A presentation on market structure GROUP MEMBERS
Transcript of A presentation on market structure GROUP MEMBERS
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GROUP MEMBERSMOHSIN RAFIQUE MB-S1-09-41
ABDUL JABBAR MB-S1-09-83
MUHAMMAD IMRAN MB-S1-09-119
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Market structure identifies how a marketis made up in terms of:
The number of firms in the industry
The nature of the product producedThe degree of monopoly power each firm has
The degree to which the firm can influence price
Profit levels
Firms behaviour pricing strategies, non-price competition,output levels
The extent of barriers to entry
The impact on efficiency
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More competitive (fewer imperfections)
PerfectCompetition
PureMonopoly
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Market Structure
Less competitive (greater degreeof imperfection)
PerfectCompetition
PureMonopoly
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Market StructurePerfect
Competition
PureMonopoly
Monopolistic Competition Oligopoly Duopoly Monopoly
The further right on the scale, the greater the degreeof monopoly power exercised by the firm.
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` Importance:
` Degree of competition affects
the consumer will it benefit
the consumer or not?` Impacts on the performance
and behaviour of the company/companies
involved
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` One extreme of the market structure spectrum` Characteristics:
Large number of firms Products are homogenous (identical) consumer
has no reason to express a preference for any firm
Freedom of entry and exit into and outof the industry
Firms are price takers have no controlover the price they charge for their product
Each producer supplies a very small proportionof total industry output
Consumers and producers have perfect knowledge about themarket
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Diagrammatic representation
Cost/Revenue
Output/Sales
The industry price isdetermined by the demandand supply of the industryas a whole. The firm is avery small supplier withinthe industry and has nocontrol over price. They will
sell each extra unit for thesame price. Price therefore= MR and AR
P = MR = AR
MC
The MC is the cost ofproducing additional(marginal) units of output. Itfalls at first (due to the law ofdiminishing returns) then risesas output rises.
AC
The average cost curve is thestandard U shaped curve.MC cuts the AC curve at itslowest point because of themathematical relationshipbetween marginal and averagevalues.
Q1
Given the assumption of profitmaximisation, the firm producesat an output where MC = MR(Q1). This output level is afraction of the total industrysupply.
At this output the firm
is making normal profit.
This is a long run
equilibrium position.
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` Where the conditions of perfect competition
do not hold, imperfect competition will exist` Varying degrees of imperfection give rise to
varying market structures
` Monopolistic competition is one of these
not to be confused with monopoly!
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` Characteristics: Large number of firms in the industry
May have some element of control over price due tothe fact that they are able to differentiate their product
in some way from their rivals products are thereforeclose, but not perfect, substitutes
Entry and exit from the industry is relatively easy fewbarriers to entry and exit
Consumer and producer knowledge imperfect
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Implications for the diagram:
Cost/Revenue
Output / Sales
MC
AC
Marginal Cost andAverage Cost will be thesame shape. However,because the products
are differentiated insome way, the firm willonly be able to sell extraoutput by lowering
price.
D (AR)
The demand curve facingthe firm will be downward
sloping and represents theAR earned from sales.
MR
Since the additionalrevenue received from
each unit sold falls, theMR curve lies under the
AR curve.
We assume that the firmproduces where MR = MC(profit maximising output).At this output level, AR>AC
and the firm makesabnormal profit (the greyshaded area).
Q1
1.00
0.60
Abnormal Profit
If the firm produces Q1 andsells each unit for 1.00 on
average with the cost (onaverage) for each unit being
60p, the firm will make 40p xQ1 in abnormal profit.
This is a short run equilibriumposition for a firm in a
monopolistic marketstructure.
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Monopolistic or ImperfectCompetitionImplications for the diagram:
Cost/Revenue
Output / Sales
MC
AC
D (AR)MR
Q1
Because there is relativefreedom of entry and exitinto the market, newfirms will enter
encouraged by theexistence of abnormalprofits. New entrants willincrease supply causing
price to fall. As price falls,the AR and MR curvesshift inwards as revenuefrom each sale is nowless.
AR1MR1
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Monopolistic or ImperfectCompetitionImplications for the diagram:
Cost/Revenue
Output / Sales
MC
AC
D (AR)MR
Q1
AR1MR1
Notice that the existenceof more substitutes makesthe new AR (D) curvemore price elastic. The
firm reduces output to apoint where MC = MR(Q2). At this output AR =AC and the firm will make
normal profit.
Q2
AR = AC
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Monopolistic or ImperfectCompetitionImplications for the diagram:
Cost/Revenue
Output / Sales
MC
AC
AR1MR1
This is the long runequilibrium positionof a firm in monopolisticcompetition.
Q2
AR = AC
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` Some important points about monopolistic
competition: May reflect a wide range of markets
Not just one point on a scale reflects many degreesof imperfection
Examples?
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` Restaurants
` Plumbers/electricians/local builders
` Solicitors
` Private schools
` Plant hire firms` Insurance brokers
` Health clubs
` Hairdressers
` Funeral directors
` Estate agents
` Damp proofing control firms
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` In each case there are many firmsin the industry
` Each can try to differentiate its productin some way
` Entry and exit to the industry is relatively free` Consumers and producers do not have perfect
knowledge of the market the market may indeed berelatively localised. Can you imagine trying to search outthe details, prices, reliability, quality of service, etc for
every plumber in the UK in the event of an emergency??
