
P1
Q (millions)
S
D1
(b) Firm
D1 = MR1
MC
P2
D2 = MR2
D2
P3
D3 = MR3
D3
Q (thousands)
Deriving the short-run supply curve
a
b
c
= S
Perfect Competition
• Long-run equilibrium of the firm
– all supernormal profits competed away
– LRAC = AC = MC = MR = AR
O O
(a) Industry
P R
Q (millions)
S1
D
(b) Firm
LRAC
PL
P1
QL
Se
AR1 D1
ARL DL
Q (thousands)
Long-run equilibrium under perfect competitionNew firms enterSupernormal profits
Profits returnto normal
R
Q O
(SR)AC
(SR)MC
LRAC
AR = MR
DL
LRAC = (SR)AC = (SR)MC = MR = AR
Long-run equilibrium of the firm under perfect competition
Perfect Competition• Incompatibility of economies of scale with
perfect competition
• Benefits of perfect competition
– price equals marginal cost
– prices kept low
– firms must be efficient to survive
Monopoly
• Defining monopoly• Barriers to entry
– economies of scale– economies of scope– product differentiation and brand loyalty– lower costs for an established firm– ownership/control of key factors– ownership/control over outlets– legal protection– mergers and takeovers– aggressive tactics– intimidation
Monopoly
• The monopolist’s demand curve– downward sloping
– MR below AR
• Equilibrium price and output– Equilibrium output, where MC = MR
Profit maximising under monopoly
MR
R
Q O
MC
Qm
Monopoly
• The monopolist’s demand curve– downward sloping
– MR below AR
• Equilibrium price and output– Equilibrium output, where MC = MR
– Equilibrium price, found from demand curve
R
Q O
MC
AC
Qm
MR
AR
AC
Profit maximising under monopoly
AR
Monopoly
• The monopolist’s demand curve– downward sloping
– MR below AR
• Equilibrium price and output– Equilibrium output, where MC = MR
– Equilibrium price, found from demand curve
• Profit– Measuring profit
R
Q O
MC
AC
Qm
MR
AR
AC
Profit maximising under monopoly
AR
Total profit
Monopoly
• The monopolist’s demand curve– downward sloping
– MR below AR
• Equilibrium price and output– Equilibrium output, where MC = MR
– Equilibrium price, found from demand curve
• Profit– Measuring profit
– Supernormal profit can persist in long run
Monopoly
• Disadvantages of monopoly– high prices / low output: short run
AR = D
MC
MR
R
Q O Q1
P1
Monopoly
Equilibrium of industry under perfect competition and monopoly: with the same MC curve
R
Q O
MC ( = supply under perfect competition)
Q1
MR
P1
P2
Q2
AR = D
Comparison withPerfect competition
Equilibrium of industry under perfect competition and monopoly: with the same MC curve
Monopoly
• Disadvantages of monopoly– high prices / low output: short run
– high prices / low output: long run
Monopoly
• Disadvantages of monopoly– high prices / low output: short run
– high prices / low output: long run
– lack of incentive to innovate
Monopoly
• Disadvantages of monopoly– high prices / low output: short run
– high prices / low output: long run
– lack of incentive to innovate
– X-inefficiency
Monopoly
• Disadvantages of monopoly– high prices / low output: short run
– high prices / low output: long run
– lack of incentive to innovate
– X-inefficiency
• Advantages of monopoly
Monopoly
• Disadvantages of monopoly– high prices / low output: short run
– high prices / low output: long run
– lack of incentive to innovate
– X-inefficiency
• Advantages of monopoly– economies of scale
R
Q O Q1
MR
P1
MCmonopoly
AR = D
Equilibrium of industry under perfect competition and monopoly: with different MC curves
R
Q O
MC ( = supply)perfect competition
Q1
MR
P1
P2
Q2
MCmonopoly
AR = D
x
Q3
P3
Equilibrium of industry under perfect competition and monopoly: with different MC curves
Monopoly
• Disadvantages of monopoly– high prices / low output: short run
– high prices / low output: long run
– lack of incentive to innovate
– X-inefficiency
• Advantages of monopoly– economies of scale
– profits can be used for investment
Monopoly
• Disadvantages of monopoly– high prices / low output: short run
– high prices / low output: long run
– lack of incentive to innovate
– X-inefficiency
• Advantages of monopoly– economies of scale
– profits can be used for investment
– high profits encourage risk taking
Monopoly
• Contestable markets
– importance of potential competition
– a perfectly contestable market
– contestable markets and natural monopolies
– importance of costless exit
• Contestable markets and the public interest
Monopolistic Competition
• Assumptions of monopolistic competition
• Equilibrium of the firm– short run
R
Q O Qs
AR = D
MC
AC
MR
Short-run equilibrium of the firmunder monopolistic competition
Ps
ACs
Monopolistic Competition
• Assumptions of monopolistic competition
• Equilibrium of the firm– short run
– long run
Long-run equilibrium of the firmunder monopolistic competition
ARL = DL
MRL
R
Q O QL
PL
LRAC
LRMC
Monopolistic Competition
• Assumptions of monopolistic competition
• Equilibrium of the firm– short run
– long run
