4_marketstructure

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Market Structure


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Market Structure

• Market structure – identifies how a marketis made up in terms of:– The number of firms in the industry– The nature of the product produced– The degree of monopoly power each firm has– The degree to which the firm can influence price– Profit levels– Firms behaviour – pricing strategies! non"price

competition! output levels– The e#tent of barriers to entry– The impact on efficiency


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Market Structure

More competitive $fewer imperfections%

Perfect&ompetition

PureMonopoly


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Market Structure

'ess competitive $greater degreeof imperfection%

Perfect&ompetition

PureMonopoly


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Market StructurePerfect

&ompetition

PureMonopoly

Monopolistic &ompetition (ligopoly )uopoly Monopoly

The further right on the scale! the greater the degreeof monopoly power e#ercised by the firm*


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Market Structure

• +mportance:• )egree of competition affects

the consumer – will it benefitthe consumer or not,

• +mpacts on the performanceand behaviour of thecompany-companies involved


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Market Structure

• Models – a word of war i g!– Market structure deals with a number of economic

.models

– These models are a representation of reality to helpus to understand what may be happening in real life

– There are e#tremes to the model that are unlikelyto occur in reality

– They still have value as they enable us to draw

comparisons and contrasts with what is observedin reality– Models help therefore in analysing and evaluating –

they offer a benchmark


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Market Structure

• Characteristics of each "odel:– /umber and si0e of firms that make up

the industry– &ontrol over price or output– Freedom of entry and e#it from the industry– /ature of the product – degree of

homogeneity $similarity% of the products inthe industry $e#tent to which products canbe regarded as substitutes for each other%

– )iagrammatic representation – the shapeof the demand curve! etc*


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Market Structure&haracteristics: 'ook at these everyday products – what type ofmarket structure are the producers of these products operatingin,

1emember tothink about thenature of theproduct! entry ande#it! behaviour ofthe firms! numberand si0e of the

firms in theindustry*

2ou might evenhave to ask whatthe industry is,,Canon SLR CameraBananas

Mercedes CLK Coupe

Vodka

ElectricGuitar –Jazz Body


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Perfect &ompetition

• (ne e#treme of the market structure spectrum• Characteristics:

– 'arge number of firms

– Products are homogenous $identical% – consumerhas no reason to e#press a preference for any firm– Freedom of entry and e#it into and out

of the industry– Firms are price takers – have no control

over the price they charge for their product– 3ach producer supplies a very small proportion

of total industry output– &onsumers and producers have perfect knowledge

about the market


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Perfect &ompetition)iagrammatic representation

&ost-1evenue

(utput-Sales

P 4 M1 4 51

M&

5&

67

5o# assume a "irm makessome "orm o" modi"ication toits product or *ains some"orm o" cost ad%anta*e +say ane# production met od,$6 at #ould appen7

5&7

M&7

5&75bnormal profit

68

Because t e model assumesper"ect kno#led*e1 t e "irm*ains t e ad%anta*e "or only as ort time !e"ore ot ers copyt e idea or are attracted to t eindustry !y t e e&istence o"a!normal pro"it$ -" ne# "irms

enter t e industry1 supply #illincrease1 price #ill "all and t e"irm #ill !e le"t makin* normalpro"it once a*ain$

P7 4 M17 4 517

T e lo#er )C and MC #ouldimply t at t e "irm is no#earnin* a!normal pro"it+)R8)C, represented !y t e*rey area$

)%era*e and Mar*inal costscould !e e&pected to !elo#er !ut price1 in t e s ortrun1 remains t e same$


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Monopolistic or +mperfect&ompetition

• 9here the conditions of perfect

competition do not hold! .imperfectcompetition will e#ist• arying degrees of imperfection give

rise to varying market structures• Monopolistic competition is one of these

– ot to be confused with monopoly;


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Monopolistic or +mperfect

&ompetition• Characteristics:

– 'arge number of firms in the industry

– May have some element of control overprice due to the fact that they are able todifferentiate their product in some way fromtheir rivals – products are therefore close!but not perfect! substitutes

– 3ntry and e#it from the industry is relativelyeasy – few barriers to entry and e#it– &onsumer and producer knowledge

imperfect


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-mplications "or t e dia*ram9Cost:Re%enue

;utput : Sales

M&

5&

Mar*inal Cost and )%era*e Cost #ill !e t esame s ape$ p1 t e "irm #ill make @>p &23 in a!normal pro"it$

T is is a s ort run e4uili!riumposition "or a "irm in amonopolistic marketstructure$


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+mplications for the diagram:&ost-1evenue

