Market structure

Market StructureMarket Structure

Chapter 12

Structure-Conduct-Structure-Conduct-Performance ModelPerformance Model

A model used for analysis of an industry which holds that structure determines conduct, which in turn determines performance

Market StructureMarket Structure

The amount of competition that exists in a market between producers

Perfect CompetitionMonopolyOligopolyMonopolistic Competition

Perfect Perfect Competition:ConditionsCompetition:Conditions

So many buyers and sellers in the market, no one of them can influence price

Homogeneous goodsPerfect knowledgePerfect mobilityNo barriers to entry or exit

Perfect Competition:Price Perfect Competition:Price DeterminationDetermination

Normal profit- minimum level of profits in order to stay in business

Abnormal profits – profits over and above normal profits Firms will decide what level of output to produce by

setting the cost of producing the last unit of good equal to the revenue gained from selling the last unit (marginal cost = marginal revenue)

In perfect competition, as firms have perfect knowledge, abnormal profits are unsustainable in the long run

Example of Perfect Example of Perfect CompetitionCompetition

Closest example is a fruit and vegetable market

Monopoly: CharacteristicsMonopoly: Characteristics

Has market power, and can decide price OR quantity sold (not both)

Either no substitutes for the goods, or high barriers to entry

Monopolist may use price discrimination

Price DiscriminationPrice Discrimination

Consumers pay different prices for the same good

Can occur when: the producer is monopolistic and able to control supplythere are groups of consumers with different demand conditionsable to separate the groups

Compare and contrast Compare and contrast monopoly and perfect monopoly and perfect

competitioncompetitionHow do these two structures affect prices?

Choice of products? Innovation?

OligopolyOligopoly

A small number of producers supply a market in which the product is differentiated in some way

Oligopoly CharacteristicsOligopoly Characteristics

High interdependence between firmsA lack of price competition in the marketLack of price competition leads to different

forms of non-price competition taking place, such as branding and advertising

Price is determined by a price leader or by collusion

Monopolistic CompetitionMonopolistic Competition

Monopolistic competition exists when all conditions for perfect competition exist except for homogeneous goods

Goods are slightly different in some way (technical or economic)

Abnormal prices may exist in the short-term but cannot last for a long-time

Are These Theories Accurate?Are These Theories Accurate?

Both perfect competition and monopolies are unrealistic, while oligopolies and monopolistic competition are more realistic

In oligopolistic markets, prices tend to be sticky, but occasionally price wars occur

Price Wars: Mini-Case (P.340)Price Wars: Mini-Case (P.340)

How do price wars affect firms in the industry?

How do price wars affect buyers?

Porter’s 5 Forces ModelPorter’s 5 Forces Model

Structure of an industry and the ability of firms to act strategically depend on the relative strengths of five forces:current competitionpotential competitionthreat of substitute productspower of buyerspower of suppliers

Current CompetitionCurrent Competition

Competition can be determined by the 4 types of markets discussed before

BUT, according to Porter’s Model, firms may change the structure of the industry

Firms in highly competitive markets may dislike their lack of power over various factors and try to change the situation, which will change the level of competition

Potential CompetitionPotential Competition

Degree of potential competition depends upon the existence and height of barriers to entry and exit

Natural monopolies – industries where competition would be wasteful (like public utilities)

Economies of scale – cost benefits associated with large operations

Economies of Scale:SourcesEconomies of Scale:Sources

Technical economies – come from increased specialization and indivisibilities

Marketing economies – spreading market costs over a larger output, so average costs are lower (bulk buying is often used)

Financial economies – easier and cheaper to borrow capital

Risk diversification

Other Barriers to EntryOther Barriers to Entry

LegalBrand loyaltyHigh initial capital investment

Contestable MarketContestable Market

A market in which there are no barriers to entry or exit

All firms have access to the same technology, so there are no cost barriers to entry

No unrecoverable costs to prevent firms from leaving the market

What regulates the market behavior is not actual but potential competition

Threat of Substitute ProductsThreat of Substitute Products

If there are no substitutes, producer of the good will face little competition and have high market power

Firms often differentiate to reduce the threat of substitute goods

Power of BuyersPower of Buyers

Monopsony - market where there is only one buyer, and the buyer has the market power not the seller (example: coal industry)

The existence of strong buyers and weak sellers may benefit the market, or it could lead to higher seller concentration as sellers come together to counteract buyer power

The existence of strong sellers and weak buyers may result in consumer rights groups forming to protect buyers

Power of SuppliersPower of Suppliers

Where there are few suppliers, supplier power will be high (can affect producers costs)

The decision of whether to produce components needed in the production process or to buy from a supplier is covered by transaction cost economics

Measuring Degree of Actual Measuring Degree of Actual CompetitionCompetition

Level of competition is measured by concentration ratios

These measure:the percentage of value addedtotal outputor employmentthat is produced by the largest firms in the industry (3 or 5 firms)

Reasons for High Reasons for High ConcentrationConcentration

At the Minimum Efficient Scale of Production (MES) point, all economies of scale have been taken by the firm

The higher the MES relative to the total output of the industry, the fewer the number of firms operating in the industry and therefore the higher the level of concentration

Firms in every industry face differing average cost curves and therefore market structures will differ

In services, for example, the scope of economies of scale is small, and the MES is small relative to the size of the total market (industries are unconcentrated)

Structure-Conduct-Structure-Conduct-Performance Analysis:AirlinesPerformance Analysis:Airlines

What type of market is the airline industry? How much market power do airlines have? How does the market structure affect price? What barriers to entry exist in the airline industry? What is the level of seller competition? Buyer competition? What demand factors affect the structure? Supply factors? How do airlines use pricing conduct to respond to industry structure?

Merger activity? How has market structure and conduct affected airline performance?

Homework: Due 2Homework: Due 2ndnd Class Class Next WeekNext Week

Using the structure-conduct-performance model, analyze an industry of your choice

This assignment is worth 10% of final grade