Microeconomics and Corporate Analysis
Microeconomic Foundations for the Analisys of Market Structure
Lecture Slides
Rui Baptista
Consumer TheoryBudget Constraint Showing Increase in Income
Q2
Q1
M / P2
M / P1
Slope = - P1 / P2
M’ / P1
M’ / P2
M’ > M
Consumer TheoryBudget Constraint Showing Increase in Price
Q2
Q1
M / P2
M / P1M / P’1
P’1 > P1
Consumer Theory:Indifference Curves
Q2
Q1
U1
U2
U1 < U2
Q’1
Q’2
Slope=MRS
Consumer TheoryOptimal Choice
Q1
Q2
Q*1
Q*2
U*dQ2 / dQ1 = - P1 / P2
Consumer TheoryThe Consumer Problem
Max U(Q1, Q2) subject to P1.Q1 + P2.Q2 = M
leads to the First Order Conditions:
MU1 / MU2 = MRS = P1 / P2
P1.Q1 + P2.Q2 = M
thus deriving:
Q1 = Q1 (M, P1, P2) - P1 = Q1(P1)
Q2 = Q2 (M, P1, P2) - P2 = Q2(P2)
Inverse Demand Funcions
Technology and CostsInternal Efficiency
Min C = w.L + r.K subject to Q = Q(L, K)
Leads to: C = C(Q, w, r) = C(Q)
Average Cost: AC = C(Q) / Q
Marginal Cost MC = dC(Q) / dQ
Short Run: CSR = r.K + w.L(Q) = FC + VC(Q)
ACSR = FC / Q + VC(Q) / Q
MCSR = dVC(Q) / dQ
Technology and CostsFixed and Variable costs
Q
C
CSR
VC
FC
Technology and CostsShort Run Average Costs
AC AC
AVC
AFC
AC
Technology and CostsLong Run Average Costs
Q
AC
ACLR
ACSR (K1)ACSR (K2)
Q1 Q2
Technology and CostsMarginal Costs and Firm Supply
Q
P P = P(QS) = MC
P*
Q*
AC (Q)AC(Q*)
Perfect CompetitionShort Run Market Equilibrium
DS
S’
MCi
ACi
Q (Market)Q Q’ Q (Firm i)QiQi’
P
P’
MonopolyMarket Equilibrium
AC
MC
DMR
PM
ACM
PPC
Q
P
QM
M
QPC
Welfare Loss from Monopoly
AC
MC
DMR
PM
PPC
P
M
M
C
M’
Oligopoly:Reaction Curves and Isoprofit Lines
Q1
Q2
Reaction Curve - f2 (Q2)
Isoprofit Lines - firm 2
Q1
Oligopoly:Stackelberg Equilibrium
Q1
Q2
Isoprofit Lines - Firm 1
Reaction curve - Firm 2 - f2 (Q2)
Q1*
Q2*
Oligopoly:Cournot Equilibrium
Q1
Q2
Q1=f1(Q2)
Q2=f2(Q1)
T
T+1
T+2
T+3
T+4
T+5
T*
Oligopoly:Quantity Games
Stackelberg Equilibrium
Follower’s Problem: Max 2 = P(Q1+Q2).Q2 -C2(Q2)
yielding the Reaction Function: Q2 = f2(Q1)
Leader’s Problem: Max 1 = P(Q1 + f2(Q2)).Q1 - C1(Q1)
Equilibrium: dQ2 / dQ1 = df2 / dQ1
Cournot Equilibrium
Max 1 = P (Q1 + Q2).Q1 - C1(Q1) yields Q1 = f1(Q2)
Max 2 = P (Q2 + Q1).Q2 - C2(Q2) yields Q2 = f2(Q1)
Equilibrium: f1(Q2) = f2(Q1)
Oligopoly:Collusion
Cartel’s Problem:
Max P(Q1+Q2).(Q1+Q2) - C1(Q1) - C2(Q2)
yielding:
MR = P + (dP / dQ).Q = MC1 = MC2 with Q = Q1 + Q2
and:
d1 / dQ1 = P + (dP / dQ).Q1 - MC1 = - (dP / dQ).Q2 > 0
d2 / dQ2 = P + (dP / dQ).Q2 - MC2 = - (dP / dQ).Q1 > 0
(incentive to break the agreement)
Corporate Analysis
Firm Behaviour and the Determinants of Market Structure
Lecture Slides
Rui Baptista
Performance
• Efficiency in Production
• Efficiency in Resource Allocation
• Productivity and Quality
• Technological Progress
• Macroeconomic Stability and Employment
• Equity
Basic Conditions
• Technology
• Accessibility of Raw Materials
• Product Characteristics
• Price elasticity and Substitutes
• Life-Cycle
• Seasonality of Demand
Market Structure
• Concentration
• Cost Structures
• Barriers to Entry
• Vertical Integration
• Diversification
• Product Differentiation
Firm Conduct
• Pricing Competition (Rivalry vs. Collusion)
• Product Strategy and Advertising
• Research and Innovation
• Investment in Production Capacity
Public Policy
• Taxes and Subsidies
• Trade Policy
• Regulation and Price controls
• Anti-Trust Laws
• Public Ownership
Basic Conditions Determining Market Concentration
• Economies of Scale
• Indivisibilities
• Learning Economies
• Product Life-Cycle
Firm Strategies Leading to Concentration
• Rivalry and Co-operation
• R&D Strategies
• Product Differentiation Strategies
• Barriers to Entry Strategies
Government Strategies Leading to Concentration
• Trade Policy - Promoting Competitiveness
• Development Policy - Protecting Infant Industries
• Patents and Technology Policy
• Regulation of Natural Monopolies
Market structure and the Intensity of Price Competition
Nature of Market Structure Range of H Intensity of Competition
Close to PerfectCompetition
below 0.2 Fierce, depending onproduct differentiation
Oligopoly 0.2 to 0.7 Fierce or light, dependingon the degree of collusion
Close toMonopoly
above 0.7 Usually light, unlessthreatened by entry
Vertical Integration: The Value Chain
Primary Activities• Inbound Logistics
• Manufacturing Activity
• Outbound Logistics
• Marketing and Sales
• Customer Service
Support Activities
• Procurement
• Technology Development
• Human Resources Management
• Infrastructure Activities
Determinants of Vertical Integration
• Localised Economies of Scale
• Efficiency and Innovation
• Agency and Influence Costs
• Transaction Costs:– Co-ordination– Information– Market Imperfections
Determinants of Product Diversification
• Economies of Scope
• Scale Economies and Market Size
• Capital-Raising Economies
• Pricing Strategies
• Departmental Inefficiencies
• Agency and Influence Costs
• Managerial Diseconomies
Sources of Scale Economies
• Technological Indivisibilities
• Increases in the Productivity of Variable Inputs
• The Need for Inventories
• Physical Properties of the Processing Units
• Marketing, Purchasing and R&D Costs
• Experience and Learning Economies
Structural Conditions Facilitating Oligopolistic Co-ordination
• Environment and Business Attitudes
• Market Concentration
• Conditions Affecting the Speed of Detection and Reaction
• Asymmetries between Firms
• Multimarket Contact
Behavioural Conditions Facilitating Oligopolistic Co-ordination
• The Nature of The Adopted Strategies
• Price Leadership Practices
• Advance Public Announcements
• Most Favoured Customer Clauses
• Uniform Delivered Prices