– underutilisation of capacity in the long run
Q2
P2 DL under perfect
competition
Long run equilibrium of the firm under perfect andmonopolistic competition
R
QO
P1
LRAC
DL under monopolistic
competition
Q1
Monopolistic Competition
• Assumptions of monopolistic competition• Equilibrium of the firm
– short run– long run– underutilisation of capacity in the long run
• Non-price competition
Monopolistic Competition
• Assumptions of monopolistic competition• Equilibrium of the firm
– short run– long run– underutilisation of capacity in the long run
• Non-price competition• The public interest
Monopolistic Competition
• Assumptions of monopolistic competition• Equilibrium of the firm
– short run– long run– underutilisation of capacity in the long run
• Non-price competition• The public interest
– comparison with perfect competition
Monopolistic Competition
• Assumptions of monopolistic competition• Equilibrium of the firm
– short run– long run– underutilisation of capacity in the long run
• Non-price competition• The public interest
– comparison with perfect competition– comparison with monopoly
Oligopoly
• Key features of oligopoly
– barriers to entry
– interdependence of firms
• Competition versus collusion
• Collusive oligopoly: cartels
– equilibrium of the industry
R
Q O
Industry D = AR
Profit-maximising cartel
Profit-maximising cartelR
Q O
Industry D = AR
Industry MC
Industry MR
Q1
P1
Oligopoly
• Key features of oligopoly
– barriers to entry
– interdependence of firms
• Competition versus collusion
• Collusive oligopoly: cartels
– equilibrium of the industry
– allocating and enforcing quotas
0
5
10
15
20
25
30
35
70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02
$ per barrel Actual price
Yom KippurWar: Arab oil
embargo
First oil fromNorth Sea
Revolutionin Iran
Iraq invadesIran OPEC’s first
quotas
Cease-fire inIran-Iraq war Recession
in Far East
Iraq invadesKuwait
New OPECquotas
World-widerecovery
World-wideslowdown
Impendingwar
with Iraq
Oil pricesOil prices
0
5
10
15
20
25
30
35
70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02
$ per barrel Actual priceCost in 1973 prices
Yom KippurWar: Arab oil
embargo
First oil fromNorth Sea
Revolutionin Iran
Iraq invadesIran OPEC’s first
quotas
Cease-fire inIran-Iraq war Recession
in Far East
Iraq invadesKuwait
New OPECquotas
World-widerecovery
World-wideslowdown
Impendingwar
with Iraq
Oil pricesOil prices
Oligopoly
• Tacit collusion
– price leadership: dominant firm
R
Q O
MR leader
AR = D leader
AR = D market
Price leader aiming to maximise profits for a given market share
Assume constantmarket share
for leader
R
Q O
AR = D market
MC
MR leader
PL
QT
AR = D leader
QL
l t
Price leader aiming to maximise profits for a given market share
Oligopoly
• Tacit collusion
– price leadership: dominant firm
– price leadership: barometric
Oligopoly
• Tacit collusion
– price leadership: dominant firm
– price leadership: barometric
– rules of thumb
Oligopoly• Factors favouring collusion
– Few firms– Open with each other– Similar production methods and average costs– Similar products– Dominant firm– Significant entry barriers– Stable market– No government measures to curb collusion
Oligopoly• The breakdown of collusion• Non-collusive oligopoly: game theory
– alternative strategies• maximax and maximin
– simple dominant strategy games
Profits for firms A and B at different prices
R2.00 R1.80
R2.00
R1.80
X’s price
Y’s price
A B
C D
R10m each
R8m eachR12m for YR5m for X
R5m for YR12m for X
Oligopoly• The breakdown of collusion• Non-collusive oligopoly: game theory
– alternative strategies• maximax and maximin
– simple dominant strategy games• Nash equilibrium
Profits for firms A and B at different prices
R2.00 R1.80
R2.00
R1.80
X’s price
Y’s price
A B
C D
R10m each
R8m eachR12m for YR5m for X
R5m for YR12m for X
Oligopoly• The breakdown of collusion• Non-collusive oligopoly: game theory
– alternative strategies• maximax and maximin
– simple dominant strategy games• Nash equilibrium• the prisoners’ dilemma
The prisoners' dilemma
Not confess Confess
Notconfess
Confess
Amanda's alternatives
Nigel'salternatives
A B
C D
Each gets1 year
Each gets3 years
Nigel gets3 months
Amanda gets10 years
Nigel gets10 years
Amanda gets3 months
Oligopoly• The breakdown of collusion• Non-collusive oligopoly: game theory
– alternative strategies• maximax and maximin
– simple dominant strategy games• the prisoners’ dilemma• Nash equilibrium
– more complex non-dominant strategy games
Oligopoly• The breakdown of collusion• Non-collusive oligopoly: game theory
– alternative strategies• maximax and maximin
– simple dominant strategy games• the prisoners’ dilemma• Nash equilibrium
– more complex non-dominant strategy games– the importance of threats and promises
Oligopoly• The breakdown of collusion• Non-collusive oligopoly: game theory
