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Competition and Market Structure
Frederick University
2011
Industry
Industry (market) – a collection of firms, each of which is supplying products that have some degree of substitutability, to the same potential buyers
Common buyers for sellers Common sellers for buyers Relatively homogeneous product
SCP Paradigm Basic Conditions
Market Structure
Conduct
Performance
BASIC CONDITIONS SUPPLY
raw material technology product durability value/weight business attitudes unionization
DEMAND price elasticity rate of growth substitutes marketing type purchase method cyclical and
seasonal character
Market Structure
Market Structure – those characteristics of the market that significantly affect the behavior and interaction of buyers and sellers
MARKET STRUCTURE number and size of sellers and
buyers type of the product conditions of entry and exit transparency of information
Perfect Competition - structure Many and small sellers, so that no
one can affect the market Homogeneous product Free entry to and exit from the
industry Transparent and free information
Pure Monopoly- market structure Only one producer in the industry The product does not have close
substitutes Blocked entry
Monopolistic competition - structure Many and small sellers Differentiated product Free entry and exit Transparent and free information
Oligopoly – market structure A) Tight oligopoly – a few big firms in the
industry with comparable market shares/ B) Dominant firm oligopoly – one of the big firms in the industry is recognized as the price leader
Homogeneous / Heterogeneous oligopoly Significant barriers to entry to and exit
from the industry Significant barriers to information
Entry into an industry or to a segment of an industry can occur because there is
•de novo entry. •takeover from outside the industry
•the development of technologically similar firms who develop their product range.•the transference of brand names across sectors •an increase in import penetration. Again, the scale of the firm involved is important here.
Entry
Barriers to EntryStructural barriers High capital cost Economies of scale Product differentiation and brand loyalty High switching cost Ownership/control of key factors or outlets Strategic barriers Limit pricing Excess capacity Vertical integration Sleeping patents Predatory pricing Tying sales Institutional barriers Patents Regulations
Alternative Market Structures The four market structures
perfect competition monopoly monopolistic competition oligopoly
Features of the four market structures
Features of the four market structures
Features of the four market structures
Features of the four market structures
Features of the four market structures
Features of the four market structures
Market Conduct Market Conduct – a firm’s policies toward its market and toward the moves made by its rivals in that market
CONDUCT pricing behavior product strategy research and innovation advertising legal tactics
Perfect competition - conductIndustry’s marketP
Q
D S
Pe
Qe
Firm’s market
P
Q0 10 20
d
P q TR MR5 0 0 -5 10 50 55 20 100 5
MR
Perfect competition – short run “conduct”p
Q
dd = MR
MC
P = MR MC = MRq
P>AC
AC
Economic profit = (P-AC) q
Perfect Competition – long run “conduct”Industry’s equilibriumP
Q
DS
Pe
Qe
P’
If P>AC, new firms startentering the industry andthe equilibrium price falls.
The industry is in a long runequilibrium when P = AC
In the long run the firms make normal profit
If Р < АС, the firms willstart leaving the industry and the equilibrium price will increase.
fig(a) Industry
P
P1
Q (millions)
S
D1
(b) Firm
d1 = MR1
MC
P2
d2 = MR2
D2
P3
d3 = MR3
D3
Q (thousands)
Perfect Competition - Deriving the short-run supply curve
ab
c
= S
The firm’s short run supply curve is determined by its MC curve above AVC
Q
(SR)AC
(SR)MC
LRAC
AR = MR
DL
LRAC = (SR)AC = (SR)MC = MR = AR
Long-run equilibrium of the firm under perfect competition
Pure Monopoly - conductP
Q
D
P Q TR MR10 1 10 1011 2 18 88 3 24 6
MR
P>MR
MC=MR
MC
Qm
P
ACEconomic
Profit
L
P
Q Qm
AR D
MC
AC
MR
Pure Monopoly and Perfect competition
Pm
Qp.c.
