ECW2731 Weeks 7 & 8 Competition, market structures and business decisions Market structures What is...

ECW2731Weeks 7 & 8

Competition, market structures and business decisionsCompetition, market structures and business decisions

Market structures Market structures

What is the market structure?

• The competitive environment in the market for any product is the market structure faced by the firm– Is measured in terms of

• the number of the actual buyers and sellers plus potential entrants

• Barriers to entry and exit

• Capital requirements

• Price vs Non-price competition

• Etc

– Potential entrants pose a sufficiently credible threat of entry to affect price/output decisions of incumbents

ECW2731Weeks 7 & 8

Factors that Shape the Competitive Environment

• Product Differentiation– R&D, innovation, and advertising are important in

many markets.

• Production Methods– Economies of scale can preclude small-firm size.

• Entry and Exit Conditions– Barriers to entry and exit can shelter incumbents

from potential entrants.

• Buyer Power– Powerful buyers can limit seller power.



ECW2731Weeks 7 & 8



Perfect competition

Perfect competition

OligopolyOligopoly

The firm in competitive marketsThe firm in competitive markets

MonopolyMonopoly

Non-perfect competitionNon-perfect competition

Monopolistic competition

Monopolistic competition

ECW2731Weeks 7 & 8


Market structures Market structures “Perfect competition” – competitive markets

Profit maximiser Identical product Very small share of the market Price-taker Produces a homogeneous product Perfect information No barriers to entry (legal, technological, or

resource) No technical progress No investment lag - Immediate implementation of

production decisions) Homogeneous goals of the owners and

managerial staff

ECW2731Weeks 7 & 8

• Examples of Competitive Markets– Agricultural commodities.– Some prominent markets for intermediate goods and

services.– Unskilled labor market.



ECW2731Weeks 7 & 8

• Profit Maximization Imperative– Normal profit is return necessary to attract and maintain

capital investment.– Efficient firms can earn normal profit.– Inefficient firms suffer losses.

• Role of Marginal Analysis– Set Mπ = MR – MC = 0 to maximize profits.– MR=MC when profits are maximized.



ECW2731Weeks 7 & 8


Market structures Market structures Monopoly

Basic Properties

• One firm in industry

• Profit-maximiser

• Faces market demand curve

• One product

• No close substitutes

• Price-maker

• No restrictions on resources

• Blockaded entry and/or exit

• Imperfect dissemination of information

• Opportunity for economic profits in long-run equilibrium.

ECW2731Weeks 7 & 8

• Examples of Monopoly– Electricity utilities, – Gas – Water– Public Tramsport– Telecommunications



ECW2731Weeks 7 & 8



Social Costs of Monopoly• Monopoly Underproduction

Monopolists produce too little output.

Monopolists charge prices that are too high.

Deadweight Loss from MonopolyMonopoly markets creates

a loss in social welfare due to the decline in mutually beneficial trade activity.

There is also a wealth transfer problem associated with monopoly.

Under monopoly, consumer surplus is transferred to producer surplus.

ECW2731Weeks 7 & 8

Social Benefits From Monopoly

• Economies of ScaleMonopoly is sometimes the natural result of vigorous

competitive forces.In natural monopoly, LRAC declines continuously and one

firm is most efficient.Some real-world monopolies are government-created or

government-maintained.

• Invention and InnovationPublic policy sometimes confers explicit monopoly rights to

spur productivity.



ECW2731Weeks 7 & 8

Monopoly Regulation

• Dilemma of Natural MonopolyMonopoly has the potential for efficiency.Unregulated monopoly can lead to economic profits and

underproduction.

ECW3830 COMPETITION AND REGULATION



ECW2731Weeks 7 & 8

Contrast Between Monopolistic Competition and Oligopoly

• Monopolistic Competition

• Large number of sellers that offer differentiated products.

• Normal profit opportunity in long-run equilibrium.

• Oligopoly

• Few sellers.

• Economic profits are possible in long-run equilibrium.

• Dynamic Nature of Competition

• Timely market structure information is required for managerial investment decisions


Market structures Market structures Oligopoly and Monopolistic Competition

ECW2731Weeks 7 & 8


Market structures Market structures Мonopolistic competition

• The market consists of n mono-product firms;

• The products are viewed by the buyers as close though not perfect substitutes for one another;

• Therefore, each of the sellers is a monopolist of its particular product variant with a limited degree of monopoly power.

• Such a monopolist is enjoying a monopoly power and making economic profit during only a short period of time

• from the introduction of an unique product or technology

• until such a technology becomes available to rivals, or

• until a new “more innovative” product is introduced by a rival.

ECW2731Weeks 7 & 8

Q

Short-run Monopoly EquilibriumMonopolistically competitive firms take full advantage of short-run monopoly.



