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Competition and Market Structure. Frederick University 20 11. 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

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competition and market structure

Competition and Market Structure

Frederick University

2011

industry
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
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

BASIC CONDITIONS
market structure

Market Structure

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

market structure6
MARKET STRUCTURE
  • number and size of sellers and buyers
  • type of the product
  • conditions of entry and exit
  • transparency of information
perfect competition structure
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
Pure Monopoly- market structure
  • Only one producer in the industry
  • The product does not have close substitutes
  • Blocked entry
monopolistic competition structure
Monopolistic competition - structure
  • Many and small sellers
  • Differentiated product
  • Free entry and exit
  • Transparent and free information
oligopoly market structure
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
slide11

Entry

  • 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.
barriers to entry
Barriers to Entry

Structural barriers

  • High capital cost
  • Economies of scale
  • Product differentiationand 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
Alternative Market Structures
  • The four market structures
    • perfect competition
    • monopoly
    • monopolistic competition
    • oligopoly
market conduct

Market Conduct

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

conduct
CONDUCT
  • pricing behavior
  • product strategy
  • research and innovation
  • advertising
  • legal tactics
perfect competition conduct
Perfect competition - conduct

Firm’s market

Industry’s market

  • P q TR MR
  • 5 0 0 -
  • 5 10 50 5
  • 5 20 100 5

P

D

S

P

d

MR

Pe

Q

20

Q

Qe

0

10

perfect competition short run conduct
Perfect competition – short run “conduct”

p

MC

AC

dd = MR

Economic profit= (P-AC) q

q

Q

P = MR

MC = MR

P>AC

perfect competition long run conduct
Perfect Competition – long run “conduct”

Industry’s equilibrium

S

If P>AC, new firms start

entering the industry and

the equilibrium price falls.

P

D

If Р < АС, the firms will

start leaving the industry

and the equilibrium price

will increase.

Pe

P’

The industry is in a long run

equilibrium when P = AC

Qe

Q

In the long run the firms make

normal profit

perfect competition deriving the short run supply curve

S

MC

a

P1

b

P2

c

P3

D1

D2

D3

Perfect Competition - Deriving the short-run supply curve

P

= S

d1 = MR1

d2 = MR2

d3 = MR3

Q (thousands)

Q (millions)

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

(a) Industry

(b) Firm

fig

long run equilibrium of the firm under perfect competition

(SR)MC

(SR)AC

LRAC

DL

AR = MR

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

Long-run equilibrium of the firm under perfect competition

Q

pure monopoly conduct
Pure Monopoly - conduct
  • P Q TR MR
  • 1 10 10
  • 2 18 8
  • 8 3 24 6

P

MC

D

P

P>MR

Economic

Profit

AC

MC=MR

Q

Qm

MR

pure monopoly and perfect competition

MC

AC

AR =D

MR

Pure Monopoly and Perfect competition

Consumer surplus = ∑ (P –MWP)

Under perfect competition=KLN

Under pure monopoly=NRT

L

P

N

Producer surplus=

∑ (P-MC)

Under pure monopoly the producer

surplus rises byKGTR at the expense

of the consumer surplus

R

T

Pm

GTL – the portion of the

consumer surplus,

which is a deadweight loss for the society

JGL – the portion of the producer surplus, which is a deadweight loss for the society

Pp.c.

K

G

J

Qp.c.

Qm

Q

TLJ – total deadweight loss for the society

monopolistic competition conduct in the long run

LRMC

LRAC

ARL=DL

MRL

Monopolistic competition – conduct in the long run

IfP>AC new firms will enter

the industry and the firm’s

market segment will shrink

- its individual demand curve

shifts leftwards

P

PL

Q

The long run equilibrium is achieved at P = AC, however, АС is not minimized

– there is excess capacity

QL

long run equilibrium under perfect competition and under monopolistic competition

P2

DL under perfect

competition

Long run equilibrium under perfect competition and under monopolistic competition

P

LRAC

P1

DL undermonopolistic

competition

fig

Q1

Q2

Q

the kinked demand curve

a

b

MRf

The kinked demand curve

P

P1

MRnf

D = AR

Q

Q1

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

P

Sothers

Dindustry

Dleader

Q

price leadership of the dominant firm37

MCleader

l

f

t

MRleader

Price leadership of the dominant firm

P

Sother firms

PL

Dindustry

Dleader

QT

QF

QL

Q

market performance

Market Performance

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

performance
PERFORMANCE
  • profitability
  • allocative efficiency
  • static production efficiency
  • dynamic efficiency - progress
  • full employment
  • equity
perfect competition performance
Perfect Competition - Performance
  • P = MR
  • MC = MR
  • P = MC
  • P = AC
  • AC = MC
  • AC minimum
perfect competition performance41
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 Efficiency

There is NO potential and motivation for innovations and technological progress

The Perfect Competition does not achieve dynamic efficiency

pure monopoly performance
Pure Monopoly - performance

Static efficiency

  • Efficiency in allocation MC < P
  • Efficiency in motivationexcess capacity
  • Efficiency in distributionAC < P

The pure monopoly does not achieve static efficiency

Dynamic efficiency

There 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
Monopolistic competition - performance

Static Efficiency

  • Efficiency in allocation MC < P
  • Efficiency in motivationexcess capacity
  • Efficiency in distribution AC = P
contestable markets
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 markets45
Contestable markets

Contestable market

  • Ultra easy entry
  • Ultra easy exit
  • Zero sunk cost
  • “Hit and run” strategy”
oligopoly non collusive behavior
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
The Prisoners’ dilemma

Two suspects, Valio and Georgy, 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?

the prisoners dilemma48
The Prisoners’ dilemma

Valio’s alternatives

Does not confess

Confesses

Georgy -

10 years

Valio -

3 months

Does not confess

Everyone gets

1 year

Georgy’s

alterantives

Georgy -

3 months

Valio- 10 years

Everyone gets

3 years

Confesses

fig

the prisoners dilemma49
The Prisoners’ dilemma

The Prisoners’ dilemmais the duopoly’sdilemma. 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.

payoffs for firms a b under different pricing policies
Payoffs for firms A и B under different pricing policies

A’s Price

2.00

1.80

5 for В

12 for А

2.00

10mil. for each

B’s Price

12 for В

5 for А

1.80

8 for each

fig

collusive behavior
Collusive behavior
  • How could the firms overcome the prisoners’ dilemma?
  • Collusive behaviorwill set higher prices for the buyers!