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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.

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.

Perfect Competition
Many sellers and buyers. Therefore one can not make
any impact on price. Then the industrys demand curve is
fatter (horizontal). All the producers are price takers not the
Makers.
Produce homogeneous or identical goods.
Elastic demand - price takers.
All firms have identical costs.
Perfect mobility
Free entry and exit.
No transaction costs (e.g. transport, distribution).
Perfect information

Short run Supply in Perfect Competition


Figure 1

(page 417 and 418 in main text)

Profits maximising
Condition: MR = MC
(MR = MC = P = AR)

P, C

SR supply curve is the


SRMC curve above the A.
A is the shutdown point at SR
P2 is the shutdown price
A B: Normal profits (It covers
Part of the fixed cost)
Below A: Loss
Above B: Supernormal profit

SRMC

B
P1
P2
o

A
Q Q1

SRTC
SRVC

MR=P
MR=P
Output

Long run Supply in Perfect Competition


Page 422 in main text

P, C

LMC is flatter than


SRMC because
no fixed factors.

Figure 2

LRMC

LR supply curve is the


LRMC curve above the A.
A = industry leaving point.
P
P is the entry or exist
price

LRAC

Q
0
Industry supply curve
Q1
Summation of the individual supply curve is the market supply
curve. Shapes are different in two period supply curves: SR
steep and LR flatter

Marginal Firm
Highest cost producer in the industry but can remain in the
industry in the long run. In some text book says it is the last
LRM
firm to enter the industry
C
LRMC
Figure 3

LRAC

LRAC

The Horizontal Long-run Industry Supply Curve


When all existing firms potential entrants have identical costs
Industry output can be expanded without offering a price
higher than P.
Figure 4
LRMC
Most unlikely to have this
type of supply curve:
Every firm in the industry
may not have identical cost
curve.
Higher prices need to
P
increase supply
Therefore long run
supply curve is rising
rather flatter.

LRAC

LRSS

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).

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 up
Q and p, If MC, AC and MR goes down
Q 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 bu
yers are not relevant and in long-run abnormal profit
s are not available.Therefore, this market structure i
s unrealistic.

Monopoly (page no. 415 in main text)


Sole and potential supplier
of the industrys product
(Firm and industry coincide),
No substitutes, existence of
barriers to entry and exist,
price maker.
Monopolist TR = P.Q
MR = 1/2AR
Monopolist never produce
on the inelastic part of the
demand curve.
In pure monopoly: no
spending on advertising, full
market power, price
discrimination, abnormal
profits exist.

Relationship AR, MR and TR


AR, MR

MR

AR

TR

TR
Q

q*

MC

Price

Profits maximising output


for monopoly (MR=MC) Q
P1-P = Super profits
Monopolists Profits Maximization

AC
P1

Marginal condition:
MR>MC, Q Goes up
MR = MC, Q Optimal
MR<MC, Q Goes down
Average condition
Short-run
P>SAVC, produce
P<SAVC, shut-down
Long-run
P>LAC, stay
P<LAC, exist

P
AR
0

Output
MR

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:
1) Price war or other reactions to stop new comers.
2) Creation of excess capacity.
3) Brand loyality and large scale advertising.
4) High R & D expenditure.
(Pure monopoly concept is very unrealistic)

Comparision between Monopoly and


Perfect Competition
1) 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.
2) 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.

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).

Why market structure differ:


Monopolistic Competition:
1) Large number of quite small firms and each can not have
impact 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 remain
higher 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 cost
and in-turn it raises the price.

Equilibrium for a Monopolistic Competition


In the short run the monopolistic P
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 P0
AR1they reach long run tangencyAC1
equilibrium at F. The firm sets
MR1=MC to produce Q1 at which AC0
P1 equals AC1. Firms are
breaking even and there is no
further entry.

MC

AC

K
AR

Q1

M
R

Q0
MR1

AR1

MR

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 by
perceptions of rivals countermoves. Interdependence is the key
feature 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 firms
to avoid competition with each other. Collusion increases joint
profits 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.

The Kinked Oilgopoly Demand Curve


Demand curve depends on competitors reactions. Firms
reacts only for price cuts but not for the price rises.
P, MR, MC

A
P0
MC
MR

DD
0

Q0

MR

Oligopolists demand
curve kinked at A. Price
rises lead to a large
loss of market share, but price
cuts increase quantity only
by increasing industry sales.
MR is discontinuous at Q0.
Produces Q0 at the point
MR=MC
Qd

In oligopoly price is sticky at p0 due to explicit or implicit collusion.