Price

Costs

Quantity

MR Demand

MCAC

Qmc

Pmc

ECW2731Weeks 7 & 8

Long-run equilibrium same costs, lower demand and excess capacity – low output high price decision

With differentiated products, P=AC at a point above minimum LRAC.P > MR = MC.



Price

Costs

QuantityMR1

D1

MC AC

MR2

D2

Price

Costs

Quantity

MC AC

Pmc

Qmc

MRD

Entry of new firms offering product substitutes shifts the demand and MR curves)

ECW2731Weeks 7 & 8

Long-run equilibrium– high output low price decision (corresponds to perfect Competition) With homogenous products, P=AC at minimum LRAC.

This is a competitive market equilibrium with homogeneous production.



Price

Costs

QuantityMR1

D1

MC AC

MR2

D2

Price

Costs

Quantity

MC AC

Pmc

Qmc

MRD

Qac

Pac

Long-run equilibrium same costs, lower demand and excess capacity – low output high price decision

With differentiated products, P=AC at a point above minimum LRAC.P > MR = MC.

ECW2731Weeks 7 & 8

• Oligopoly Market Characteristics

• Few sellers.

• Homogenous or unique products.

• Blockaded entry and exit.

• Imperfect dissemination of information.

• Opportunity for above-normal (economic) profits in long-run equilibrium.

• Examples of Oligopoly

• National markets for aluminum, cigarettes, electrical equipment, filmed entertainment, ready-to-eat cereals, etc.

• Local retail markets for gasoline, food, specialized services, etc.


Market structures Market structures Oligipoly

ECW2731Weeks 7 & 8

Cartels and Collusion

• Overt and Covert Agreements

• Cartels operate under formal agreements.

• Powerful cartels function as a monopoly.

• Collusion exists when firms reach secret, covert agreements.

• Enforcement Problem

• Cartels are typically rather short-lived because coordination problems often lead to cheating.

• Cartel subversion can be extremely profitable.

• Detecting the source of secret price concessions can be extremely difficult.


Market structures Market structures Oligipoly

ECW2731Weeks 7 & 8

• Types of Games– Zero-sum game: offsetting gains/losses.– Positive sum game: potential for mutual gain.– Negative-sum game: potential for mutual loss.– Cooperative games: joint action is favored.

• Role of Interdependence– Sequential games: moves in succession. – Simultaneous-move game: coincident moves.

• Strategic Considerations


Market structures Market structures Game Theory Basics

ECW2731Weeks 7 & 8

Prisoner’s Dilemma

• Classic Riddle– Rational behavior can give suboptimal result.– Rationality can hamper beneficial cooperation.

• Business Application– Dominant strategy gives best result regardless of moves by

other players. – Secure strategy gives best result assuming the worst

possible scenario.

• Broad Implications


Market structures Market structures Game Theory Basics

ECW2731Weeks 7 & 8


Competitive strategies in Imperfectly competitive markets


A competitive advantage is a unique or rare ability to create, distribute or service valued by customers.

It is a business-world analogue to what economists call comparative advantage or when one nation or region of the country is better suited to the production of one product than to the production of some other product

Above-normal rate of return require a competitive advantage that cannot easily be copied

In production;

In distribution; or

In marketing

A competitive advantage is a unique or rare ability to create, distribute or service valued by customers.

It is a business-world analogue to what economists call comparative advantage or when one nation or region of the country is better suited to the production of one product than to the production of some other product

Above-normal rate of return require a competitive advantage that cannot easily be copied

In production;

In distribution; or

In marketing

ECW2731Weeks 7 & 8




Reasons for competitive advantage: Access to a unique resource

(Exclusive) Access to a mineral deposit

(Exclusive) Access to a material Efficient energy source Unique climatic condition Unique technology Unique (specially qualified or very talented) labour

force; or Access to a unique market

A university bookshop The rice market in Japan etc

Reasons for competitive advantage: Access to a unique resource

(Exclusive) Access to a mineral deposit

(Exclusive) Access to a material Efficient energy source Unique climatic condition Unique technology Unique (specially qualified or very talented) labour

force; or Access to a unique market

A university bookshop The rice market in Japan etc

ECW2731Weeks 7 & 8


Non-price competition.Non-price competition.

Product differentiationProduct differentiation

Product differentiation refers to the increase in time of the number of

product categories suppled and the number of items in each category

Product differentiation refers to the increase in time of the number of

product categories suppled and the number of items in each category

Historically, a step from oligopolistic to monopolistic competition

Historically, a step from oligopolistic to monopolistic competition

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ECW2731 Weeks 7 & 8 Competition, market structures and business decisions Market structures What is...

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