Ekonomi industri hands out

Industrial Economics: Introduction

Industrial economics is concerned with the behavior of firms in industries:

• the policies of firms toward rivals and toward customers prices, advertising, R&D

• firms in industries that are competitive as well as less than competitive

Industrial Economics: Introduction

theory of the firm; price theory: focus on simple market structures (competition and monopoly)

industrial economics: oligopoly; the real world

industrial economics: public policy toward business; role of government

SCP: Structure-Conduct-Performance

Structure Conduct Performance

Market structure determines the behavior of the firms in the market, and the behavior of the firms detrmines the various aspects of market performance

Structure

• number and size distribution of sellers

• number and size distribution of buyers

• product differentiation

• entry conditions

Conduct

• collusion

• strategic behavior

• advertising

• research and development

Performance

• profitability

• efficiency

• progressiveness

Interactive SCP framework

progressiveness

technology

profitability

perfomance

structure

strategy

conductdemand

sales effort

Interactive SCP framework

technology

perfomance

structure

conductFreedom of entry

The welfare consequences of market power

The consequences of market power

The ability of firms to influence the price or the product they sell

the economics of compettive market

monopoly

welfare

Competition

Formal assumption of the competitive model:

• many small buyers and sellers

• standardized product

• free and easy entry and exit

• complete and perfect knowledge

Inputs and costs: fixed and variable

• fixed inputs past investment decission

• variable inputs level of output

• fixed costs services of fixed factors

• variable costs variable factors of production

variable factor: labor

fixed factor: capital

opportunity cost, rental cost of capital services

normal profit: (average cost-AVC)

economic profit: (price-average cost)

Costs curves: typical firm & market

AC: average cost

AVC: average variable cost

MC: marginal cost

S1, S1 : short-run supply curves

D: demand curve

(qSD , pSD): shutdown point minimizes losses

(qLR , pLR): long-run equilibrium for a typical firm

(QLR , PLR): market long-run equilibrium

Cost curves under competition

price MC

qSD

The firm’s supply decission: to maximize profit

Firm is a price taker choose the ouput that MC=P1 q1

typical firm

AC

AVC

qLR q1

PSD

PLR

P1

S1

S2

D

Q1 QLRfirm output

market output

market

Short-run and Long-run equilibrium: Competition

S1 : short-run supply curves

D: demand curve

P1 : initial short-run equilibrium price

Q1 : market output in the short-run

q1 : firm’s output in the short-run equilibrium

Firm’s profit economic profit attract new firms

S1 S2

PLR : long-run equilibrium price

QLR : market output in the long-run

qLR : firm’s output in the long-run equilibrium

Economies and diseconomies of scale

price

MC

QMES : minimum efficient scale outpout

ACConstant return to

scale

0QMES output

AC

MC

Monopoly

only one supplier

entry is blockaded

price maker

A

quantity

price

C

E

P1

P2

0Q1 Q2 F

Monopoly: output decission

MC=MR

maximize profit

quantity

price

MCPm

0q1 Qm F

MR D

Welfare consequences of market power

Consumers’ surplus

quantity

price

P1

0

1 F

D

2 3

P2

P3

Welfare consequences of market power

Deadweight welfare loss

quantity

price

Pm

0

Qm

F

GPc

B

E

Qc

Income transfer to monopolist

Spending shifted to other industries

c=marginal cost

Monopoly restrict output and raise price, compared with the price of competitive industry

The Dominant Firm (DF)

• Many industries supplied by a large firm and a fringe of smaller rivals (including new entrants)

• Many of these DFs have maintained their leadership positions for generations

• Difference between DF and monopoly dominant firm must take into account the reaction of its fringe competitors;

If monopolist raises price some customers leave the market

If DF raises some customers begin to buy froms its rivals

Monopolist How much it will produce, what it will charge, implications of its market power

DF + How a DF acquires its position and how it keeps it

Behavior of DF: A Static Limit Price Model

DF can keep the price so low that entry by new firms or expansions by existing fringe firms is not profitable

P

market demand curve

Pe

0

qe

Q

MR

AC entrant

Residual demand curve

ACe

qd

Residual marginal revenue curve

MC entrant

Entrant’s profit

The entrant’s output decission

Behavior of DF: A Static Limit Price Model

P

market demand curve

PL

0Q

MR

AC entrant

Residual demand curve

qL

Residual marginal revenue curve

MC entrant

Limit output (qL) and limit price (PL)

The more the DF’s output, the closer will the residual demand curve to the origin

below entrant’s AC

A natural monopoly government regulation

P

market demand curve

Pm

0Q

AC entrant

MC df

Blockaded entry

If the market is very small and entry costs are

very high it will not profitable for new

entrant

qm

Dynamic limit pricing

The static model ignores the fact that entry takes time trade off between current and future profit

the difference between the limit profit if it sets a low price and the larger short run profit if it sets a higher price

the rate at which DF loses market share (profit) to the fringe if the fringe begins to expand

the discount rate

Strategy to achieve and maintain dominance

Dominance is a power relation between two agents in which the dominator restricts the action of the dominatedDF’s weapon: its output level which influence the price