See page no.215 in main text.

Game Theory and Interdependent Decision


Oligopolists have to guess their rivals moves to determine
their 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 are
necessarily interdependent.
Oilgopoly firms are the players and their payoffs are the profits.
Each player must choose a strategy: Strategy is a game plan
describing how the player will act or move in every conceivable
situation.

Industry Structure :
The Competitive Spectrum
Number of Suppliers

PERFECT COMPETITION
MONOPOLISTIC COMPETITION
OLIGOPOLY
MONOPOLY
Barriers to entry/exit
Number of differentiated products

Identifying Structure :
Market Concentration
Market 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).

PC Operating Systems Sales, 1999


Other
3%

Windows
3.X, 95, 98
97%
Source : Mintel

UK Detergent Sales, 1992


Other
11%

Procter &
Gamble
45%

Unilever
44%

UK Market Share 1992, source : Pass and Lowes (1993)

UK Amplifier Sales, 1992

Pioneer
Marantz
Kenwood

Rotel
Audio Lab
Linn

Arcam
Quad
Nalm

Akai
Denon
Others

Sony
Mission

UK Market Share 1992, source : Pass and Lowes (1993)

Technics
AND

Worldwide PC Shipments, Q2 2001


HP/Compaq
18%

Dell
13%
Other
58%

IBM
7%
NEC
4%

Source : The Economist, 8/9/2001, p. 84

Many sellers - individual


firm faces perfectly
elastic demand - price
takers
All firms have identical
costs
Homogeneous products
Free entry and exit
No transaction costs (e.g.
transport, distribution)
Perfect information

Price

Perfect Competition : Structure

MC
AC

MR=AR

Output

Price

Perfect Competition : Conduct


MC
AC

MR=AR

Output

At 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...

Perfect Competition : Performance

combined with complete information, identical


costs, no transaction costs
firms enter the market until the price is bid down to
P*.
No firm makes abnormal profits in the long run.
MC

Price

AC
P
MR=AR

P*

Q*

Output

Single supplier - market


demand is the firms
demand - price maker
Highly differentiated
product
Barriers to entry and
exit
No transaction costs
Perfect information

Price

Monopoly : Structure

MC
AC

AR
0

Q
MR

Output

Price

Monopoly :
Conduct

MC
AC

C
0

AR
Q

Output

MR
Monopolist 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...

Monopoly : Performance

mean that others cannot enter the market.


So monopolist is able to make abnormal profit in the
long run...
Price

MC
AC

P
C

AR
0

Q
MR

Output

Many suppliers
Some product
differentiation individual firm faces
elastic demand curve
-price makers
Free entry and exit
Perfect information
Identical costs
No transaction costs

Price

Monopolistic Competition : Structure

MC
AC

AR
0

Q
MR

Output

Price

Monopolistic
Competition :
Conduct

MC
AC

C
0

AR
Q
MR

Output

Maximise 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...

Monopolistic Comp. : Performance

Price

will attract new entrants into the market with the


same cost structure
So 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.

Price

MC

MC

AC

AC
P*

AR1
AR2
Output

AR2
0

Q*

MR2

Output

Very few suppliers interdependent demand


curves - either price
maker or price taker
Sometimes products
differentiated, sometimes
homogeneous
Barriers to entry and exit
No transaction costs
Perfect information

Price

Oligopoly : Structure
MC

AR
0

Q
MR

Output

Oligopoly : Conduct

In oligopoly, conduct depends on


relationships between the players

non-cooperative behaviour
tacit collusion (kinked demand curve)
collusive behaviour - e.g. cartels

Simple cost curves are not enough to explain


this behaviour - need to think more
strategically because of interdependence

Exercise : Identifying Industry


Structures

Identify the industry structure for your


company or organization.

Pros and Cons of Monopoly

Against monopoly :
not allocatively efficient
lack of competition may hinder productive efficiency
For monopoly :
dynamic v. static efficiency
the possibility of innovatory behaviour and technical
change
natural monopolies
relaxation of assumptions - cost structures,
differential transaction costs and imperfect
information

Competition Policy
Belief that monopoly (and oligopoly) can lead to
net welfare loss is basis of competition policy
Anti-trust authorities, including the Competition
Commission in the UK, regulate competition
Main concern is to protect consumers and
society from abuse of monopoly power through
regulating:

monopolies, mergers, restrictive practices & other


anti-competitive practices

Class Exercise : Industry Structures and


Society

In 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?