MarketStructures

The Degree of Competition

• Classifying markets– number of firms– freedom of entry to industry– nature of product– nature of demand curve

• The four market structures– perfect competition– monopoly– monopolistic competition– oligopoly

Features of the four market structures

Features of the four market structures

Features of the four market structures

Features of the four market structures

Features of the four market structures

Features of the four market structures

The Degree of Competition

• Classifying markets– number of firms– freedom of entry to industry– nature of product– nature of demand curve

• The four market structures– perfect competition– monopoly– monopolistic competition– oligopoly

• Structure conduct performance

Perfect Competition

• Assumptions– firms are price takers– freedom of entry– identical products– perfect knowledge

• Short-run equilibrium of the firm– price, output and profit

O

£

(b) Firm

Q (thousands)

O

(a) Industry

P

Q (millions)

S

D

Pe

MC

AR D = AR= MR

Qe

AC

AC

Short-run equilibrium of industry and firm under perfect competition

Qe

P1

D1 = AR1

= MR1

AR1

O O

(a) Industry

P £

Q (millions)

S

D

(b) Firm

MC AC

AC

Q (thousands)

Loss minimising under perfect competition

Perfect Competition

• Assumptions– firms are price takers– freedom of entry– identical products– perfect knowledge

• Short-run equilibrium of the firm– price, output and profit

• The short-run supply curve of the firm

O O

(a) Industry

P £

P1

Q (millions)

S

D1

(b) Firm

D1 = MR1

MC

P2

D2 = MR2

D2

P3

D3 = MR3

D3

Q (thousands)

Deriving the short-run supply curve

ab

c

= S

Perfect Competition

• Long-run equilibrium of the firm

– all supernormal profits competed away

– LRAC = AC = MC = MR = AR

O O

(a) Industry

P £

Q (millions)

S1

D

(b) Firm

LRAC

PL

P1

QL

Se

AR1 D1

ARL DL

Q (thousands)

Long-run equilibrium under perfect competition

New firms enterSupernormal profitsProfits returnto normal

£

Q O

(SR)AC

(SR)MC

LRAC

AR = MR

DL

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

Long-run equilibrium of the firm under perfect competition

Perfect Competition

• Incompatibility of economies of scale with perfect competition

• Benefits of perfect competition

– price equals marginal cost

– prices kept low

– firms must be efficient to survive

Monopoly

• Defining monopoly• Barriers to entry

– economies of scale– economies of scope– product differentiation and brand loyalty– lower costs for an established firm– ownership/control of key factors– ownership/control over outlets– legal protection– mergers and takeovers– aggressive tactics– intimidation

Monopoly

• The monopolist’s demand curve– downward sloping– MR below AR

• Equilibrium price and output– Equilibrium output, where MC = MR

Profit maximising under monopoly

MR

£

Q O

MC

Qm

Monopoly

• The monopolist’s demand curve– downward sloping– MR below AR

• Equilibrium price and output– Equilibrium output, where MC = MR– Equilibrium price, found from demand curve

£

Q O

MC

AC

Qm

MR

AR

AC

Profit maximising under monopoly

AR

Monopoly

• The monopolist’s demand curve– downward sloping– MR below AR

• Equilibrium price and output– Equilibrium output, where MC = MR– Equilibrium price, found from demand curve

• Profit– Measuring profit

£

Q O

MC

AC

Qm

MR

AR

AC

Profit maximising under monopoly

AR

Total profit

Monopoly

• The monopolist’s demand curve– downward sloping– MR below AR

• Equilibrium price and output– Equilibrium output, where MC = MR– Equilibrium price, found from demand curve

• Profit– Measuring profit– Supernormal profit can persist in long run

Monopoly

• Disadvantages of monopoly– high prices / low output: short run

AR = D

MC

MR

£

Q O Q1

P1

Monopoly

Equilibrium of industry under perfect competition and monopoly: with the same MC curve

£

Q O

MC ( = supply under perfect competition)

Q1

MR

P1

P2

Q2

AR = D

Comparison withPerfect competition

Equilibrium of industry under perfect competition and monopoly: with the same MC curve

