Market Structures Recap Lecture (FLT) 2

7/27/2019 Market Structures Recap Lecture (FLT) 2

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Focused Learning Time

REVISION SERIES


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PJL


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SSSSPPPPEEEECCCCTTTTRRRRUUUUMMMMof competition

Perfect

Competition

MonopolyMonopolistic

Competition

Oligopoly

Degree of competition


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Structure

Conduct

Performance

influences

influences


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StructureKnowledgeof product

Nature ofproduct

Number ofsellers

Barriers toentry


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Features PerfectCompetition MonopolisticCompetition Oligopoly Monopoly

Number ofsellers

Many smallfirms, each withinsignificant

market share

Many smallfirms, each withinsignificant

market share

Few dominantand mutually

interdependentfirms, whotogether control

a significantportion of

market share

Single seller

Barriers toentry

No barriers toentry

Very lowbarriers to

entry

High barriers toentry

Very highbarriers to

entry

Type ofproduct

Homogeneousproducts

Differentiatedproducts

Usuallydifferentiatedproducts

Unique productwith no closesubstitutes

Knowledgeof product

Perfectknowledge

Imperfect knowledge


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Barriers to entry

Artificial Natural Very huge sunk costs

relative to mkt demand

natural monopoly

Exclusive control ofessential raw materials

Contrived barriers (e.g., cartel,mergers and acquisitions)

Legal barriers (e.g., patents,copyrights, tariffs)

Price war

Non-price competition

- Product differentiation- Advertising

anything that prevents or impedes the entry of firms intoan industry and thereby limits the amount of competition

faced by existing firms


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Reminder for Perfect Competition

Individual firms can sell all they want at the prevailing

market price, P*

P

Qty

Industry (Market)

P

Qty

Individual Firm

Mkt Ss

Mkt Dd

Price determined by mkt

Individual firms musttake the mkt price

Indvs Dd

P*P*


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Reminder for Monopolistic CompetitionReminder for Monopolistic CompetitionReminder for Monopolistic CompetitionReminder for Monopolistic Competition

No market demand curve

Firms have some degree ofmonopoly power over itsproducts

Contingent on productdifferentiation

Non-price competition


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Reminder for Monopoly

Firms DD curve =Industry DD curve

Contingent on the

maintenance of barriersto entry

Monopoly can influenceeitherprice oroutput, butnot both


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Something to Think AboutType of market structure depends on

definition of industry

EXAMPLE:

Restaurants

Restaurants in Vivocity Spanish restaurant in Vivocity


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ConductOthers (e.g., price

discrimination)

Non-pricecompetitionPricecompetition


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Conduct of PC Firm If firm sells its goods above the set

market price, consumers will simplybuy from any other firm

No incentive to lower price either,

since the seller can sell all hewants at the prevailing market price

Therefore, no price competition

Also no non-price competitioneither, since homogeneous product


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Conduct of Monopolistic Competition

Tend to avoid price competition

prices cannot be cut indefinitely +potential gain in market share issmall + no supernormal profits to

fall back on

Prefer non-price competition product promotion + product

development

Degree of non-price competition will

be less than oligopoly


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Product Differentiation Real physical differences

Imaginary differences

Different conditions of sale

LN P14


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Product Differentiation Increase demand

Demand more price inelastic

GIVE MEMORE!!!!!

I only want

this!!!!!


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Conduct of Oligopoly

Collusive

model

Competitive

model

VS


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CollusionCartel Price leadership

DominantPrice

Leadership

BarometricLeadership

formal informal/tacit

Act as one to determineprice by controllingcombined output

Predetermined market share

Incentive to cheat

Reduceunpredictability of

rivals reactions


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CompetitionKinked Demand Curve

D = AR

Quantity

MR

Firm will not match each others priceincrease perceive a price elasticdemand

Firms will match each othersprice reduction perceive a priceinelastic demand

Region ofindeterminacy

Price


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D = AR

Quantity

Price

MR

Should MC fluctuate within thisregion, firm will absorb higher

costs same profit-maximising level

Significance of regionof indeterminacy

MC1

MC3MC2

Q*


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Offers some insight as to why prices inoligopoly tend to be rigid (sticky)

However,

Model does not explain how the prices are set inthe first place

Price stability could be due to other factors

Menu costs

Fear of harming firms image


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Other Points to Note Degree of non-price competition

distinguishes oligopolies and MPC firms

- Real incentives for oligopolies compete

extensively using non-price competition potentially huge profits!