– alternative strategies• maximax and maximin
– simple dominant strategy games• the prisoners’ dilemma• Nash equilibrium
– more complex non-dominant strategy games– the importance of threats and promises– the importance of timing of decisions
Oligopoly• The breakdown of collusion• Non-collusive oligopoly: game theory
– alternative strategies• maximax and maximin
– simple dominant strategy games• the prisoners’ dilemma• Nash equilibrium
– more complex non-dominant strategy games– the importance of threats and promises– the importance of timing of decisions
• decision trees
Boeingdecides
500
seat
er
500 seater
500 seater
400 seater
400 seater
400 seater
A decision treeA decision tree
Boeing –R10mAirbus –R10m
(1)
Boeing +R30mAirbus +R50m
(2)
Boeing +R50mAirbus +R30m
(3)
Boeing –R10mAirbus –R10m (4)
Airbusdecides
B2
Airbusdecides
B1
A
Oligopoly
• Non-collusive oligopoly: the kinked demand curve theory– assumptions of the model
Kinked demand for a firm under oligopolyR
QO
P1
Q1
Current priceand quantity
give one pointon demand curve
R
QO
P1
Q1
D
D
Kinked demand for a firm under oligopoly
Oligopoly
• Non-collusive oligopoly: the kinked demand curve theory– assumptions of the model
– stable prices
R
QO
P1
Q1
MC2
MC1
MR
a
bD = AR
Stable price under conditions of a kinked demand curveStable price under conditions of a kinked demand curve
Oligopoly
• Non-collusive oligopoly: the kinked demand curve theory– assumptions of the model
– stable prices
– limitations of the model
Oligopoly
• Non-collusive oligopoly: the kinked demand curve theory– assumptions of the model
– stable prices
– limitations of the model
• Oligopoly and the public interest
Oligopoly
• Non-collusive oligopoly: the kinked demand curve theory– assumptions of the model
– stable prices
– limitations of the model
• Oligopoly and the public interest– advantages
Oligopoly
• Non-collusive oligopoly: the kinked demand curve theory– assumptions of the model
– stable prices
– limitations of the model
• Oligopoly and the public interest– advantages
– disadvantages
Oligopoly
• Non-collusive oligopoly: the kinked demand curve theory– assumptions of the model
– stable prices
– limitations of the model
• Oligopoly and the public interest– advantages
– disadvantages
– difficulties in drawing general conclusions
Price Discrimination
• Meaning of price discrimination
– First degree
– Second degree
– Third degree (the most common form)
Third-degree price discrimination
P
QO
P1
D
200
Revenue froma single price
O
P1
D
200
P2
150
P
Q
Increased revenuefrom price
discriminationA higher discriminatoryprice is now introduced
Third-degree price discrimination
Price Discrimination
• Meaning of price discrimination
– First degree
– Second degree
– Third degree (the most common form)
• Conditions necessary for price discrimination
Price Discrimination
• Meaning of price discrimination
– First degree
– Second degree
– Third degree (the most common form)
• Conditions necessary for price discrimination
• Advantages to the firm
Price Discrimination
• Profit maximising prices and output under price discrimination
O O OMRX
(a) Market X
DX
Profit-maximising output underthird degree price discrimination
O O O
DY
MRX
MRY
(a) Market X (b) Market Y
DX
Profit-maximising output underthird degree price discrimination
O O OMRX
MRY MRT
(a) Market X (b) Market Y (c) Total
(markets X + Y)
DX
Profit-maximising output underthird degree price discrimination
DY
Profit-maximising output underthird degree price discrimination
O O OMRX
MRY MRT
MC
(a) Market X (b) Market Y (c) Total
(markets X + Y)
DX
DY
O O OMRX
MRY MRT
MC
(a) Market X (b) Market Y (c) Total
(markets X + Y)
DX
3000
Profit-maximising output underthird degree price discrimination
DY
O O O
DX
MRX
MRY MRT
MC
5
(a) Market X (b) Market Y (c) Total
(markets X + Y)
3000
Profit-maximising output underthird degree price discrimination
DY
O O OMRX
MRY MRT
MC
5
1000
(a) Market X (b) Market Y (c) Total
(markets X + Y)
DX
3000
Profit-maximising output underthird degree price discrimination
DY
O O OMRX
MRY MRT
MC
5
1000 2000
(a) Market X (b) Market Y (c) Total
(markets X + Y)
DX
3000
Profit-maximising output underthird degree price discrimination
DY
O O OMRX
MRY MRT
MC
5
9
1000 2000
(a) Market X (b) Market Y (c) Total
(markets X + Y)
DX
3000
Profit-maximising output underthird degree price discrimination
DY
O O OMRX
MRY MRT
MC
DY
5
7
1000 2000 3000
(a) Market X (b) Market Y (c) Total
(markets X + Y)
9
DX
Profit-maximising output underthird degree price discrimination
Price Discrimination
• Profit maximising prices and output under price discrimination
• Price discrimination and the public interest
– competition
Price Discrimination
• Profit maximising prices and output under price discrimination
• Price discrimination and the public interest
– competition
– profits
