Competition and Market Structure

Frederick University

2013

Industry

Industry (market) – a collection of firms, each of which is supplying products that have some degree of substitutability, to the same potential buyers

Common buyers for sellers Common sellers for buyers Relatively homogeneous product

SCP Paradigm

Basic Conditions

Market Structure

Conduct

Performance

BASIC CONDITIONS

SUPPLY raw material technology product durability value/weight business attitudes unionization

DEMAND price elasticity rate of growth substitutes marketing type purchase method cyclical and

seasonal character

Market Structure

Market Structure – those characteristics of the market that significantly affect the behavior and interaction of buyers and sellers

MARKET STRUCTURE

number and size of sellers and buyers

type of the product conditions of entry and exit transparency of information

Perfect Competition - structure

Many and small sellers, so that no one can affect the market

Homogeneous product Free entry to and exit from the

industry Transparent and free information

Pure Monopoly- market structure

Only one producer in the industry The product does not have close

substitutes Blocked entry

Monopolistic competition - structure

Many and small sellers Differentiated product Free entry and exit Transparent and free information

Oligopoly – market structure A) Tight oligopoly – a few big firms in

the industry with comparable market shares/ B) Dominant firm oligopoly – one of the big firms in the industry is recognized as the price leader

Homogeneous / Heterogeneous oligopoly

Significant barriers to entry to and exit from the industry

Significant barriers to information

Entry into an industry or to a segment of an industry can occur because there is

•de novo entry. •takeover from outside the industry

•the development of technologically similar firms who develop their product range.•the transference of brand names across sectors •an increase in import penetration. Again, the scale of the firm involved is important here.

Entry

Barriers to EntryStructural barriers High capital cost Economies of scale Product differentiation and brand loyalty High switching cost Ownership/control of key factors or outlets Strategic barriers Limit pricing Excess capacity Vertical integration Sleeping patents Predatory pricing Tying sales Institutional barriers Patents Regulations

Alternative Market Structures

The four market structures

perfect competition

monopoly

monopolistic competition

oligopoly

Features of the four market structuresFeatures of the four market structures

Features of the four market structuresFeatures of the four market structures

Features of the four market structuresFeatures of the four market structures

Features of the four market structuresFeatures of the four market structures

Features of the four market structuresFeatures of the four market structures

Features of the four market structuresFeatures of the four market structures

Market Conduct

Market Conduct – a firm’s policies toward its market and toward the moves made by its rivals in that market

CONDUCT

pricing behavior product strategy research and innovation advertising legal tactics

Perfect competition - conduct

Industry’s marketP

Q

D S

Pe

Qe

Firm’s market

P

Q0 1020

d

P q TR MR5 0 0 -5 10 50 55 20 100 5

MR

Perfect competition – short run “conduct”p

Q

dd = MR

MC

P = MR MC = MRq

P>AC

AC

Economic profit = (P-AC) q

Perfect Competition – long run “conduct”Industry’s equilibriumP

Q

DS

Pe

Qe

P’

If P>AC, new firms startentering the industry andthe equilibrium price falls.

The industry is in a long runequilibrium when P = AC

In the long run the firms make normal profit

If Р < АС, the firms willstart leaving the industry and the equilibrium price will increase.

fig(a) Industry

P

P1

Q (millions)

S

D1

(b) Firm

d1 = MR1

MC

P2

d2 = MR2

D2

P3

d3 = MR3

D3

Q (thousands)

Perfect Competition - Deriving the short-run supply curvePerfect Competition - Deriving the short-run supply curve

a

b

c

= S

The firm’s short run supply curve is determined by its MC curve above AVC

Q

(SR)AC

(SR)MC

LRAC

AR = MR

DL

LRAC = (SR)AC = (SR)MC = MR = AR

Long-run equilibrium of the firm under perfect competition

Pure Monopoly - conductP

Q

D

P Q TR MR10 1 10 1011 2 18 88 3 24 6

MR

P>MR

MC=MR

MC

Qm

P

ACEconomic

Profit

L

P

Q Qm

AR D

MC

AC

MR

Pure Monopoly and Perfect competitionPure Monopoly and Perfect competition

Pm

Qp.c.