Monopoly

• Disadvantages of monopoly– high prices / low output: short run– high prices / low output: long run

Monopoly

• Disadvantages of monopoly– high prices / low output: short run– high prices / low output: long run– lack of incentive to innovate

Monopoly

• Disadvantages of monopoly– high prices / low output: short run– high prices / low output: long run– lack of incentive to innovate– X-inefficiency

Monopoly

• Disadvantages of monopoly– high prices / low output: short run– high prices / low output: long run– lack of incentive to innovate– X-inefficiency

• Advantages of monopoly

Monopoly

• Disadvantages of monopoly– high prices / low output: short run– high prices / low output: long run– lack of incentive to innovate– X-inefficiency

• Advantages of monopoly– economies of scale

£

Q O Q1

MR

P1

MCmonopoly

AR = D

Equilibrium of industry under perfect competition and monopoly: with different MC curves

£

Q O

MC ( = supply)perfect competition

Q1

MR

P1

P2

Q2

MCmonopoly

AR = D

x

Q3

P3

Equilibrium of industry under perfect competition and monopoly: with different MC curves

Monopoly

• Disadvantages of monopoly– high prices / low output: short run– high prices / low output: long run– lack of incentive to innovate– X-inefficiency

• Advantages of monopoly– economies of scale– profits can be used for investment

Monopoly

• Disadvantages of monopoly– high prices / low output: short run– high prices / low output: long run– lack of incentive to innovate– X-inefficiency

• Advantages of monopoly– economies of scale– profits can be used for investment– high profits encourage risk taking

Monopoly

• Contestable markets

– importance of potential competition

– a perfectly contestable market

– contestable markets and natural monopolies

– importance of costless exit

• Contestable markets and the public interest

Monopolistic Competition

• Assumptions of monopolistic competition

• Equilibrium of the firm– short run

£

Q O Qs

AR D

MC

AC

MR

Short-run equilibrium of the firmunder monopolistic competition

Ps

ACs

Monopolistic Competition

• Assumptions of monopolistic competition

• Equilibrium of the firm– short run– long run

Long-run equilibrium of the firmunder monopolistic competition

ARL DL

MRL

£

Q O QL

PL

LRAC

LRMC

Monopolistic Competition

• Assumptions of monopolistic competition

• Equilibrium of the firm– short run– long run– underutilisation of capacity in the long run

Q2

P2 DL under perfectcompetition

Long run equilibrium of the firm under perfect andmonopolistic competition

£

QO

P1

LRAC

DL under monopolistic competition

Q1

Monopolistic Competition

• Assumptions of monopolistic competition

• Equilibrium of the firm– short run– long run– underutilisation of capacity in the long run

• Non-price competition

Monopolistic Competition

• Assumptions of monopolistic competition

• Equilibrium of the firm– short run– long run– underutilisation of capacity in the long run

• Non-price competition• The public interest

Monopolistic Competition

• Assumptions of monopolistic competition

• Equilibrium of the firm– short run– long run– underutilisation of capacity in the long run

• Non-price competition• The public interest

– comparison with perfect competition

Monopolistic Competition

• Assumptions of monopolistic competition

• Equilibrium of the firm– short run– long run– underutilisation of capacity in the long run