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` Competition between the few May be a large number of firms in the industry but the
industry is dominatedby a small number of very large producers
` Concentration Ratio the proportion of totalmarket sales (share) held by the top 3,4,5, etcfirms: A 4 firm concentration ratio of 75% means the top 4
firms account for 75% of allthe sales in the industry
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` Example:
` Music sales The music industry hasa 5-firm concentrationratio of 75%.Independents make up
25% of the market butthere could be manythousands of firms thatmake up this
independents group.An oligopolistic marketstructure thereforemay have many firmsin the industry but it isdominated by a fewlarge sellers.
Market Share of the Music Industry 2002. Source IFPI: http://www.ifpi.org/site-content/press/20030909.html
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` Features of an oligopolistic market structure: Price may be relatively stable across the industry
kinked demand curve?
Potential for collusion
Behaviour of firms affected by what they believe their rivalsmight do interdependence of firms
Goods could be homogenous or highly differentiated
Branding and brand loyalty may be a potent source of competitive advantage
Non-price competition may be prevalent
Game theory can be used to explain some behaviour
AC curve may be saucer shaped minimum efficient scale
could occur over large range of output High barriers to entry
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The kinked demand curve - an explanation for price stability?Price
Quantity
D = elastic
D = Inelastic
5
100
Kinked D Curve
The principle of the kinked demandcurve rests on the principlethat:
a. If a firm raises its price, its
rivals will not follow suitb. If a firm lowers its price, its
rivals will all do the same
Assume the firm is charging a price of5 and producing an output of 100.
If it chose to raise price above 5, itsrivals would not follow suit and the firm
effectively faces an elastic demandcurve for its product (consumers would
buy from the cheaper rivals). The %change in demand would be greaterthan the % change in price and TRwould fall.
Total Revenue A
Total
Revenue B
If the firm seeks to lower its price togain a competitive advantage, its rivalswill follow suit. Any gains it makes will
quickly be lost and the % change indemand will be smaller than the %reduction in price total revenuewould again fall as the firm now facesa relatively inelastic demand curve.
Total Revenue B
Total Revenue A
The firm therefore, effectively facesa kinked demand curve forcing it tomaintain a stable or rigid pricing
structure. Oligopolistic firms mayovercome this by engaging in non-price competition.
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` Pure monopoly where onlyone producer exists in the industry
` In reality, rarely exists always
some form of substitute available!` Monopoly exists, therefore,
where one firm dominates the market` Firms may be investigated for examples of
monopoly power when market share exceeds
25%` Use term monopoly power with care!
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` Monopoly power refers to cases where firms
influence the market in some way through their
behaviour determined by the degree
of concentration in the industry Influencing prices
Influencing output
Erecting barriers to entry
Pricing strategies to prevent or stifle competition
May not pursue profit maximisation encourages unwantedentrants to the market
Sometimes seen as a case of market failure
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` Origins of monopoly: Through growth of the firm
Through amalgamation, merger
or takeover
Through acquiring patent or license
Through legal means Royal charter, nationalisation,
wholly owned plc
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` Summary of characteristics of firms exercising
monopoly power: Price could be deemed too high, may be set to
destroy competition (destroyer or predatory pricing),price discrimination possible.
Efficiency could be inefficient due to lack of
competition (X- inefficiency) or
x could be higher due to availability of high profits
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Costs / Revenue
Output / Sales
AC
MC
ARMR
AR (D) curve for a monopolistlikely to be relatively priceinelastic. Output assumed tobe at profit maximising output(note caution here not allmonopolists may aimfor profit maximisation!)
Q1
7.00
3.00
MonopolyProfit
Given the barriers to entry,the monopolist will be able toexploit abnormal profits in thelong run as entry to themarket is restricted.
This is both the short run andlong run equilibrium positionfor a monopoly
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MonopolyCosts / Revenue
Output / Sales
AC
MC
ARMR
Welfareimplications ofmonopolies
A look back at the diagram forperfect competition will revealthat in equilibrium, price will be
equal to the MC of production.
We can look therefore at acomparison of the differencesbetween price and output in acompetitive situation comparedto a monopoly.
Q1
3
The price in a competitivemarket would be 3 withoutput levels at Q1.
Q2
7The monopoly price would be7 per unit with output levelslower at Q2.
On the face of it, consumersface higher prices and less
choice in monopoly conditionscompared to more competitiveenvironments.
Loss of consumersurplus
The higher price and loweroutput means that consumersurplus is reduced, indicated by
the grey shaded area.
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MonopolyCosts / Revenue
Output / Sales
AC
MC
ARMR
Welfareimplications ofmonopolies
Q1
3
Q2
7The monopolist will beaffected by a loss of producersurplus shown by the grey
triangle but..
The monopolist will benefitfrom additional producersurplus equal to the grey
shaded rectangle.Gain in producersurplus
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` Final reminders:` Models can be used as a comparison they are not necessarily meant to
BE reality!
` When looking at real world examples, focus on the behaviour of the firm inrelation to what the model predicts would happen that gives the basis for
analysis and evaluation of the real world situation.` Regulation or the threat of regulation may well affect
the way a firm behaves.
` Remember that these models are based on certain assumptions in thereal world some of these assumptions may not be valid, this allows us todraw comparisons and contrasts.
`
The way that governments deal with firms may be based on a generalassumption that more competition is better than less!