Behaviour of oligopolies maychange quite radically over time


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Conduct of Monopoly Monopoly will strive to

maintain its barriers to entry(e.g., through advertising,legal protection, R&D)

Price discrimination


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PriceDiscrimination


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Price discrimination occurs when

Same commodity at differentprices

For reasons other than differencesin cost of production

Examples:Different bus fares for adults and kids

Different movie prices for weekends

Definition

LN P21


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Definition

Price discrimination is nota resultof differences in cost of production

Price differentiation:

$2 chicken rice at hawker centre

vs

$3 chicken rice at foodcourt


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Market power

Market segmentation (no resale)

Each market has different PED

Conditions


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Charge the maximum price thecustomer is willing and able to

pay for each unit bought(reservation price)

aka perfect price discrimination Dd curve is now new MR curve incremental revenue earned from each additional unit is

simply the price paid for that unit

First Degree P.D.


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First Degree P.D.

7

MR = Dd

Price

Qty

1 2 3

8

6

Firm can capture all of theconsumer surplus if o/pis divisible into infinitelysmall units


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Evaluation

In practice, almost impossible impractical

unknown reservation price

First Degree P.D.


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Charge different prices fordifferent blocks of the same

good according to how muchconsumer purchases

aka block pricing

Second Degree P.D.


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Second Degree P.D.

7

AR = Dd

Price

Qty

100 200 300

8

6

Additional revenue bythe monopoly = loss ofconsumer surplus


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Third Degree P.D.

Charge different prices for samegood according to different buyers

Higher price charged in market withmore price inelastic demand curve

Distribute o/p in each market suchthat MC = MR = same in both markets


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Third Degree P.D.

Market X Market Y Market X + Y

Price Price Price

Qty Qty Qty

9

7

5Dx Dy

MRTotal

MRx MRy

MC

1000 2000 3000

5 5

Note: higher price charged in the market with the less price elastic demand curve

Horizontal summation


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Oligopolist, arguably, will

engage in greater degreeof non-price

competition, as there is apossibility of capturing asignificant share of the

market (unlike themonopolisticallycompetitive firm)

ConductBecause of the mutual

interdependence of firms,oligopolists may choose

collude, compared to othermarket structures where such

conduct is unlikely.

Because of differentfeatures of the market

structures, firms in each ofthese markets maybehave differently

Both oligopolists andmonopolistically

competitive firms are likelyto avoid price

competition in favour ofnon-price competition


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Performance

EfficiencyPrice and

output levels

Profitability

EquityInnovationConsumer

Choice

Allocativeefficiency

Productiveefficiency

X-inefficiency

SR LR


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Profitability

Firms in all 4 market structures can earnsupernormal, normal and subnormalprofits in the SR

Firms in all 4 market structures earn atleast normal profits in the LR (i.e., cannot

make subnormal profits in the LR) Oligopolists and monopolists can earn

supernormal profits in the LR


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MC = MR

If MC < MRthe addition of the last unit of output

adds more to total revenue than it does to total cost

[YES! Produce that last unit]

If MC > MR

the addition of the last unit of output

adds more to total cost than it does to total revenue

[NO! Dont produce that last unit]

Hence, firm will product up to the point where MC = MR

Conditions for Profit-Maximisation


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MR > MC MC > MR

For a perfectly

competitive firm

DD = MR = AR

P/C/R

Q

MC

Q


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MR > MC MC > MR

For an imperfectlycompetitive firm


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SR Equilibrium In the SR, firms in all market structures

can make Supernormal profits

Normal profits Subnormal profits


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SR Equilibrium In the SR, PC firms can make

Supernormal profits

.

Price

Output0

ATC

MC

P = AR = MRP

q

AC

B

MC = MRTR = ?

TC = ?

TR > TC


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Normal profitsPrice

Output

0

ATC

MC

.

P = AR = MRP

q

B

MC = MR

TR = ?

TC = ?

TR = TC


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Subnormal profits

.

Price

Output

0

MC

.

P = AR = MRP

q

C

B

MC = MR

ATC

A

TR = ?

TC = ?

TR < TC


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SR Equilibrium In the SR, firms under imperfect market structure can make

Supernormal profits

Price

Output0

ATC

MCTR = ?

TC = ?

TR > TC

AR

MR

MC = MR

P

q

BC

A


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P

q

A

Price

Output0

TR = ?

TC = ?

TR = TC

AR

MR

MCATC

MC = MR


Normal profits


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Price

Output0

TR = ?

TC = ?