• Non-price competition• The public interest

– comparison with perfect competition– comparison with monopoly

Oligopoly

• Key features of oligopoly

– barriers to entry

– interdependence of firms

• Competition versus collusion

• Collusive oligopoly: cartels

– equilibrium of the industry

£

Q O

Industry D AR

Profit-maximising cartel

Profit-maximising cartel£

Q O

Industry D AR

Industry MC

Industry MR

Q1

P1

Oligopoly

• Key features of oligopoly

– barriers to entry

– interdependence of firms

• Competition versus collusion

• Collusive oligopoly: cartels

– equilibrium of the industry

– allocating and enforcing quotas

0

5

10

15

20

25

30

35

70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02

$ per barrel Actual price

Yom KippurWar: Arab oil

embargo

First oil fromNorth Sea

Revolutionin Iran

Iraq invadesIran OPEC’s first

quotas

Cease-fire inIran-Iraq war Recession

in Far East

Iraq invadesKuwait

New OPECquotas

World-widerecovery

World-wideslowdown

Impendingwar

with Iraq

Oil prices

0

5

10

15

20

25

30

35

70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02

$ per barrel Actual priceCost in 1973 prices

Yom KippurWar: Arab oil

embargo

First oil fromNorth Sea

Revolutionin Iran

Iraq invadesIran OPEC’s first

quotas

Cease-fire inIran-Iraq war Recession

in Far East

Iraq invadesKuwait

New OPECquotas

World-widerecovery

World-wideslowdown

Impendingwar

with Iraq

Oil prices

Oligopoly

• Tacit collusion

– price leadership: dominant firm

£

Q O

MR leader

AR D leader

AR D market

Price leader aiming to maximise profits for a given market share

Assume constantmarket share

for leader

£

Q O

AR D market

MC

MR leader

PL

QT

AR D leader

QL

l t

Price leader aiming to maximise profits for a given market share

Oligopoly

• Tacit collusion

– price leadership: dominant firm

– price leadership: barometric

Oligopoly

• Tacit collusion

– price leadership: dominant firm

– price leadership: barometric

– rules of thumb

Oligopoly

• Factors favouring collusion– Few firms– Open with each other– Similar production methods and average

costs– Similar products– Dominant firm– Significant entry barriers– Stable market– No government measures to curb collusion

Oligopoly

• The breakdown of collusion• Non-collusive oligopoly: game theory

– alternative strategies• maximax and maximin

– simple dominant strategy games

Profits for firms A and B at different prices

£2.00 £1.80

£2.00

£1.80

X’s price

Y’s price

A B

C D

£10m each

£8m each£12m for Y£5m for X

£5m for Y£12m for X

Oligopoly

• The breakdown of collusion• Non-collusive oligopoly: game theory

– alternative strategies• maximax and maximin

– simple dominant strategy games• Nash equilibrium

Profits for firms A and B at different prices

£2.00 £1.80

£2.00

£1.80

X’s price

Y’s price

A B

C D

£10m each

£8m each£12m for Y£5m for X

£5m for Y£12m for X

Oligopoly

• The breakdown of collusion• Non-collusive oligopoly: game theory

– alternative strategies• maximax and maximin

– simple dominant strategy games• Nash equilibrium• the prisoners’ dilemma

The prisoners' dilemma

Not confess Confess

Notconfess

Confess

Amanda's alternatives

Nigel'salternatives

A B

C D

Each gets1 year

Each gets3 years

Nigel gets3 months

Amanda gets10 years

Nigel gets10 years

Amanda gets3 months

Oligopoly

• The breakdown of collusion• Non-collusive oligopoly: game theory

– alternative strategies• maximax and maximin

– simple dominant strategy games• the prisoners’ dilemma• Nash equilibrium

– more complex non-dominant strategy games

Oligopoly

• The breakdown of collusion• Non-collusive oligopoly: game theory

– alternative strategies• maximax and maximin

– simple dominant strategy games• the prisoners’ dilemma• Nash equilibrium

– more complex non-dominant strategy games

– the importance of threats and promises

Oligopoly

• The breakdown of collusion• Non-collusive oligopoly: game theory

– alternative strategies• maximax and maximin

– simple dominant strategy games• the prisoners’ dilemma• Nash equilibrium

– more complex non-dominant strategy games

– the importance of threats and promises– the importance of timing of decisions

Oligopoly

• The breakdown of collusion• Non-collusive oligopoly: game theory

– alternative strategies• maximax and maximin

– simple dominant strategy games• the prisoners’ dilemma• Nash equilibrium

– more complex non-dominant strategy games

– the importance of threats and promises– the importance of timing of decisions

• decision trees

Boeingdecides

500 s

eater

500 seater

500 seater

400 seater

400 seater

400 seater

A decision tree

Boeing –£10mAirbus –£10m (1)

Boeing +£30mAirbus +£50m (2)

Boeing +£50mAirbus +£30m (3)

Boeing –£10mAirbus –£10m (4)

