hc3 market structures

7/27/2019 HC3 Market Structures

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Transport Economics and ManagementMarket structures and pricing

Eric Pels

[email protected]


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TEM2

This lecture

Market structures Revenues

Strategies Pricing

Learning objective Repetition of basic economic concepts.

Know different market structures from economic theory, andknow how to apply them in the transport sector.


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TEM4

Strategies

Profit maximization

Marginal profits equal to 0 (MR=MC). Why?

Classic economic theory: entrepreneurial capitalism Owner makes strategic decisions

Managerial capitalism. Ownership changed (shareholders)

Control changed (board rooms) Potential conflicts between shareholders and management

Firms got bigger: coordination difficulties

So other strategies than profit maximization?


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TEM5

Strategies

Revenue maximization (Baumol, 1959)

Decreasing revenues bad for image?

Financial institutions want certainty

Low revenues mean relatively high risk for suppliers

Low revenues may lead to budget cuts, including management

Bonus!

MR=0 Marketing effort


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TEM6

Strategies

Managerial utility maximization (Williamson, 1963)

Managers maximize own satisfaction

Not efficient; not only expenditures for production. Examples?

Growth maximisation (Marris, 1964)

Long term strategy

Profit constraint

Behaviourhal theories Different groups, satisfy all groups to survive: satisficing

Altruistic objectives: public interest Welfare maximization

E.g. NS?


7/37TEM7

Strategies

What strategy is relevant?

Quince and Whittaker survey (2003)

Autonomy and income advancement Profit maximization

Sucessful business is most important personal objective

Profit maximization

Growth objective

Profit maximization Model!

Economic profit accounting profit


8/37TEM8

Market structures

Perfect competition

Monopolistic competition Oligopoly

Monopoly


9/37TEM9

Perfect competition

Many (small) suppliers and buyers: price takers. Demand function for individual company?

Price = marginal revenue. Why? Price level?

Products are perfect substitutes

Free entry and exit

Information is perfect (available to all at no cost) Free movement of products: Supply responsive to market

forces

Innovation exogenous: producers reactive rather than

proactive


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Perfect competition

TEM10

P

Q0

Marginal costs

Inverse demand

Average costs


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Perfect competition

Benchmark: Welfare is maximized (p=mc, lecture 1)

Efficiency Productive efficiency: AC cannot be lower

MC curve passes through minimum of AC

Allocative efficiency: resources are distributed and used as preferred by

consumers: P=MC

Pareto efficiency: no one can be made better off without making

anyone else worse off.

Realistic?


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Marginal revenues

P

Q

Inverse demand ( a/b-1/b*Q )

Marginal revenues:

{(Q*a/b-1/b*Q2)}/Q=a/b-2/b*Q

What does this tell us?(M+G, p81)


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Monopoly

TEM15

P

Q0

Marginal costs

Inverse demand

Marginal revenues

Average costs

Qm

Pm


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Oligopoly

A few sellers.

Homogeneous or heterogeneous products. Barriers to entry and exit (e.g. sunk costs).

Limited information for consumer (price, quality, cost).

Oligopolists may have monopoly (or market) power:

they may be able to influence the price.


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Barriers to entry

Anything that physically prevents entry to or exit from a

market help to sustain monopoly or oligopoly

Government policy: regulation

Spatial pre-emption: new entrants do not have access to

necessary inputs

Cost barriers

Reputation: customer loyalty, safety. Exit barriers: shrinking a firm is expensive (labor, capacity).

Entry-deterring strategies: pricing, spare-capacity,

corporate deals (price discrimination).


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TEM19

Oligopoly: non-cooperative behavior

Competition based on output (quantity) or price.

2 basic oligopoly models: Cournot (quantity competition)

Bertrand (price competition)

Cournot: firms determine output simultaneously, and

then bring this to the market Bertrand: firms announce prices. Demand is allocated

to low-price firm(s), who then produce(s) demand


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TEM20

Cournot competition

Assume that firms produce identical products

Demand: Q=a-b*PInverse demand: P=a/b-1/b*Q

Now we have 2 producers (duopoly):P=a/b-1/b*(Q1+Q2)

Profits maximized when MR=MC (equivalent tomonopolist), taking the competitors actions asgiven.


