Market Structure Comparison and Evaluation

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Market Structure Comparison and Evaluation

Perfect competition Assumptions:

Firms are small and have little affect on impact on price (price takers) or total output

Industry has lots of firmsIdentical products (no brand names)Perfect (symmetrical) informationEntry/exit Easy (investment and sunk

costs low)

Perfect competition

Advantages:

Lower pricesCommunity Surplus

Allocative EfficiencyProductive (Technical) Efficiency

Perfect competition cont.

Disadvantages:No incentive to innovateLack of variety to consumerGiven normal profits, price fluctuations occur due to resource (input) prices.

No EOS: economies of scale

Monopolies: Assumptions

One firm in the industry, No substitute goods.

Barriers to entry exist, very high barriers associated with high capital costs (sunk costs)

May be able to make abnormal profit in the long run because of the barriers to entry

Monopolies: AdvantagesMay Charge Lower Prices than firms in Perfect

Competition Since pure monopolies supply the whole market, their

output is large -> they often achieve economies of scale and have lower costs

May invest more in research and development (which should benefit consumers) Because they earn abnormal profits and can afford to

May be more efficient if can use abnormal profits to innovate and invest in technology that makes production efficient

Contestable Market theory

Monopolies: Disadvantages

Productively and Allocatively inefficient -less incentive to be

Can charge higher price for lower output

Can use anti-competitive behavior to maintain power

Monopolies: Disadvantages

Lower Prices to Suppliers - A monopoly may use its market power and pay lower prices to its suppliers. E.g. Supermarkets have been criticized for paying low prices to farmers.

Worse products Lack of competition may lead to less product innovation.

Charge Higher prices to producers Monopolies may use their supernormal profits to charge higher prices to producers of other products

Diseconomies of Scale - It is possible that if a monopoly gets too big it may experience diseconomies of scale. - higher average costs because it gets too big

Oligopolies: Assumptions

High Concentration Ratio-A few firms hold a high percentage of market share (there may be many small firms)

Usually high barriers to entryProducts may be identical (homogenous) or differentiated

Firms are interdependent (Large enough to effect the market price)

Oligopolies: Advantages

Economies of scale may be achieved, leading to lower costs

Greater innovation through R & D because of supernormal profits

Product development may lead to greater choice of products

Oligopolies: Disadvantages

No productive or allocative efficiencyHigher prices and lower outputLack of competition may lead to higher

costs and prices (x-inefficiency)

High advertising costs may exclude firms from enteringAdvertising may add cost, but no true

valueAdvertising may create demand for

unnecessary products

Collusive oligopoly

Acts like a monopolist in the market

Collusive oligopolies may crash if:Great number of firmsDifferentiated productProduction costs differMarket demand is shrinking (fighting

for survival)

Non-Collusive OligopoliesTend to:

Avoid price competition (sticky prices) Avoid changing output Use non-price competition

Non-price competition Heavy advertising Product differentiation Gifts, coupons, volume discounts service, store hours, warranties Cover every market niche

P

Q

D1

MR1D2

MR2

McDonald's Demand

P1

Q1

P

QD

MR

McDonald's Demand

P1

Q1

Assumptions: ·JB will match a price decrease by McD's so as to not lose market share·JB will ignore a price increase by McD's so it can capture customers who will switch to JB. ·D1 represents demand when McD's increases price, D2 when it lower price. ·Put together, the demand curve faced by a oligopolist is kinked, highly elastic above current price and highly inelastic below current price

Price Discrimination

When producers sell the exact same item to consumers at different prices

3 Necessary Conditions Producer must be price-maker to some extent (can’t

be perfect competition) Consumers must have different PEDs for the product

(consumers with inelastic demand will pay ______prices)

Producer must be able to separate consumers so one consumer doesn’t buy the good at a low price and sell to another at a higher price

Price Discrimination: Advantages for firms

More revenueMay allow producer to produce more

and gain economies of scaleCharging higher prices to market with

inelastic PED might allow them to lower prices in markets with elastic PED and gain competitive edgeIllegal to “dump” (selling product

below costs in foreign market)

Price discrimination: Advantages for customers

Some poorer consumers get subsidized by wealthier consumers (like college tuition & financial aid)

Sometimes entire groups of consumers can get lower prices because they are subsidized by another group (ex: domestic students get lower tuition because higher tuition for foreign students helps cover costs)

Usually leads to higher output in the market which should lead to economies of scale and lower costs thus lower prices for consumers

Price Discrimination: Disadvantages

Loss of consumer surplus for consumers

Some consumers pay more than they would have at market equilibrium prices

Monopolistic Competition: Characteristics

Small firms exist in the marketFirms differentiate their product

No great barriers to entry

Monopolistic Competition:Advantages

Consumers enjoy a greater variety of products

Prices are low… cannot be much higher than average costs

Monopolistic Competition: disadvantages

Normal profits in the long run

No allocative efficiencyNo productive efficiency

Not soo much R&DToo not tend to enjoy Economies of Scale

Alternatives to profit maximization:

Revenue maximize —produce where MR=OMaximize sales —sell too much instead of decreasing

output and increasing priceMaximize employment —may feel that more workers

means the company is successfulAim for Environment or Social goals —may pay more

for inputs (fair trade coffee) or pay a fair wage above what is required by the labor market (local crafts) Starbucks

Satisfice —many business owners work hard enough to make a living and get by or not get fired by shareholders

Short-run cost curves vs. Long –run cost curves

Law of diminishing returns:

Economies of scale