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Market Structures
The structure of a market is a description of the behaviour of
number of buyers and sellers in that market.
Main market structures (perfect competition, Oilgopoly,
Monopolistic competition, Duopoly, Monopoly and Monopsony).
Perfect competition: both buyers and sellers believe that their
own buying or selling decisions have no effect on the market
price.
Monopoly: Only seller or potential seller of that good in the
industry.
Monopsony: Only buyer or potential buyer of that good in the
industry.
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Imperfectly competitive market structures (these firms cannot
sell as much as it wants at the existing price. Their demand curve
slopes down and output price depend on the quantity of goods
produce and sell): Monopolistic competition and Oligopoly.
Monopolistic competition: Many sellers and close substitutes and
has only limited ability to affect for price. Oligopoly: (more than
two sellers but number is less to have impact for a market. Its own
price depends on its own output and actions of the competitors in
the industry)
Duopoly: Two sellers in the market.
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Perfect Competition
Many sellers and buyers. Therefore one can not makeany impact on
price. Then the industrys demand curve isfatter (horizontal). All
the producers are price takers not theMakers.Produce homogeneous or
identical goods.Elastic demand - price takers.All firms have
identical costs.Perfect mobilityFree entry and exit.No transaction
costs (e.g. transport, distribution).Perfect information
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Short run Supply in Perfect CompetitionOutputQ Q1oProfits
maximising Condition: MR = MC(MR = MC = P = AR)
MR=PMR=PP1P2P, CASR supply curve is theSRMC curve above the
A.
A is the shutdown point at SRP2 is the shutdown priceA B: Normal
profits (It coversPart of the fixed cost)Below A: LossAbove B:
Supernormal profitBFigure 1(page 417 and 418 in main text)
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Long run Supply in Perfect CompetitionLRMCLMC is flatter
thanSRMC because no fixed factors.
LR supply curve is theLRMC curve above the A.
A = industry leaving point.P is the entry or exist priceP,
CQ0PQ1AIndustry supply curveSummation of the individual supply
curve is the market supply curve. Shapes are different in two
period supply curves: SR steep and LR flatterFigure 2Page 422 in
main text
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Marginal FirmHighest cost producer in the industry but can
remain in theindustry in the long run. In some text book says it is
the last firm to enter the industry
LRMCLRMCPQFigure 3
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The Horizontal Long-run Industry Supply Curve
When all existing firms potential entrants have identical
costsIndustry output can be expanded without offering a pricehigher
than P. QPLRMCLRSSMost unlikely to have thistype of supply
curve:Every firm in the industrymay not have identical
costcurve.Higher prices need toincrease supply Therefore long
runsupply curve is rising rather flatter. 0Figure 4
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Short-run equilibrium: the market price equates the quantity
demanded to the total quantity supplied by the given number of
firms in the industry when each firm produces on its short-run
supply curve (Figure 1).
Long-run equilibrium: the market price equates the quantity
demanded to the total quantity supplied by the given number of
firms in the industry when each firm produces on its long-run
supply curve. Since firm can freely enter or exist from the
industry, the marginal firm must take only normal profits so that
there is no further incentive for entry or exist (Figure 2).
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Comparative static analysis: This examines the changes in
equilibrium conditions with respect to changes of revenue (demand)
and cost conditions.
Q and P, If MC, AC and MR goes upQ and p, If MC, AC and MR goes
downQ and P, If AC, MC and MR are going up and down at the same
time in different proportions. In perfect competition model
advertising, product differentiation, market power of the suppliers
and buyers are not relevant and in long-run abnormal profits are
not available.Therefore, this market structure is unrealistic.
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Monopoly (page no. 415 in main text)
Sole and potential supplierof the industrys product (Firm and
industry coincide), No substitutes, existence of barriers to entry
and exist, price maker.Monopolist TR = P.QMR = 1/2ARMonopolist
never produce on the inelastic part of thedemand curve. In pure
monopoly: no spending on advertising, full market power, price
discrimination, abnormal profits exist.AR, MRMRARTRTRQRelationship
AR, MR and TR
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PProfits maximising outputfor monopoly (MR=MC) QP1-P = Super
profits
Monopolists Profits Maximization
Marginal condition:MR>MC, Q Goes upMR = MC, Q OptimalMRSAVC,
producePLAC, stayP
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Examples for Monopoly:
1) Patent for instant cameras held by Polarid and golfball type
writers by IBM.2) Government regulations, licenses and
nationalization.tariffs and non-tariffs barriers to imports.3)
Natural monopolies (postal, water, airline, gas, electricity).4)
Lower cost of production than the competitors.5) Control of
necessary factors of production.6) The need of high capital cost.7)
Control of distribution channels.