(utput - Sales

M&

5&

) $51%M167

Because t ere is relati%e"reedom o" entry and e&itinto t e market1 ne#"irms #ill enterencoura*ed !y t ee&istence o" a!normalpro"its$ 5e# entrants #illincrease supply causin*price to "all$ )s price"alls1 t e )R and MRcur%es s i"t in#ards asre%enue "rom eac saleis no# less$

517M17


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(utput - Sales

M&

5&

) $51%M167

517M17

5otice t at t e e&istenceo" more su!stitutes makest e ne# )R +A, cur%emore price elastic$ T e"irm reduces output to apoint # ere MC ( MR+2 ,$ )t t is output )R (

)C and t e "irm #ill makenormal pro"it$

68

51 4 5&


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(utput - Sales

M&

5&

517M17

T is is t e lon* rune4uili!rium positiono" a "irm in monopolisticcompetition$

68

51 4 5&


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&ompetition• Some important points about

monopolistic competition:

– May reflect a wide range of markets– /ot ?ust one point on a scale –

reflects many degreesof .imperfection

– 3#amples,


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• 1estaurants• Plumbers-electricians-local builders• Solicitors

• Private schools• Plant hire firms• +nsurance brokers• @ealth clubs

• @airdressers• Funeral directors• 3state agents• )amp proofing control firms


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&ompetition• +n each case there are many firms

in the industry• 3ach can try to differentiate its product

in some way• 3ntry and e#it to the industry is relatively free• &onsumers and producers do not have perfect

knowledge of the market – the market mayindeed be relatively localised* &an you imaginetrying to search out the details! prices! reliability!Auality of service! etc for every plumber in theBC in the event of an emergency,,


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(ligopoly

• 3#ample:• Music sales –

The music industry hasa "firm concentrationratio of G H*+ndependents make up

8 H of the market butthere could be manythousands of firms thatmake up this

.independents group*5n oligopolistic marketstructure thereforemay have many firmsin the industry but it isdominated by a fewlarge sellers*

Market Share of the Music +ndustry 8==8* Source +FP+: http:--www*ifpi*org-site"content-press-8==D=I=I*html

http://www.ifpi.org/site-content/press/20030909.htmlhttp://www.ifpi.org/site-content/press/20030909.html


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(ligopoly• Features of an oligopolistic market

structure:– Price may be relatively stable across the industry –

kinked demand curve,– Potential for collusion– Jehaviour of firms affected by what they believe their rivals

might do – interdependence of firms– Koods could be homogenous or highly differentiated– Jranding and brand loyalty may be a potent source of competitive

advantage

– /on"price competition may be prevalent– Kame theory can be used to e#plain some behaviour– 5& curve may be saucer shaped – minimum efficient scale

could occur over large range of output– @igh barriers to entry


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(ligopolyThe kinked demand curve " an e#planation for price stability,Price

6uantity

) 4 elastic

) 4 +nelastic

<

7==

Cinked ) &urve

T e principle o" t e kinked demandcur%e rests on t e principlet at9

a$ -" a "irm raises its price1 itsri%als #ill not "ollo# suit

!$ -" a "irm lo#ers its price1 itsri%als #ill all do t e same

)ssume t e "irm is c ar*in* a price o"= and producin* an output o" 3>>$

-" it c ose to raise price a!o%e = 1 itsri%als #ould not "ollo# suit and t e "irme""ecti%ely "aces an elastic demandcur%e "or its product +consumers #ould!uy "rom t e c eaper ri%als,$ T e Dc an*e in demand #ould !e *reatert an t e D c an*e in price and TR#ould "all$

Total Revenue A

Total

Revenue B

-" t e "irm seeks to lo#er its price to*ain a competiti%e ad%anta*e1 its ri%als#ill "ollo# suit$ )ny *ains it makes #ill4uickly !e lost and t e D c an*e indemand #ill !e smaller t an t e D

reduction in price – total re%enue#ould a*ain "all as t e "irm no# "acesa relati%ely inelastic demand cur%e$

Total Revenue B

Total Revenue A

T e "irm t ere"ore1 e""ecti%ely "acesa .kinked demand cur%e0 "orcin* it tomaintain a sta!le or ri*id pricin*structure$ ;li*opolistic "irms mayo%ercome t is !y en*a*in* in non

price competition$


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)uopoly• Market structure where the industry is

dominated by two large producers– &ollusion may be a possible feature

– Price leadership by the larger of the two firms maye#ist – the smaller firm follows the price leadof the larger one

