4. Market Structures

1
4. Market Structures
2
The Degree of Competition

• Classifying markets
• number of firms
• freedom of entry to industry
• nature of product
• nature of demand curve
• The four market structures
• perfect competition
• monopoly
• monopolistic competition
• oligopoly
• Structure ? conduct ? performance

3
Perfect Competition

• Assumptions
• firms are price takers
• freedom of entry
• identical products
• perfect knowledge
• Short-run equilibrium of the firm
• price, output and profit
• The short-run supply curve of the firm

4
Short-run equilibrium of industry and firm under
perfect competition

P
O
O
Qe
Q (thousands)
Q (millions)
(a) Industry
(b) Firm
5
Perfect Competition

• Assumptions
• firms are price takers
• freedom of entry
• identical products
• perfect knowledge
• Short-run equilibrium of the firm
• price, output and profit
• The short-run supply curve of the firm

6
Deriving the short-run supply curve
P

S
D1 MR1
D2 MR2
D3 MR3
O
O
Q (thousands)
Q (millions)
(a) Industry
(b) Firm
7
Perfect Competition

• Long-run equilibrium of the firm
• all supernormal profits competed away
• LRAC AC MC MR AR

8
Long-run equilibrium under perfect competition
Profits return to normal
Supernormal profits
New firms enter
P

O
O
QL
Q (thousands)
Q (millions)
(a) Industry
(b) Firm
9
Long-run equilibrium of the firm under perfect
competition

O
Q
10
Perfect Competition

• Long-run equilibrium of the firm
• all supernormal profits competed away
• LRAC AC MC MR AR
• Incompatibility of economies of scale with
  perfect competition

11
Monopoly

• Defining monopoly
• Barriers to entry
• economies of scale
• product differentiation and brand loyalty
• lower costs for an established firm
• ownership/control of key factors
• ownership/control over outlets
• legal protection
• mergers and takeovers
• aggressive tactics
• intimidation

12
Monopoly

• The monopolists demand curve
• downward sloping
• MR below AR
• Equilibrium price and output
• Equilibrium output, where MC MR

13
Profit maximising under monopoly

Qm
O
Q
14
Monopoly

• The monopolists demand curve
• downward sloping
• MR below AR
• Equilibrium price and output
• Equilibrium output, where MC MR
• Equilibrium price, found from demand curve

15
Profit maximising under monopoly

MC
MR
Qm
O
Q
16
Monopoly

• The monopolists demand curve
• downward sloping
• MR below AR
• Equilibrium price and output
• Equilibrium output, where MC MR
• Equilibrium price, found from demand curve
• Profit
• Measuring profit

17
Profit maximising under monopoly

MC
MR
Qm
O
Q
18
Monopoly

• The monopolists demand curve
• downward sloping
• MR below AR
• Equilibrium price and output
• Equilibrium output, where MC MR
• Equilibrium price, found from demand curve
• Profit
• Measuring profit
• Supernormal profit can persist in long run

19
Monopoly

• Disadvantages of monopoly
• high prices / low output short run

20
Equilibrium of industry under perfect
competition and monopoly with the same MC curve

Monopoly
Q1
O
Q
21
Equilibrium of industry under perfect
competition and monopoly with the same MC curve

MC ( supply under perfect competition)
Comparison with Perfect competition
P1
AR D
MR
Q1
Q2
O
Q
22
Monopoly

• Disadvantages of monopoly
• high prices / low output short run
• high prices / low output long run

23
Monopoly

• Disadvantages of monopoly
• high prices / low output short run
• high prices / low output long run
• lack of incentive to innovate

24
Monopoly

• Disadvantages of monopoly
• high prices / low output short run
• high prices / low output long run
• lack of incentive to innovate
• X-inefficiency

25
Monopoly

• Disadvantages of monopoly
• high prices / low output short run
• high prices / low output long run
• lack of incentive to innovate
• X-inefficiency
• Advantages of monopoly

26
Monopoly

• Disadvantages of monopoly
• high prices / low output short run
• high prices / low output long run
• lack of incentive to innovate
• X-inefficiency
• Advantages of monopoly
• economies of scale

27
Monopoly

• Disadvantages of monopoly
• high prices / low output short run
• high prices / low output long run
• lack of incentive to innovate
• X-inefficiency
• Advantages of monopoly
• economies of scale
• profits can be used for investment