DF is giving up the profit to maintain position

STRATEGIC BEHAVIOR:

MERGER

DIRECT COST-BASED STRATEGIES: increasing rival’s costs

TECHNOLOGY-BASED STRATEGIES: capacity expansion, vertical integration

MARKETING-BASED STRATEGIES: product differentiation, access to consumers

Summary

Firms may achieve a dominant position

By superior competitive performance

By merger

By strategic behavior design to exclude competitors and prevent competition on the merits

PUBLIC POLICY

toward

DOMINANT FIRMS

OligopolyOligopoly: The recognition of interdependence: The recognition of interdependence

Competititve market each firm is so small price taker Monopolist has no rival price maker

Dominant firm does consider the reaction of fringe firms one sided recognition no recognition if entry cost is low give up mkt share fringe firms approach the size of DF OLIGOPOLY

supplied by few firms,

which recognize their mutual interdependence

OligopolyOligopoly: measuring fewness: measuring fewness

percentage of industry sales the largest 4, the largest 10 when the largest 4 40% of supply

each must be aware of the others OLIGOPOLY

concentration ratio summary index of fewness

the Herfindahl Index

combining information about market shares of all firms in the market

OligopolyOligopoly: the decision making: the decision making

decide how much to produce

let the market determine the price

sunk cost

set the price

sell whatever quantity demanded at that price

the technology allows rapid changes in the rate of output

P

OligopolyOligopoly: the quantity-setting: the quantity-setting

market demand curve

Q

Residual demand curve

Residual marginal revenue curve

MC = AC

Cournot Duopoly a market supplied by two identical firms

q2

q1(q2)

OligopolyOligopoly: the quantity-setting: the quantity-setting

Firm’s 1 reaction curve

Firm’s 2 output

qc

Firm’s 2 reaction curve

Firm’s 1 outputqm

qm

qc

A

B

q1,A

q2’,B

q2,A

The ouput each firm will choose

depends on what it thinks the other firm will do

OligopolyOligopoly: price-setting: price-setting

homogenous product differentiated product

public policy toward oligopoly conspiracy to monopolize

COLLUSION

The determinants of market structure The determinants of market structure

3 faktor penting dalam struktur pasar

entry condition

economies of scale product differentiation absolute cost advantages of existing firms

The determinants of marketThe determinants of market

If there is economies of scale

average cost falls as output increases

for constant MC = c

C (q) = F = cq

AC(q) = c + (F/q)

Function coefficient: economies of scale

FC = AC/MC = (c+(F/q)/c = 1 + F/cq

Economies of scale becomes more important as fixed cost increases

market demand curve: P=a-bQ

PSR

Short-run equilibrium, n-firm Cournot oligopolyShort-run equilibrium, n-firm Cournot oligopoly

Q

Residual demand curve

Residual marginal revenue

MC = c

SqSR

AC=(F/q)+cACSR

a

Short-run equilibrium, n-firm Cournot oligopolyShort-run equilibrium, n-firm Cournot oligopoly

Firm i’s MR

Firm i’s revenue will change as firm i changes its output

MRi = P + qi( Pi/ qi) = P-bqi = a – bQ – bqi

maximizing profit by picking the output level that

MR=MC atau a – bQ – bqi = c atau Q + qi = (a-c)/b

a natural measure of market size = S = (a-c)/b

All firms produce the same output in equilibrium: Q=Nq

qSR = S/(n+1)

PSR = c + (bS/(n+1))

market demand curve: P=a-bQ

Long-run equilibrium, Cournot oligopolyLong-run equilibrium, Cournot oligopoly

Q

Residual demand curve

MC = c

SqLR

AC=(F/q)+cPLR = ACLR

a

Number of firmsNumber of firms

In SR equilibrium, each firm earns a profit:

SR = b (S/(N+1))2 – F

the LR equilibrium number of firms SR firm’s profit = 0

nLR= (S/(F/b)) – 1

number of firms market concentration fixed cost

The market ought to be more concentrated in the long run, the greater the economies of large scale production

The determinants of marketThe determinants of market

Differentiation

Advertising

Efforts of sales forces

Design changes

Oligopolist behavior market power

If output is restricted, price is rised above MC rivals will come in, expand capacity, and force price down to a competititve level

Entrants will not come unless can make profit

Minimum efficient scale (MES)

The determinants of firm structure The determinants of firm structure

The separation of ownership and control in modern corporation firms may be managed to pursue the interests of

managers rather than owners

Firms may expand horizontally, ……………… market power vertically, or ……………… market imperfection … costs into unrelated markets …. conglomerate mergers … risk