Market Structure & Market Conduct

AG BM 102

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

Market Models Summary

• With same curves, very different solution with pure competition, monopoly, and monopsony

• Monopolies overcharge

• Monopsonies hold prices down

Elements of market structure

• Seller concentration – concentration ratio – market share by n leading firms, n= 4, 8, 20, 50

• Lots of ways for this to vary – Four equal firms– One big, three smaller– Two big, two smaller – beef packing, poultry

Elements of market structure

• Product differentiation– Commodity vs differentiated products– Is this a product where people like to

experiment? – wine– Is this a major purchase - automobile

Barriers to entry

• Product differentiation• Large initial investment• Control of raw materials• Can you start small and expand later?• Do established firms have cost advantages?• Will established firms fight back?• If things don’t work can you salvage your

investment?

Elements of market structure

• Buyer concentration

• Economies of scale

• Multi-plant economies of scale

• Height of fixed costs & barriers to exit

• Growth in market demand– Growing market is easier to enter– This usually does not mean food

Comments about structure

• Structure > conduct > performance

• How the market is organized affects choices

• Some structures have a lot of market power

• Monopolies & monopsonies

• Oligopoly – a few big sellers – most industries

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

Areas of Market Conduct

1. Setting Quality

2. Setting Prices

3. Discouraging new entrants or coercing rivals

Monopolistic competition

• Small firms

• Easy entry

• Differentiated product

• Differentiated product lets firms set prices

• Ease of entry means new competition erodes profits – pizza shops

• Lots of coming and going

Oligopoly

• A few big firms – known competitors

• Some control over own destiny

• Prisoner’s dilemma

Prisoner’s dilemma

Firm A large Q Firm A small Q

Firm B large Q Losses for both B makes some money, A loses money

Firm B small Q A makes some money, B loses money

Large profits for both

Prisoner’s dilemma

• If firms conspire they can do well

• If we can keep them apart, we are better off

• Airlines

• Archer Daniels Midland- lysine

Kinked Demand Curve

• A few firms

• Two demand curves – one if everyone does same thing

• The other if you change and they stay the same

Kinked Demand

• On D1, you change price, everyone else does too

• On D2, you change price no one follows

• When you lower price, D1 prevails – everyone else lowers price

• When you raise price, D2 prevails – no one else raises price

• Result prices rarely change

Kinked Demand

• Since prices can’t change, firms lose more and more money as costs go up

• Firms need to try something else

• Government won’t let them get together and talk

Cartels

• OPEC – Organization of Petroleum Exporting Countries

• Try to restrict supply and keep prices up – sometimes works

• Act jointly like a monopolist

• Requires a lot of discipline

• Medellin Cocaine Cartel – enforcement mechanism

Price Leadership

• February 2003 – Airlines tried to raise fares – Northwest wouldn’t follow – plan failed – few days later smaller increase

• Some firm is accepted as price leader

• They announce increase – everyone else expected to follow promptly

• If not, price war

• Steel, interest rates

Oligopoly

• Hard to work things out

• Kinked demand is trap

• Cooperation is illegal

• Lots of different outcomes

Product differentiation

• Way of competing besides price

• Food industry has a lot of this

• Hard to duplicate competitor’s success

• Coke & Pepsi

Coercion

• Predatory pricing – set prices to drive out rival

• Entry deterrence – act to keep potential rivals out

Conduct

• Structure > Conduct > Performance

• Structure defines choices

• Some industries deal with them better than others

• Oligopoly especially problem for participants