Market Structures and Firm Behavior

1
Market Structures and Firm Behavior
2
Barriers to Entry

• What is an entry barrier?
• Wall or Hurdle
• Factors that hinder or foreclose entry into a
  market by another firm
• Walls Insurmountable barriers
• Patents
• Resource Control

3
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

4
Alternative Monopoly Behavior

• Price Discrimination
• 1st Degree Perfect Price Discrimination
• 2nd Degree Two-Part Pricing
• 3rd Degree Market Segmentation
• Monopolistic Competition
• Is it Monopoly or Competition?
• Tangency Solution
• Efficiency?

5
Monopolistic Competition

• What is it?
• Conditions
• Many Buyers, Many(?) Sellers
• Free Entry/Exit
• Full Information
• Differentiated Products
• Not Price Taking Behavior
• Long Run PLRAC, PgtLRMC

6
Evaluating Monopolies

• Effects on Consumer Surplus

Price
MC
Pm
Pc
D
MR
Quantity
Qm
Qc
7
Price Discrimination
Price
MC
Pm
Pc
D
MR
Quantity
Qm
Qc
8
Monopolistic Competition The Tangency Solution
Price
MC
LRAC
Pm
Pc
D
MR
Quantity
Qm
Qc
9
Oligopoly

• Putnam Do you have a suggestion for me?
• Crandall Yes, I have a suggestion for you.
  Raise your _at__at__at_ fares 20 . Ill raise mine the
  next morning.
• Putnam Robert, we . . .
• Crandall Youll make more money and I will too.
• Putnam We cant talk about pricing.
• Crandall Oh, _at__at_ Howard. We can talk about
  any _at_ thing we want to talk about.

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Oligopoly

• Key feature of this type of market Mutual
  Interdependence
• Price or output choices made by one firm affects
  the profits of all firms
• This produces
• Strategic Interaction Taking the reaction of
  other firms into account when making decisions
• Compare this to the behavior of both monopolies
  and firms in competitive markets

11
Oligopoly

• Characterizing the market
• Buyers are Price Takers
• Sellers are Price Makers
• Sellers behave strategically
• Entry Conditions Variable (from blocked entry
  to free entry)
• Information Availability (with respect to prices
  and available alternatives

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Cartels

• What is a Cartel?
• An agreement by which suppliers join to restrict
  output and raise price and profits
• Examples
• U.S.
• NCAA
• Agricultural Marketing Orders
• World
• Diamond Market
• Oil Market (?)
• Internal Problems Cheating
• External Problems Entry
• Laws against cartel formation

13
Oligopoly Models

• Duopoly models illustrating some of the
  principles of oligopoly behavior
• Simple framework
• Two sellers in the market
• Entry is blocked
• Homogeneous Products
• Identical constant (marginal) costs
• Strategic decisions based upon output choice

14
Duopoly Models

• Compare with Perfect Competition, Monopoly
• Equilibrium outcomes
• Cartel
• Self-enforcing agreement
• Tacit agreement
• Best Response a decision makers best course of
  action, given what other decision makers are
  doing.

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Equilibrium Concepts

• Nash Equilibrium This is the outcome in which
  every player is acting optimally, and rationally
  in their own self interest. In this context, it
  is in choosing the strategy that maximizes its
  profit, given the strategies of the other firm.
  No player can do better than this by a unilateral
  change in their strategy. This has to be
  self-enforcing to be viable.

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Equilibrium Concepts

• Cournot Equilibrium In the context of the
  model set out here, this is the choice of output
  that yields a Nash equilibrium.
• That is, it is the firms choice of output that
  maximizes its profits given the output level that
  the other firm is producing.

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An Example

• To illustrate some of these principles, let us
  consider an example a duopoly consisting of two
  airlines AirLion and Beta Air
• The conditions are those set out earlier
• Two sellers in the market
• Entry is blocked
• Homogeneous Products
• Identical constant (marginal) costs
• Strategic decisions based upon output choice
• There is a market demand that is satisfied by the
  two firms.

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An Example, cont.

• Call this demand, D(p) (an inverse demand
  relationship).
• Each firm has a demand based upon the production
  decision of the other firm

Market Demand
Price
260
205
115
D(p)
Quantity
450
200
850
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Residual Demand
Price
AirLionS demand, given that Beta Air produces
200 seats
260
205
115
D(p)-200
Quantity
250
650
20
Residual Demand
Price
AirLionS demand, given that Beta Air produces
200 seats, shifts by 50 when Beta increases to
250 seats.
260
240
205
50 seats
115
Quantity
250
650
D(p)-250
This process would vary as Betas output varies.
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Residual Demand
Price
AirLionS Demand, given that Beta Air produces
200 seats
260
D(p)-200
205
115
MCAirLion
MR
Quantity
Q
250
650
Profit maximizing Quantity for AirLion when Beta
produces 200 seats
22
Best Response Curve

• For each output level that Beta produces there is
  a profit maximizing output level for AirLion,
  based upon its residual demand, and the marginal
  costs that it faces.
• This output level is AirLions Best Response.
• If these best response outputs are plotted, this
  produces a Best Response or Reaction curve.
• There is a curve like this for each firm.

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Best Response Curves
Betas Output
AirLions Best Response curve
240
AirLions Output
290
24
Best Response Curves
Betas Output
AirLions Best Response curve
240
Betas Best Response Curve
AirLions Output
290
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Cournot Equilibrium
Betas Output
AirLions Best Response curve
Where the two reaction curves intersect, this is
the Cournot (Nash) Equilibrium
Betas Best Response Curve
E
AirLions Output