28
Monopoly

• Disadvantages of monopoly
• high prices / low output short run
• high prices / low output long run
• lack of incentive to innovate
• X-inefficiency
• Advantages of monopoly
• economies of scale
• profits can be used for investment
• high profits encourage risk taking

29
Monopoly

• Contestable markets
• importance of potential competition
• a perfectly contestable market
• contestable markets and natural monopolies
• importance of costless exit
• Contestable markets and the public interest

30
Monopolistic Competition

• Assumptions of monopolistic competition
• Equilibrium of the firm
• short run

31
Short-run equilibrium of the firmunder
monopolistic competition

O
Q
32
Monopolistic Competition

• Assumptions of monopolistic competition
• Equilibrium of the firm
• short run
• long run

33
Long-run equilibrium of the firmunder
monopolistic competition

O
Q
34
Monopolistic Competition

• Assumptions of monopolistic competition
• Equilibrium of the firm
• short run
• long run
• underutilisation of capacity in the long run

35
Long run equilibrium of the firm under perfect
andmonopolistic competition

LRAC
P1
DL under monopolistic competition
O
Q1
Q
36
Monopolistic Competition

• Assumptions of monopolistic competition
• Equilibrium of the firm
• short run
• long run
• underutilisation of capacity in the long run
• Non-price competition

37
Monopolistic Competition

• Assumptions of monopolistic competition
• Equilibrium of the firm
• short run
• long run
• underutilisation of capacity in the long run
• Non-price competition
• The public interest

38
Monopolistic Competition

• Assumptions of monopolistic competition
• Equilibrium of the firm
• short run
• long run
• underutilisation of capacity in the long run
• Non-price competition
• The public interest
• comparison with perfect competition

39
Monopolistic Competition

• Assumptions of monopolistic competition
• Equilibrium of the firm
• short run
• long run
• underutilisation of capacity in the long run
• Non-price competition
• The public interest
• comparison with perfect competition
• comparison with monopoly

40
Oligopoly

• Key features of oligopoly
• barriers to entry
• interdependence of firms
• Competition versus collusion
• Collusive oligopoly cartels
• equilibrium of the industry

41
Profit-maximising cartel

O
Q
42
Profit-maximising cartel

Industry D AR
Industry MR
O
Q
43
Oligopoly

• Key features of oligopoly
• barriers to entry
• interdependence of firms
• Competition versus collusion
• Collusive oligopoly cartels
• equilibrium of the industry
• allocating and enforcing quotas

44
Oligopoly

• Tacit collusion
• price leadership dominant firm

45
Price leader aiming to maximise profits for a
given market share

O
Q
46
Price leader aiming to maximise profits for a
given market share

MC
AR D market
AR D leader
MR leader
O
Q
47
Oligopoly

• Tacit collusion
• price leadership dominant firm
• price leadership barometric

48
Oligopoly

• Tacit collusion
• price leadership dominant firm
• price leadership barometric
• rules of thumb

49
Oligopoly

• Factors favouring collusion
• Few firms
• Open with each other
• Similar production methods and average costs
• Similar products
• Dominant firm
• Significant entry barriers
• Stable market
• No government measures to curb collusion

50
Oligopoly

• The breakdown of collusion
• Non-collusive oligopoly game theory
• alternative strategies maximax and maximin
• simple dominant strategy games

51
Profits for firms A and B at different prices
Xs price
2.00
1.80
A
B
5m for Y 12m for X
2.00
10m each
Ys price
D
C
12m for Y 5m for X
1.80
8m each
52
Oligopoly

• The breakdown of collusion
• Non-collusive oligopoly game theory
• alternative strategies maximax and maximin
• simple dominant strategy games
• the prisoners dilemma

53
The prisoners' dilemma
Amanda's alternatives
Not confess
Confess
A
B
Nigel gets 10 years Amanda gets 3 months
Not confess
Each gets 1 year
Nigel's alternatives
D
C
Nigel gets 3 months Amanda gets 10 years
Each gets 3 years
Confess
54
Oligopoly

• The breakdown of collusion
• Non-collusive oligopoly game theory
• alternative strategies maximax and maximin
• simple dominant strategy games
• the prisoners dilemma
• more complex non-dominant strategy games

