Econ 3125

1
Chapter 12
2
Porter's Five Forces
Entry
Internal Rivalry
SupplierPower
Buyer Power
Substitutes Complements
3
Industry Concentration

• Concentration ratio measures market share of the
  largest companies in the industry
• Available for 4, 8 and 20 companies
• Market structures

4
Sample Concentration Ratios
5
Concentration Ratios' Limitations

• Ratios are defined for relevant product groups
  and markets
• Actual markets depend vary geographically (e.g.
  haircuts v. motor vehicles manufacturing)
• Industry groupings can produce heterogeneous
  products
• Consumer drugs have low concentration but
  specific drugs are highly concentrated
• Imports decrease concentration but they are
  excluded from the calculations
• Sales are less concentrated than production

6
Concentration Supports High Prices

• The smaller the number of firms, the more likely
  they will cooperate implicitly to maintain higher
  prices
• Data supports the hypothesis that higher
  concentration is associated with higher prices
• An alternative viewpoint is that highly
  concentrated industries could be caused by
  greater efficiencies which would decrease prices
  for consumers e.g., Wal-Mart)
• Tight oligopolies could have both higher profit
  levels and lower prices if they are more efficient

7
Airfare Pricing

• Average fares on point-to-point routes decrease
  as the number of carriers increases
• US deregulation began in 1978
• Carriers on each route increased by about 1/3
• In the first 10 years, fares decreased 20
• Continued decline since then
• Mergers and hub system decreases competition on
  many routes
• Fares at hubs dominated by one carrier are 20
  higher than comparable routes
• Presence of discount carrier on a route decreases
  price 30 50

8
Airfare Pricing Less Competitive Abroad

• National carriers protected from competition
• Landing slots limited
• Smaller number of carriers with higher prices
• Fare structure
• High intra-national fares in Europe
• Somewhat lower intra-Europe fares
• Competitive international fares
• Airport operating costs are up to 40 higher than
  in US
• Low labor productivity, high costs
• High concentration high fares

9
Quantity Competition the Dominant Firm

• Industry model 1 dominant firm, several small
  firms
• Dominant firm sets P for industry
• Small firms take P as given and supply
  accordingly
• Dominant firm supplies remainder of market

10
Dominant Firm Model
Industry demand

SS
Supply curve for small firms
D
Supplied by small firms
Supplied by dominant firm
Output
11
Dominant Firm Model
P0
Supplied by dominant firm
12
Dominant Firm Model
P1
Supplied by small firms
Supplied by dominant firm
13
Dominant Firm Model
P1
P0
Supplied by dominant firm
14
Dominant Firm Model
P2
Supplied by dominant firm
Supplied by small firms
15
Dominant Firm Model
P1
P0
P2
Supplied by dominant firm
16
Dominant Firm Model
P1
P0
P2
Demand curve for dominant firm
DD
17
Dominant Firm Model
MCD
P
Supplied by dominant firm
DD
Supplied by small firms
MRD
18
Duopoly Competing on Quantity

• Two identical suppliers, Firm 1 and Firm 2
• MC 6
• Demand P 30 (Q1 Q2)
• Firm 1's view P (30 Q2) Q1

19
Duopoly

• Firm 1 maximizes profits in the usual way
• Decision rule MC1 MR1
• MC 6
• MR comes from the demand curve
• P (30 Q2) Q1
• MR1 dTR1 / dQ1 (30 Q2) 2 Q1
• Use the decision rule
• 6 (30 Q2) 2 Q1
• 2 Q1 30 Q2 6
• 2Q1 24 Q2
• Q1 12 0.5 Q2

20
Duopoly

• Firm 1 Firm 2
• Q1 12 0.5 Q2 Q2 12 0.5 Q1
• Solve for Q1 by substituting for Q2 in the first
  equation
• Q1 12 0.5 Q2
• Q1 12 0.5 (12 0.5 Q1)
• Q1 12 6 0.25 Q1
• 0.75 Q1 6
• Q1 8
• Since the firms are the same, Q2 8

21
Duopoly

• Q1 Q2 8 so industry output, Q 16
• To find the market price,
• P (30 Q2) Q1 30 16 14
• Profits for each firm are
• ? TR TC
• ? 8 (14) 8 (6)
• ? 8 (8) 64

22
Problem 4

• The small firm supply is the horizontal sum of
  the marginal cost curves of the four small firms
• MC 6 QF
• where QF is the quantity supplied by a single
  small firm.
• Let QS quantity supplied by small firms
• See Check Station 2, Chapter 10, page 407 to
  finish the problem.

23
Problem 4

• Part b asks you to find the demand curve for the
  dominant firm
• Review the series of slides on this topic from 11
  April
• Pick a price and work the solution
• Repeat until you get an understanding of how to
  translate industry demand and the supply of the
  small firms to write the demand for the dominant
  firm
• HINT when you get stuck with a problem, look at
  it very specifically until you can generalize

24
Oligopoly Competing on P

• Fundamental assumptions
• If a company increases its price, no one follows
• If a company lowers its price, everyone follows

25
Oligopoly Competing on P

• The implications are
• Above current price, demand is relatively elastic
• Raising price causes the firm to lose market
  share to competitors
• Below current price, demand is relatively
  inelastic
• Lowering price causes competitors to follow and
  only a small gain in customers is realized
• Small changes in MC do not change Q or P

26
Oligopoly Competing on P
27
Prisoner's Dilemma

• 2 criminals participated in the same crime
• When arrested, they have the same choices
• If neither confesses, each gets 2 years in jail
• If one implicates the other, his sentence is 1
  year and his colleague gets 8 years
• If both confess, each gets 5 years
• No communication or cooperation between criminals
  is allowed
• Best outcome is if neither confesses
• Equilibrium outcome is both confess

28
Company's Dilemma

• Two companies with the same marginal costs must
  decide whether to charge a high price or a low
  price
• No cooperation or collusion allowed
• Payoff matrix
• Cell shows firm 1's profit, firm 2's profit

29
Duopoly Price Competition

• Two suppliers have undifferentiated products and
  the same MC
• Consumers buy only from the supplier with the
  lower price
• Higher priced firm sells nothing
• Similar to bidding for contract
• Equilibrium outcome is P MC