Pp.c.K
N
Consumer surplus = ∑ (P –MWP)Under perfect competition = KLNUnder pure monopoly = NRT
R T
GGTL – the portion of theconsumer surplus,which is a deadweight loss for the societyJGL – the portion of the producer surplus, which is a deadweight loss for the society
Producer surplus =∑ (P-MC)Under pure monopoly the producersurplus rises by KGTR at the expense of the consumer surplus
J
TLJ – total deadweight loss for the society
P
Q Qs
AR D
MC
AC
MR
Monopolistic competition – conduct in the short run
Ps
ACs
P>MRMC = MR
Monopolistic competition – conduct in the long run
ARL DL
MRL
P
Q QL
PL
LRAC
LRMC
If P>AC new firms will enterthe industry and the firm’smarket segment will shrink - its individual demand curveshifts leftwards
The long run equilibrium is achieved at P = AC, however, АС is not minimized – there is excess capacity
figQ2
P2 DL under perfectcompetition
Long run equilibrium under perfect competition and under monopolistic competition
P
Q
P1
LRAC
DL under monopolisticcompetition
Q1
Tight oligopoly - conductP
Q
NFDFD
fig
P
Q
P1
Q1
FD
NFD
The kinked demand curve under the tight oligopoly
P
Q
P1
Q1
MRf
a
b D AR
The kinked demand curve
MRnf
P
Q
P1
Q1
MC2
MC1
MR
а
bD AR
Rigid prices under the tight oligopoly
Price leadership of the dominant firmP
Q
DindustryDleader
Sothers
P
Q
Sother firms
Dindustry
Dleader
PL
MRleader
MCleader
QL QF QT
f tl
Price leadership of the dominant firm
Market Performance Market Performance – how well does an industry do what society might reasonably expect it to do
PERFORMANCE profitability allocative efficiency static production efficiency dynamic efficiency - progress full employment equity
Perfect Competition - Performance P = MR MC = MR P = MC P = AC AC = MC AC minimum
Perfect Competition - Performance
Static Efficiency Efficiency in allocation MC = P Efficiency in motivation AC = MC Efficiency in distribution AC = PThe Perfect Competition achieves static
efficiencyDynamic Efficiency
There is NO potential and motivation for innovations and technological progress
The Perfect Competition does not achieve dynamic efficiency
Pure Monopoly - performance
Static efficiency
Efficiency in allocation MC < P Efficiency in motivation excess capacity
Efficiency in distribution AC < P
The pure monopoly does not achieve static efficiency
Dynamic efficiencyThere is a potential and motivation for innovations and technological progress
The pure monopoly is motivated to achieve dynamic efficiency at the presence of potential competition
Monopolistic competition - performance
Static Efficiency
Efficiency in allocation MC < P Efficiency in motivation excess
capacity Efficiency in distribution AC = P
Contestable MarketsKey characteristics: Firms’ behaviour influenced by the
threat of new entrants to the industry – if even the industry is concentrated, the incumbent firms behave as if they are perfect competitors
Firms’ performance depends on the potential competition
Contestable markets Ultra easy entry Ultra easy exit Zero sunk cost “Hit and run”
strategy”
Contestable market
Oligopoly – non-collusive behavior Game theory – the study of multi-person
decision problems (the reactions of a few interdependent decision makers)
Game - any situation that involves well-defined rules and outcomes, where outcomes are dependent on players’ strategic decisions
Strategy – a complete plan, specifying the game under any possible circumstances
The Prisoners’ dilemma Two suspects, Valio and Georgy, are arrested by the
police. The police have insufficient evidence for a conviction, and, having separated both prisoners, visit each of them to offer the same deal: if one testifies for the prosecution against the other and the other remains silent, the betrayer gets 3 months and the silent accomplice receives the full 10-year sentence. If both stay silent, both prisoners are sentenced to only 1 year in jail for a minor charge. If each betrays the other, each receives a three-year sentence. Each prisoner must make the choice of whether to betray the other or to remain silent. However, neither prisoner knows for sure what choice the other prisoner will make. So this dilemma poses the question: How should the prisoners act?
fig
The Prisoners’ dilemma
Does not confess Confesses
Does not confess
Confesses
Valio’s alternatives
Georgy’s alterantives
Everyone gets1 year
Everyone gets 3 years
Georgy - 3 months
Valio- 10 years
Georgy - 10 years
Valio -3 months
The Prisoners’ dilemma The Prisoners’ dilemma is the
duopoly’s dilemma. Prisoners cannot coordinate their confessions. Even though they both would get less if they do not confess, they betray the other player, because of the greater payoff.
No matter what the other player does, one player will always gain a greater payoff by playing defect. Since in any situation playing defect is more beneficial than cooperating, all rational players will play defect.
fig
Payoffs for firms A и B under different pricing policies
2.00 1.80
2.00
1.80
A’s Price
B’s Price
10mil. for each
8 for each12 for В5 for А
5 for В12 for А
Collusive behavior How could the firms overcome the How could the firms overcome the
prisoners’ dilemma?prisoners’ dilemma? Collusive behavior will set
higher prices for the buyers!