Airbusdecides

B2

Airbusdecides

B1

A

Oligopoly

• Non-collusive oligopoly: the kinked demand curve theory– assumptions of the model

Kinked demand for a firm under oligopoly£

QO

P1

Q1

Current priceand quantity

give one pointon demand curve

£

QO

P1

Q1

D

D

Kinked demand for a firm under oligopoly

Oligopoly

• Non-collusive oligopoly: the kinked demand curve theory– assumptions of the model– stable prices

£

QO

P1

Q1

MC2

MC1

MR

a

b D AR

Stable price under conditions of a kinked demand curve

Oligopoly

• Non-collusive oligopoly: the kinked demand curve theory– assumptions of the model– stable prices– limitations of the model

Oligopoly

• Non-collusive oligopoly: the kinked demand curve theory– assumptions of the model– stable prices– limitations of the model

• Oligopoly and the public interest

Oligopoly

• Non-collusive oligopoly: the kinked demand curve theory– assumptions of the model– stable prices– limitations of the model

• Oligopoly and the public interest– advantages

Oligopoly

• Non-collusive oligopoly: the kinked demand curve theory– assumptions of the model– stable prices– limitations of the model

• Oligopoly and the public interest– advantages– disadvantages

Oligopoly

• Non-collusive oligopoly: the kinked demand curve theory– assumptions of the model– stable prices– limitations of the model

• Oligopoly and the public interest– advantages– disadvantages– difficulties in drawing general conclusions

Price Discrimination

• Meaning of price discrimination

– First degree

– Second degree

– Third degree (the most common form)

Third-degree price discriminationP

QO

P1

D

200

Revenue froma single price

O

P1

D

200

P2

150

P

Q

Increased revenuefrom price

discriminationA higher discriminatoryprice is now introduced

Third-degree price discrimination

Price Discrimination

• Meaning of price discrimination

– First degree

– Second degree

– Third degree (the most common form)

• Conditions necessary for price discrimination

Price Discrimination

• Meaning of price discrimination

– First degree

– Second degree

– Third degree (the most common form)

• Conditions necessary for price discrimination

• Advantages to the firm

Price Discrimination

• Profit maximising prices and output under price discrimination

O O OMRX

(a) Market X

DX

Profit-maximising output underthird degree price discrimination

O O O

DY

MRX

MRY

(a) Market X (b) Market Y

DX

Profit-maximising output underthird degree price discrimination

O O OMRX

MRY MRT

(a) Market X (b) Market Y (c) Total(markets X + Y)

DX

Profit-maximising output underthird degree price discrimination

DY

Profit-maximising output underthird degree price discrimination

O O OMRX

MRY MRT

MC

(a) Market X (b) Market Y (c) Total(markets X + Y)

DX

DY

O O OMRX

MRY MRT

MC

(a) Market X (b) Market Y (c) Total(markets X + Y)

DX

3000

Profit-maximising output underthird degree price discrimination

DY

O O O

DX

MRX

MRY MRT

MC

5

(a) Market X (b) Market Y (c) Total(markets X + Y)

3000

Profit-maximising output underthird degree price discrimination

DY

O O OMRX

MRY MRT

MC

5

1000

(a) Market X (b) Market Y (c) Total(markets X + Y)

DX

3000

Profit-maximising output underthird degree price discrimination

DY

O O OMRX

MRY MRT

MC

5

1000 2000

(a) Market X (b) Market Y (c) Total(markets X + Y)

DX

3000

Profit-maximising output underthird degree price discrimination

DY

O O OMRX

MRY MRT

MC

5

9

1000 2000

(a) Market X (b) Market Y (c) Total(markets X + Y)

DX

3000

Profit-maximising output underthird degree price discrimination

DY

O O OMRX

MRY MRT

MC

DY

57

1000 2000 3000

(a) Market X (b) Market Y (c) Total(markets X + Y)

9

DX

Profit-maximising output underthird degree price discrimination

Price Discrimination

• Profit maximising prices and output under price discrimination

• Price discrimination and the public interest

– competition

Price Discrimination

• Profit maximising prices and output under price discrimination

• Price discrimination and the public interest

– competition

– profits