Pp.c.K

N

Consumer surplus = ∑ (P –MWP)Under perfect competition = KLNUnder pure monopoly = NRT

R T

GGTL – the portion of theconsumer surplus,which is a deadweight loss for the societyJGL – the portion of the producer surplus, which is a deadweight loss for the society

Producer surplus =∑ (P-MC)Under pure monopoly the producersurplus rises by KGTR at the expense of the consumer surplus

J

TLJ – total deadweight loss for the society

P

Q Qs

AR D

MC

AC

MR

Monopolistic competition – conduct in the short runMonopolistic competition – conduct in the short run

Ps

ACs

P>MR

MC = MR

Monopolistic competition – conduct in the long runMonopolistic competition – conduct in the long run

ARL DL

MRL

P

Q

QL

PL

LRAC

LRMC

If P>AC new firms will enterthe industry and the firm’smarket segment will shrink - its individual demand curveshifts leftwards

The long run equilibrium is achieved at P = AC, however, АС is not minimized – there is excess capacity

figQ2

P2 DL under perfectcompetition

Long run equilibrium under perfect competition and under monopolistic competitionLong run equilibrium under perfect competition and under monopolistic competition

P

Q

P1

LRAC

DL under monopolisticcompetition

Q1

Tight oligopoly - conduct

P

Q

NFD

FD

fig

P

Q

P1

Q1

FD

NFD

The kinked demand curve under the tight oligopolyThe kinked demand curve under the tight oligopoly

P

Q

P1

Q1

MRf

a

bD AR

The kinked demand curve The kinked demand curve

MRnf

P

Q

P1

Q1

MC2

MC1

MR

а

bD AR

Rigid prices under the tight oligopolyRigid prices under the tight oligopoly

Price leadership of the dominant firm

P

Q

DindustryDleader

Sothers

P

Q

Sother firms

Dindustry

Dleader

PL

MRleader

MCleader

QL QFQT

f tl

Price leadership of the dominant firm Price leadership of the dominant firm

Market Performance

Market Performance – how well does an industry do what society might reasonably expect it to do

PERFORMANCE

profitability allocative efficiency static production efficiency dynamic efficiency - progress full employment equity

Perfect Competition - Performance

P = MR MC = MR P = MC P = AC AC = MC AC minimum

Perfect Competition - Performance

Static Efficiency

Efficiency in allocation MC = P Efficiency in motivation AC = MC Efficiency in distribution AC = P

The Perfect Competition achieves static efficiency

Dynamic EfficiencyThere is NO potential and motivation for innovations and technological

progress

The Perfect Competition does not achieve dynamic efficiency

Pure Monopoly - performance

Static efficiency

Efficiency in allocation MC < P Efficiency in motivation excess capacity

Efficiency in distribution AC < P

The pure monopoly does not achieve static efficiency

Dynamic efficiencyThere is a potential and motivation for innovations and technological progress

The pure monopoly is motivated to achieve dynamic efficiency at the presence of potential competition

Monopolistic competition - performance

Static Efficiency

Efficiency in allocation MC < P Efficiency in motivation excess

capacity Efficiency in distribution AC = P

Contestable Markets

Key characteristics: Firms’ behaviour influenced by the

threat of new entrants to the industry – if even the industry is concentrated, the incumbent firms behave as if they are perfect competitors

Firms’ performance depends on the potential competition

Contestable markets Ultra easy entry Ultra easy exit Zero sunk cost “Hit and run”

strategy”

Contestable market

Oligopoly – non-collusive behavior Game theory – the study of multi-person

decision problems (the reactions of a few interdependent decision makers)

Game - any situation that involves well-defined rules and outcomes, where outcomes are dependent on players’ strategic decisions

Strategy – a complete plan, specifying the game under any possible circumstances

The Prisoners’ dilemma Two suspects, V and G, are arrested by the police.

The police have insufficient evidence for a conviction, and, having separated both prisoners, visit each of them to offer the same deal: if one testifies for the prosecution against the other and the other remains silent, the betrayer gets 3 months and the silent accomplice receives the full 10-year sentence. If both stay silent, both prisoners are sentenced to only 1 year in jail for a minor charge. If each betrays the other, each receives a three-year sentence. Each prisoner must make the choice of whether to betray the other or to remain silent. However, neither prisoner knows for sure what choice the other prisoner will make. So this dilemma poses the question: How should the prisoners act?

fig

The Prisoners’ dilemma The Prisoners’ dilemma

Does not confess Confesses

Does not confess

Confesses

V’s alternatives

G’s alterantives

Everyone gets1 year

Everyone gets 3 years

G - 3 months

V- 10 years

G - 10 years

V -3 months

The Prisoners’ dilemma The Prisoners’ dilemma is the

duopoly’s dilemma. Prisoners cannot coordinate their confessions. Even though they both would get less if they do not confess, they betray the other player, because of the greater payoff.

No matter what the other player does, one player will always gain a greater payoff by playing defect. Since in any situation playing defect is more beneficial than cooperating, all rational players will play defect.

fig

Payoffs for firms A и B under different pricing policiesPayoffs for firms A и B under different pricing policies

2.00 1.80

2.00

1.80

A’s Price

B’s Price

10mil. for each

8 for each12 for В5 for А

5 for В12 for А

Collusive behavior

How could the firms overcome the How could the firms overcome the prisoners’ dilemma?prisoners’ dilemma?

Collusive behavior will set higher prices for the buyers!