Entry barriers can be created by monopolists:Price war or other
reactions to stop new comers.Creation of excess capacity.Brand
loyality and large scale advertising.High R & D expenditure.
(Pure monopoly concept is very unrealistic)
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Comparision between Monopoly and Perfect Competition
Competitive industry and multi-plant monopolist. Monopoly
produces lower output at high price and competitive industry
produces higher output at lower price. This situation persists due
to entry barriers in monopoly. It says that monopoly produces less
goods rather the society wish. This creates due to big difference
between MC and P. Competitive industry and single-plant monopolist.
Single plant monopolist supply whole industry requirement in one
plant. Natural monopoly: enjoy huge amount of economies of scales
LRAC falls over entire range of output. Then single plant is more
harmful to the society in terms of price and welfare rather
multi-plants.
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Imperfect Competition (Oligopoly and monopolistic
competition)
Imperfectly competitive firms can not sell as much as it wants
at the existing price. Its demand curve slopes down and its output
price will depends on the quantity of goods produced and sold.
Oligopoly: Industry with only few producers, each recognizing
that its own price depends not merely on its own output but also on
the actions of its important competitors in the industry.
Monopolistic Competition: Industry has many sellers producing
close substitutes and each firm has limited ability to affect its
output price (combinations of perfect competition and
monopoly).
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Why market structure differ:
Monopolistic Competition:1) Large number of quite small firms
and each can not haveimpact on other firms.2) Free entry and free
exist.3) Each firm faces downward slopping demand curve.4) Product
differentiation and brand loyality exist.
Large number of suppliers with similar products:1) Competition
will lower price and profits but price will remainhigher and output
lower than the socially best.2) Production occurs at less than
optimal scale therefore never work in MES.3) Branding
differentiation (advertising and packages) raises costand in-turn
it raises the price.
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In the short run the monopolistic competitor faces demand curve
AR and Sets MR =MC to produce Q0 (K) at a price P0. Profits are Q0.
(P0 AC0). Profits attract new entrants and shift each firms demand
curve to the left. When the demand curve reaches AR1they reach long
run tangency equilibrium at F. The firm sets MR1=MC to produce Q1
at which P1 equals AC1. Firms are breaking even and there is no
further entry.MCPQ0MRAR1MRARMR1EFP0AC0AC1Q0Q1Equilibrium for a
Monopolistic CompetitionK
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Oligopoly
Small number of large suppliers in the industry each can have
influence on the market. Barriers exist for free entry and exist
(Ex: air lines).Each firms price and output decision is influenced
byperceptions of rivals countermoves. Interdependence is the
keyfeature in oligopoly. Sticky prices and non-price competition
also can be seen in this market structure.
Competition and collusion both relevant to oligopoly.Collusion:
explicit or implicit agreement between existing firmsto avoid
competition with each other. Collusion increases jointprofits but
reduces output.
Collusion is harder if there are many firms in the industry,
product is non standards and demand and cost conditions are changed
rapidly. Non collusive oligopoly take independent decisions on
price and quantity looking at the reactions of competitors.
Competition increase profits and market share in expense of
rivals.
Cartels: Legal or other forms of agreements between firms or
countries for collusion and cooperation on prices or output.
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The Kinked Oilgopoly Demand Curve
Demand curve depends on competitors reactions. Firms reacts only
for price cuts but not for the price rises.
AMRMRDDMCP, MR, MCQ0P0Qd0Oligopolists demandcurve kinked at A.
Pricerises lead to a largeloss of market share, but pricecuts
increase quantity onlyby increasing industry sales.MR is
discontinuous at Q0. Produces Q0 at the point MR=MC In oligopoly
price is sticky at p0 due to explicit or implicit collusion. See
page no.215 in main text.
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Game Theory and Interdependent Decision
Oligopolists have to guess their rivals moves to determinetheir
own best action. For that, Game theory is the best tool. Players
are trying to maximize their own payoffs.A game is a situation in
which intelligent decisions arenecessarily interdependent.
Oilgopoly firms are the players and their payoffs are the
profits.Each player must choose a strategy: Strategy is a game
plandescribing how the player will act or move in every conceivable
situation.
