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Chapter 6: Market Structure

Brickley, Smith, and Zimmerman, Managerial Economics and

Organizational Architecture, 4th ed.

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Market structureobjectives

• Students should be able to

• Differentiate among the four archetypal market structures

• Distinguish between price takers and price searchers

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Market structure

• What is a market?• All firms and individuals willing and able to

buy or sell a particular product

• What is market structure?• Defined by attributes of the market

environment

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Market structurethe archetypes

• Perfect competition

• Monopoly

• Monopolistic competition

• Oligopoly

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Perfect competitioncharacteristics

• Many buyers and sellers

• Product homogeneity

• Low cost and accurate information

• Free entry and exit

• Best regarded as a benchmark

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Firm demand curveperfect competition

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Firm supply

• Short run– Marginal cost curve above average

variable cost– P* = SRMC

• Long run– Long-run marginal cost curve

above long-run average cost

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The firm’s short-run supply curve

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The firm’s long-run supply curve

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Competitive equilibrium

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Barriers to entry

Incumbent reactions

• Specific assets• Economies of scale• Excess capacity• Reputation effects

Incumbent advantages• Precommitment

contracts• Licenses and patents• Learning-curve effects• Pioneering brand

advantages

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Monopoly

• Strong barriers to entry single supplier

• Profit maximization– faces market demand and sets MR=MC

• Unexploited gains from trade

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Monopolist faces market demand

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Monopolistic competition

• Multiple firms produce similar products

• Firms face downsloping demand curves

• Profit maximization occurs where MC=MR

• In the limit, firms compete away economic profits

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Monopolistic competitor in the long run

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Oligopoly

• A few firms produce most market output

• Products may or may not be differentiated

• Effective entry barriers protect firm profitability

• Firm interdependence requires strategic thinking

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The Nash equilibrium

• An oligopolist does the best it can, given expectations of rival behavior

• Behaviors are noncooperative• Duopolists considering a low price or a

high price must consider rival’s response

• Nash equilibrium occurs when each firm does the best it can given rival’s actions

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Determining the Nash equilibrium

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The Cournot model• Duopolists A and B face industry demand

P=100-Q, Q=QA+QB

• Each firm takes the other’s output as fixed

E.g., PA=(100-QB*)-QA

• Marginal revenue for A is

MRA=(100-QB*)-2QA

• If MC=0, profit is maximized if

QA=50-.5QB, which is reaction function

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Cournot equilibrium

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Comparison of prices and outputamong different equilibria

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The classic prisoners’ dilemma

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The cartel’s dilemma