55
Oligopoly

• Non-collusive oligopoly the kinked demand curve
  theory
• assumptions of the model

56
Kinked demand for a firm under oligopoly

Current price and quantity give one point on
demand curve
Q
O
57
Kinked demand for a firm under oligopoly

D
P1
D
Q
O
Q1
58
Oligopoly

• Non-collusive oligopoly the kinked demand curve
  theory
• assumptions of the model
• stable prices

59
Kinked demand for a firm under oligopoly

P1
D
Q
O
Q1
60
Oligopoly

• Non-collusive oligopoly the kinked demand curve
  theory
• assumptions of the model
• stable prices
• limitations of the model

61
Oligopoly

• Non-collusive oligopoly the kinked demand curve
  theory
• assumptions of the model
• stable prices
• limitations of the model
• Oligopoly and the public interest

62
Oligopoly

• Non-collusive oligopoly the kinked demand curve
  theory
• assumptions of the model
• stable prices
• limitations of the model
• Oligopoly and the public interest
• advantages

63
Oligopoly

• Non-collusive oligopoly the kinked demand curve
  theory
• assumptions of the model
• stable prices
• limitations of the model
• Oligopoly and the public interest
• advantages
• disadvantages

64
Oligopoly

• Non-collusive oligopoly the kinked demand curve
  theory
• assumptions of the model
• stable prices
• limitations of the model
• Oligopoly and the public interest
• advantages
• disadvantages
• difficulties in drawing general conclusions

65
Price Discrimination

• Meaning of price discrimination
• First degree
• Second degree
• Third degree (the most common form)
• Conditions necessary for price discrimination
• Advantages to the firm

66
Third-degree price discrimination
P
Revenue from a single price
Q
O
67
Third-degree price discrimination
P
Increased revenue from price discrimination
A higher discriminatory price is now introduced
P1
D
Q
O
200
68
Price Discrimination

• Profit maximising prices and output under price
  discrimination
• Price discrimination and the public interest
• competition
• profits

69
Profit-maximising output underthird degree price
discrimination
DX
O
O
O
MRX
(a) Market X
70
Profit-maximising output underthird degree price
discrimination
DY
DX
MRY
O
O
O
MRX
(b) Market Y
(a) Market X
71
Profit-maximising output underthird degree price
discrimination
DY
DX
MRY
MRT
O
O
O
MRX
(c) Total (markets X Y)
(b) Market Y
(a) Market X
72
Profit-maximising output underthird degree price
discrimination
MC
DY
DX
MRY
MRT
O
O
O
MRX
(c) Total (markets X Y)
(b) Market Y
(a) Market X
73
Profit-maximising output underthird degree price
discrimination
MC
DY
DX
MRY
MRT
O
O
O
3000
MRX
(c) Total (markets X Y)
(b) Market Y
(a) Market X
74
Profit-maximising output underthird degree price
discrimination
MC
5
DY
DX
MRY
MRT
O
O
O
3000
MRX
(c) Total (markets X Y)
(b) Market Y
(a) Market X
75
Profit-maximising output underthird degree price
discrimination
MC
5
DY
DX
MRY
MRT
O
O
O
1000
3000
MRX
(c) Total (markets X Y)
(b) Market Y
(a) Market X
76
Profit-maximising output underthird degree price
discrimination
MC
5
DY
DX
MRY
MRT
O
O
O
1000
2000
3000
MRX
(c) Total (markets X Y)
(b) Market Y
(a) Market X
77
Profit-maximising output underthird degree price
discrimination
MC
9
5
DY
DX
MRY
MRT
O
O
O
1000
2000
3000
MRX
(c) Total (markets X Y)
(b) Market Y
(a) Market X
78
Profit-maximising output underthird degree price
discrimination
MC
9
7
5
DY
DX
MRY
MRT
O
O
O
1000
2000
3000
MRX
(c) Total (markets X Y)
(b) Market Y
(a) Market X
79
Price Discrimination

• Profit maximising prices and output under price
  discrimination
• Price discrimination and the public interest
• competition

80
Price Discrimination

• Profit maximising prices and output under price
  discrimination
• Price discrimination and the public interest
• competition
• profits