TR < TC

AR

MR

MC ATC

P

q

B

CA

MC = MR


Subnormal profits


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LR Equilibrium In the LR, PC firms can onlymake

normal profits, because of theassumption of no barriers to entry If supernormal profits are made, firms

enter the industry with ease and competein the industry supernormal profitseroded

If subnormal profits are made, firms leavethe industry with ease the remainingfirms return to normal profits


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LR EquilibriumP

Qty

Market

p

qty

Individual Firm

D

ATC

MC

d0P0 p0

S0

Q0 q0

S1

d1p1P1

Q1 q1

LN P8


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LR Equilibrium In the LR, the MPC firm can only make

normal profits Supernormal profits new firms enter

(ease of entry) Subnormal profits existing firms exit(ease of exit)


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LR Equilibrium Supernormal profits

new firms enter

potential substitutes

consumers have wider range of productsto choose from

dd falls and becomes more price elastic

for each firms product

normal profits in the LR


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LR Equilibrium In the LR, the monopoly can make

supernormal profits, as long as it isable to keep potential firms from

entering the industry In the LR, the monopoly will continue

production only if it can at least make

normal profits


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Price and Output

Compared to monopoly, PC has higheroutput and lower price

UNLESS monopoly can tap significant EOS(in which case, output may be higher, pricemay be lower)


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DD = AR

P/C/R

Q

MCMonopoly = SSPC industry

MR

QM QC

PM

PC

Assuming same cost conditions


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DD = AR

P/C/R

Q

MCMonopoly

MR

QC QM

PC

PM

Assuming different cost conditions

SSPC industry


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Efficiency

Condition: P = MC Only PC firm and monopoly that practices

perfect price discrimination is allocativelyefficient

All firms can be productively efficient if

they produce on LRAC Monopolist may be X-inefficient


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DD = AR

P/C/R

Q


MR

QM QC

PM

PC


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Equity

PC firm is equitable, since consumer andproducer surpluses are maximised

Under monopoly, part of consumer surpluslost to producer, hence inequity

Monopoly which practices perfect price

discrimination is most inequitable, since allconsumer surplus transferred to producer


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DD = AR

P/C/R

Q


MR

QM QC

PM

PC


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DD = MR

P/C/R

Q

MC Price discriminating monopoly

QM

PM


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Innovation

PC firm has neither incentive nor ability to innovate Monopoly has the ability to innovate since it can earn

supernormal profits, but level of innovation depends onthreat of potential competition

Oligopolist has greater ability and incentive to innovatethan a monopolistically competitive firm, since it canpotentially capture a significant market share

Level of innovation depends on many factors including Contestability of market

Extent and duration of government intervention

Other costs and benefits of innovation


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Consumer Choice

Homogeneous products lack of consumerchoice

Differentiated products greater consumer

choice May be a trade-off between consumer choice

and lower prices, since production of

homogenous products may allow for large scaleproduction and hence the tapping of EOS


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Performance by Industry


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Performance of PC Firm Profitability

SR: supernormal, normal and subnormal

profits LR: only normal profits

Efficiency

Allocatively efficient (P=MC)

Productively efficient (on LRAC) Equity equitable

R&D

Lack of ability: no supernormal profits in LR

Lack of incentive: others will copy (perfectknowledge)

Lack of consumer choice (homogeneous)

Performance of


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Monopolistic Competition Profitability

SR: supernormal, normal and subnormal profits

LR: can earn only normal profits Efficiency

Allocatively inefficient (P>MC)

Productively efficient (if on LRAC)

Equity

Reduced inequity as normal profits are made in the LR (i.e.,minimum necessary to keep firm in production)

R&D

No ability: no supernormal profits

Has more incentive than PC, but less than oligopoly andmonopoly

Wide consumer choice (product differentiation)

Wasteful competition (advertisement to create imaginary differences)

Performance of Oligopoly


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Performance of Oligopoly

Profitability


LR: can earn supernormal, at least normal profits Efficiency



Equity

Economies of scale (less than monopoly) can keep costs, andhence prices, low

Extensive advertising may result in higher cost and hencehigher prices

R&D Has ability: earns supernormal profits in LR

Has considerable incentive: can capture large market share

Wide consumer choice (product differentiation)


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Performance of Monopoly Profitability


LR: can earn supernormal, at least normal profits Efficiency



Could be X-inefficient

Equity inequitable as consumer surplus lost toproducer

R&D

Has ability: earns supernormal profits in LR

Incentive: depends on degree of threat ofpotential competition

Lack of consumer choice (no close substitutes)


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Loss of consumer surplus

Consumer may not have been able toafford the good if not for price

discrimination

Higher profits: for producer

for consumer if price increase

for consumer if reinvested in R&D to

improve products and lower costs in the LR

Performance of Monopolypractising price discrimination


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Producers may use high profitsfrom one market to withstandpossible price war in breaking into

another market Provision of goods that would

otherwise not be produced due tohigh costs



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Quantity

ATC

Quantit

D = MR

q

ATCTC

A

0

PricePrice

P

C

E

MCMC

TR

Quantity

MR

q

ATC

A

B

D

Quantity

MR

q

ATC

LossesLosses

AA

BB

0



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Structure

Conduct

Performance

influences

influences

Market Structures Recap Lecture (FLT) 2

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