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TEM21

Cournot competition

Inverse demand:

P=a/b-1/b*(Q1+Q2)

Revenues firm 1:

R1=Q1*[a/b-1/b*(Q1+Q2)]

Marginal revenues:

MR1= a/b-1/b*(2*Q1+Q2) Equilibrium: MR1=MC1

Expression in Q1and Q2

Similar expression for company 2


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TEM22

Cournot competition (2 companies)

Q2

Q1

MR1=MC1

MR2=MC2

Cournot-Nashequilibrium

See last slide for calculation of equilibrium


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TEM24

Bertrand oligopoly

Price competition (again assume identical goods).

Firms announce prices. Demand is allocated to low-pricefirm(s), who then produce(s) demand.

If a firm sets its price above its competitors prices, clients

will prefer the competitors (identical goods).

Bertrand equilibrium is therefore equivalent to competitiveequilibrium: price equals marginal cost.


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TEM25

Oligopoly strategies in e.g. aviation

strong evidence ... against the highly competitive

Bertrand hypothesis (Brander and Zhang, 1990) overall results indicate that the duopolists conduct may

be described as somewhere between Bertrand and

Cournot, but much closer to Cournot (Oum et al., 1993)


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TEM26

Price discrimination

Conditions:

Market power

Different groups of consumers (based on willingness-to-

pay, demand elasticity etc.) segmentation.

Resale not possible.

Cost of discrimination may not exceed additional profits

Markets should be transparent Charge different (groups of) consumers different prices to

maximize profits price discrimination.

First, second and third degree.


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TEM27

First degree price discrimination

Perfect discrimination: each unit of output sold at different

price.

Price determined by inverse demand curve.

What is the optimal output?

profits

Q*

Q

MC


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TEM28

Second-degree price discrimination

Non-linear pricing: price depends on

how much you buy. Fundamentals.

Application (as in Mallard and Glaister)


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TEM29


Consumer decides on how much to

buy: Self selection constraints.

2 consumers; each spends ri to receive Xi

buy Xi if benefitsi(Xi)-ri>0 benefits1(X1)-r1> benefits1(X2)-r2

benefits2(X2)-r2> benefits2(X1)-r1


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TEM30


Consider an individualdemand function (for convenience,

marginal cost are 0)

Monopolists wants to supply X1 at a total price of A.

p

X

A

X1


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TEM31


Now consider two individualdemand functions

Monopolist would like to supply X1 at A+B+C and X2

at A

p

X

A

X1

B

C

X2


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TEM32


But: if consumer 1 also purchases X2 at a price of A,

he/she will get surplus B (self selection).

If the monopolist would charge A+C for X1,

consumer 1 get surplus B and the monopolist higher

profits. Can the monopolist get higher profits?

Make X2 unattractive for consumer 1.

Offering less of X2 (loss for monopolist) allows for

higher profits from X1.


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TEM33


p

X

A

X1

B

C

X2

Extra profit

(increase inC)

Loss (reduction

in A)

p

X

A

X1

B

CX2D

Equilibrium: marginalbenefit in reduction of

X2 = marginal cost

Consumer 2pays A for X2

Consumer 1 paysA+D+C for X1


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TEM34


Examples?


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TEM35

Third degree price discrimination

Set prices for different groups of consumers: examples?

p*

p*

Q* Q*

QQ

Segmentation based on willingness-to-pay and elasticity

MCMC


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TEM36

Summary

Profit maximization

Monopoly, perfect competition: two extremes.

Regulation of monopoly: incentives.

Cournot oligopoly: decide on production, then price determined in market

Cournot ologipolist has monopoly power (p>mc)

Bertrand: decide on price, then output determined in market; p = mc

Price discrimination Higher profits

Market power


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Cournot competition: equilibrium

MR1= MC1: [a/b-1/b*(2*Q1+Q2)]=MC1

a/b-2/b*Q1-1/b*Q

2=MC

1 a/b-1/b*Q2-MC1=2/b*Q1

Q1=a/2-1/2*Q2-MC1*b/2

Q2=a/2-1/2*Q1-MC2*b/2

Q1=a/3+b*MC2/3-2*b*MC1/3 Q2=a/3+b*MC1/3-2*b*MC2/3

Q1=Q2=a/3-b*MC/3 (MC1=MC2)

P=a/b-1/b*(Q1+Q2) = a/3b+2*MC/3

hc3 market structures

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