– @ighly interdependent– @igh barriers to entry– &ournot Model – French economist – analysed

duopoly – suggested long run eAuilibrium would seeeAual market share and normal profit made

– +n reality! local duopolies may e#ist


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Monopoly• Pure monopoly – where only

one producer e#ists in the industry• +n reality! rarely e#ists – always

some form of substitute available;• Monopoly e#ists! therefore!

where one firm dominates the market• Firms may be investigated for e#amples of

monopoly power when market sharee#ceeds 8 H• Bse term .monopoly power with care;


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Monopoly• Monopoly power – refers to cases where firms

influence the market in some way throughtheir behaviour – determined by the degree

of concentration in the industry– +nfluencing prices– +nfluencing output– 3recting barriers to entry– Pricing strategies to prevent or stifle competition– May not pursue profit ma#imisation – encourages

unwanted entrants to the market– Sometimes seen as a case of market failure


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Monopoly

• $rigi s of "o opoly:– Through growth of the firm

– Through amalgamation! mergeror takeover

– Through acAuiring patent or license

– Through legal means – 1oyal charter!nationalisation! wholly owned plc


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Monopoly

• Summary of characteristics of firmse#ercising monopoly power:

– %rice – could be deemed too high! may beset to destroy competition $destroyer orpredatory pricing%! price discriminationpossible*

– &fficie cy – could be inefficient due to lackof competition $L" inefficiency% or• could be higher due to availability of high profits


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Monopoly

• ' o(atio " could be high becauseof the promise of high profits! Possibly

encourages high investment in researchand development $1N)%• Collusio – possible to maintain

monopoly power of key firms

in industry• @igh levels of branding! advertising

and non"price competition


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Monopoly

• Problems with models – a reminder:– (ften difficult to distinguish between a monopoly

and an oligopoly – both may e#hibit behaviourthat reflects monopoly power

– Monopolies and oligopolies do not necessarily aimfor traditional assumption of profit ma#imisation

– )egree of contestability of the market may influencebehaviour

– Monopolies not always .bad – may be desirablein some cases but may need strong regulation

– Monopolies do not have to be big – could e#ist locally


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Monopoly&osts - 1evenue

(utput - Sales

5&

M&

51M1

)R +A, cur%e "or a monopolistlikely to !e relati%ely priceinelastic$ ;utput assumed to!e at pro"it ma&imisin* output+note caution ere – not allmonopolists may aim

"or pro"it ma&imisationF,

67


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(utput - Sales

5&

M&

51M1

9elfareimplications ofmonopolies

) look !ack at t e dia*ram "orper"ect competition #ill re%ealt at in e4uili!rium1 price #ill !ee4ual to t e MC o" production$

6e can look t ere"ore at acomparison o" t e di""erences!et#een price and output in acompetiti%e situationcompared to a monopoly$

67


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(utput - Sales

5&

M&

51M1


67


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(utput - Sales

5&

M&

51M1


67


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&ontestable Markets• Theory developed by 9illiam O* Jaumol!

Oohn Pan0ar and 1obert 9illig $7I 8%

• @elped to fill important gaps in marketstructure theory• %erfectly co testable "arket – the

pure form – not common in reality but abenchmark to e#plain firms behaviours


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&ontestable Markets

• )ey characteristics:– Firms behaviour influenced by the threat

of new entrants to the industry– /o barriers to entry or e#it– /o sunk costs– Firms may deliberately limit profits made

to discourage new entrants – entry limitpricing

– Firms may attempt to erect artificial barriersto entry – e*g


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&ontestable Markets• (ver capacity – provides the

opportunity to flood the marketand drive down price in the event

of a threat of entry• 5ggressive marketing and branding strategies to .tighten up the market

• Potential for predatory

or destroyer pricing• Find ways of reducing costs and

increasing efficiency to gain competitiveadvantage


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&ontestable Markets

• 3#amples of markets e#hibitingcontestability characteristics:

– Financial services– 5irlines – especially flights

on domestic routes– &omputer industry – +SPs! software!

web development– 3nergy supplies– The postal service,


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Market Structures

• Final reminders:• Models can be used as a comparison – they are not necessarily

meant to J3 reality;• 9hen looking at real world e#amples! focus on the behaviour of

the firm in relation to what the model predicts would happen –that gives the basis for analysis and evaluation of the real worldsituation*

• 1egulation – or the threat of regulation may well affectthe way a firm behaves*

• 1emember that these models are based on certain assumptions– in the real world some of these assumptions may not be valid!this allows us to draw comparisons and contrasts*

• The way that governments deal with firms may be based on ageneral assumption that more competition is better than less;

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