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 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

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)

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

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

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

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 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.

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

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

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)

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.

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 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.

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

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.

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.

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.

Industry Structure :The Competitive SpectrumPERFECT COMPETITIONMONOPOLISTIC COMPETITIONOLIGOPOLYMONOPOLYBarriers to entry/exitNumber of differentiated productsNumber of Suppliers

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).

PC Operating Systems Sales, 1999Source : Mintel

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

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

Worldwide PC Shipments, Q2 2001Source : The Economist, 8/9/2001, p. 84

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

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

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

Monopoly : StructureSingle supplier - market demand is the firms demand - price makerHighly differentiated productBarriers to entry and exitNo transaction costsPerfect informationPriceOutput0

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

Monopoly : Performance mean that others cannot enter the market.So monopolist is able to make abnormal profit in the long run...

Monopolistic Competition : StructureMany suppliersSome product differentiation - individual firm faces elastic demand curve -price makersFree entry and exitPerfect informationIdentical costsNo transaction costsPriceOutput0

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

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

Oligopoly : StructureVery few suppliers - interdependent demand curves - either price maker or price takerSometimes products differentiated, sometimes homogeneousBarriers to entry and exitNo transaction costsPerfect informationOutput0Price

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

Exercise : Identifying Industry StructuresIdentify the industry structure for your company or organization.

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

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

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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