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Determinants of Market Structure

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Topics for Discussion

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The Debate

Economies of Scale

Product Differentiation

Absolute cost advantages

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The Debate

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Market structure and its implications to conduct andperformance especially to control prices has beenexplored

Market structure itself is a result of economic forces

S-C-P framework holds that market structure isdependent on the underlying technology and strategicbehaviour of firms

Chicago economists criticize this The essence of monopoly is the ability to prevent

expansion on capacity when price exceeds unit cost No theoretical link has been forged between the

structure of industry and the degree to which competitivepricing prevails

Market structure reflects something more than efficiency

(role of govt to keep the rivals from entering)

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Determinants of Market structure

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Bain identified three elements of market structureas the main determinants of the nature of entry

conditions

Economies of scale

Product differentiation

Absolute cost advantages of existing firms

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Economies of Scale

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Economies of scale and proportion of fixed cost intotal cost

Short run equilibrium

Long run Number of firms

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Market performance

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Changes in market performance and relation withfixed cost and economies of scale

Lower fixed cost, greater the number of firms in

LR equilibrium; closer the Eq. Price to MC and

less the degree of market power exercised by

individual firms

Trade off between FC and market performance-

Role of MES;

Thus, market concentration is expected to

increase with economies of scale but the market

performance is expected to worsen off

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Policy implications

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In LR, Market concentration would approach thelevel dictated by cost function; so there is little

policy makers can do about it

Strategic entry deterring behaviour of large firms

to maintain market share would make them

operate at scales that are inefficient (SCP)

Estimates of efficiency and MES flawed; the

market structure observed in real world is efficient

(Chicago)

When market economy is at work, size of firms

should not be a matter of concern

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Product Differentiation

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Methods of differentiatingAdvertising

Efforts of sales forces

Design changes

After sales etc

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Advertising

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Advertising affects demand curve

Advertising in turn affects profit as well as profit

maximizing output

Advertising influences price elasticity of demandAdvertising sales ratio is determined by two

factors

Price-cost margin: firms advertise more, the more

they make on the sale of the marginal unit Elasticity of demand with respect to advertising:

firms advertise more, the more sensitive is the

quantity demanded to advertsing

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Advertising and absolute cost

advantages

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Time lags If past advertising does not affect current demand,

then ads are not a barrier to entry for new firms

However, in reality, brand image is created by

incumbent firms and it creates an absolute costadvantage

Rate at which the effect of advertising on demand

depreciates varies from industry to industry

Cumulative affect of ad on sales of mature, frequentlypurchased, low-priced products occurs within 3-9 months of

ad

Ad effect/brand loyalty modest or enduring as

entry barrier thus varies

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Noise:Ad of incumbent firm interferes with that of new

firms

When there is noise in the market, one must shout

louder to be heard.puts the new firms at costdisadvantage as compared to existing firms

Market Penetration cost-entry barrier; market

power for existing firms

Avg. cost of production as well as of distribution willbe higher for new firms

Figure 8.3

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Product differentiation and

Economies of Scale

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Minimum amount of ad expense is needed before it startsmaking impact on public

This is FC of ad

Threshhold effect- it is the size of audience that must bereached that determines the expenditure, not the firms

sales (national market)

Ad exp of exiting firm and new entrant would be same;entrants output small as compared to existing firm, makingthe unit cost of ad higher for the former

Regional markets

Repetition effect-effectiveness of advertisement(experience effect)

Rate structures of advertising media (spot ad vs. networkad)

This limit price differential is independent of the gapcreated by market penetration cost

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Product differentiation and

welfare

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Figure 8.4

Monopolists advertise too much, from social point

of view because they take decisions based on

their private MR and MC; they do not consider

the additional cost incurred on consumer in the

form of higher prices

Oligopoly results in even more excessive

advertising; if they succeed in controlling price

competition, then they divert their rivalry in

marketing efforts

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Capital requirements

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Why firms might have a cost advantage overpotential entrants at all levels of outputindependent of scale differences and advertising

Patents, control of inputs will be important in

some industries more than others Working of financial capital market is cited as a

general source of absolute cost advantage ofestablished firms

Higher effective interest cost (cost of capital) Severe rationing of funds on potential entrants

Inefficient capital market/uncertainty/ asymmetricalinformation/reputation/

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Empirical findings

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MES (Martin)

Advertising : media impact/ (Mueller and Rogers)

Kessides: sunk cost/odds of successful entry

increase as ad per unit of sales grows

Results vary in different segments/industry to

industry