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Industry Structure :The Competitive SpectrumPERFECT
COMPETITIONMONOPOLISTIC COMPETITIONOLIGOPOLYMONOPOLYBarriers to
entry/exitNumber of differentiated productsNumber of Suppliers
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Identifying Structure : Market ConcentrationMarket concentration
refers to the extent to which the supply of a good or service is
controlled by the leading suppliers of the product
Commonly used measures :Concentration Ratio (market supplied by
the given number of firms 1.8)Market share (market share analyze
according to the industry structure)Profits rates (High profits in
monopoly)Lerner index (P-MC/P)Herfindahl Index (measures the size
distribution of the firm. Index depends on the number of firms in
the industry and their relative market share. Value closer to 1
says increased monopolization).
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PC Operating Systems Sales, 1999Source : Mintel
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UK Detergent Sales, 1992UK Market Share 1992, source : Pass and
Lowes (1993)
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UK Amplifier Sales, 1992UK Market Share 1992, source : Pass and
Lowes (1993)
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Worldwide PC Shipments, Q2 2001Source : The Economist, 8/9/2001,
p. 84
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Perfect Competition : StructureMany sellers - individual firm
faces perfectly elastic demand - price takersAll firms have
identical costsHomogeneous productsFree entry and exitNo
transaction costs (e.g. transport, distribution)Perfect
information0
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Perfect Competition : ConductAt the given market price P, firm
produces at Q.Can produce Q at an average cost of C.So makes a
profit of (P-C)*Q in the short run.But free
entry...PriceOutput0
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Perfect Competition : Performance combined with complete
information, identical costs, no transaction costsfirms enter the
market until the price is bid down to P*.No firm makes abnormal
profits in the long run.PriceOutput0MCACP
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Monopoly : StructureSingle supplier - market demand is the firms
demand - price makerHighly differentiated productBarriers to entry
and exitNo transaction costsPerfect informationPriceOutput0
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Monopoly : ConductMonopolist maximizes profit at output Q, where
MC=MR.Charges price P (from the demand curve i.e. AR).Produces Q at
cost C per unit (from AC curve).Makes (P-C)*Q profit in the short
run. But barriers to entry...C
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Monopoly : Performance mean that others cannot enter the
market.So monopolist is able to make abnormal profit in the long
run...
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Monopolistic Competition : StructureMany suppliersSome product
differentiation - individual firm faces elastic demand curve -price
makersFree entry and exitPerfect informationIdentical costsNo
transaction costsPriceOutput0
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Monopolistic Competition : ConductMaximise profit at output Q,
where MC=MR.Charge price P (from the demand curve i.e. AR), but
cost of Q units only C per unit (from AC curve).Makes (P-C)*Q
profit in the short run.But free entry...C
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Monopolistic Comp. : Performance will attract new entrants into
the market with the same cost structureSo market demand is spread
over more firms, leading to a shift in individual firm AR curve
(AR1 to AR2)Until all abnormal profits are bid away in the long
run.PriceOutput0MCACAR1PriceOutput0MCAC
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Oligopoly : StructureVery few suppliers - interdependent demand
curves - either price maker or price takerSometimes products
differentiated, sometimes homogeneousBarriers to entry and exitNo
transaction costsPerfect informationOutput0Price
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Oligopoly : ConductIn oligopoly, conduct depends on
relationships between the playersnon-cooperative behaviourtacit
collusion (kinked demand curve)collusive behaviour - e.g.
cartelsSimple cost curves are not enough to explain this behaviour
- need to think more strategically because of interdependence
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Exercise : Identifying Industry StructuresIdentify the industry
structure for your company or organization.
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Pros and Cons of MonopolyAgainst monopoly :not allocatively
efficientlack of competition may hinder productive efficiencyFor
monopoly :dynamic v. static efficiencythe possibility of innovatory
behaviour and technical changenatural monopolies relaxation of
assumptions - cost structures, differential transaction costs and
imperfect information
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Competition PolicyBelief that monopoly (and oligopoly) can lead
to net welfare loss is basis of competition policyAnti-trust
authorities, including the Competition Commission in the UK,
regulate competitionMain concern is to protect consumers and
society from abuse of monopoly power through regulating:monopolies,
mergers, restrictive practices & other anti-competitive
practices
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Class Exercise : Industry Structures and SocietyIn which
industry would you expect :(a) consumers to get the best deal?(b)
consumers to get the worst deal?(c) the government to be most
interested in intervening?
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