Concentrated Markets

1
Concentrated Markets
2
Content

• Monopoly
• Oligopoly
• Price makers and price takers
• Growth of firms
• Sources of monopoly power
• Model of the monopoly
• Collusive and non collusive oligopoly
• Interdependence in oligopolistic markets
• Price discrimination
• Consumer and producer surplus
• Contestable and non contestable markets
• Market Structure, Static Efficiency, Dynamic
  Efficiency and Resource Allocation

3
Monopolies

• Monopoly this is where there is a single
  producer in the market
• Features
• One producer is able to charge relatively high
  prices
• New products are rarely introduced
• Resources are not used efficiently
• Monopolies have market power
• Monopolies are able to set prices price setters
  

4
Oligopolies

• Few firms in the market who are interdependent in
  their actions
• Firms consider competitors reactions when
  changing prices / introducing new products
• There is a high degree of competition
• Businesses try and avoid price competition
  preferring non price competition
• Products are branded and differentiated from each
  other
• Can be many take-overs
• Collusion may occur leading to cartels being
  formed

5
Price makers and price takers

• In pure monopolies the firm is a price maker as
  they are able to take the markets demand curve as
  their own
• The monopoly firm is able to set the price
  anywhere on this demand curve
• The ability of the monopoly firm to set price is
  dependent on price elasticity of the product if
  demand is elastic it will limit the firms price
  setting power

6
Price takers

• Firms in perfect competition are price takers
• All businesses have to accept the price that is
  set by the market
• Firms are not able to set their own price

7
Factors that influence the ability of a firm to
be a price maker

• Only firms in pure monopolies can be price makers
  
• This means that there must be
• Barriers to entry and exit
• Only one producer / firm in the market
• Imperfect knowledge
• In reality this is seldom the case and pure
  monopolies rarely exist

8
Factors that influence the ability of a firm to
be a price maker

• Very few markets are dominated by just one firm
  it is more likely that they are dominated by a
  few major firms who are able to act as price
  makers
• Barriers to entry do exist in many markets
  however they may be overcome in a number of ways
  including
• Takeovers from outside / inside the industry
• Growing markets
• Increased overseas competition
• Transfers of brand names between sectors of the
  economy in companies that differentiate their
  product offerings

9
Price Makers

• As pure monopolies rarely exist having one firm
  as a price maker is unlikely
• If firms are able to set prices in a market the
  extent to which they can is influenced by price
  elasticity for that market, the more inelastic
  the demand for a product the more a firm can set
  the price

10
The Growth Of Firms

• Growth is often a key objective of firms
• Business grow for a number of reasons including
• To increase profits
• To decrease costs
• To dominate the market
• To reduce risk
• To fulfil objectives of management

11
Internal and External Growth

• Businesses can choose to grow internally by
  selling more of their products or externally by
  acquiring / merging with another firm
• Internal growth is often referred to as organic
  growth
• Internal growth is slower

12
External growth - Takeovers

• Takeovers are where one firm gains control of
  another firm
• The amount a firm pays to takeover another firm
  is dependent on its perceived value
• Attacker firms often pay a premium to
  shareholders in order to secure their shares
• Bids can be hostile or welcome
• Hostile bids have a greater degree of risk

13
Mergers

• Mergers occur when at least two firms join
  together to form one organisation
• Mergers and takeovers can take the following
  forms
• Horizontal firms join together who are at the
  same stage in the production process
• Vertical firms join together who are at
  different stages in the production process
• Conglomerate firms in different markets join
  together

14
Why do firms merge ?

• Mergers and takeovers are ways for businesses to
  grow
• Firms decide to merge / take over due to synergy
• Synergy is where the performance of the new firm
  is greater than the performance of the separate
  firms
• Synergy is created by shared resources, ideas and
  skills

15
Management Buyouts

• Where managers in a business take it over by
  buying a controlling interest in its shares
• Managers may do this as they think they can turn
  the business around, or if shareholders lose
  interest in a particular part of the business
• Manager often need to borrow money to finance
  MBOs
• MBOs are risky however if successful they allow
  managers to reap plenty of rewards

16
Joint Ventures

• Joint ventures occur when two businesses set up a
  third business together to develop a new product,
  enter a new market etc
• Joint ventures are set up to achieve a specific
  objective or project for both parties
• There are benefits for both parties from these
  relationships
• Sony and Ericsson enjoyed a joint venture where
  they worked together to develop mobile phones

17
Outsourcing

• Outsourcing allows a business to contract out
  some of their operations to a third party to
  perform
• Outsourcing of production overseas has allowed
  businesses to reduce their costs e.g. call
  centres locating overseas in lower wage countries
  
• Outsourcing has been driven by technological
  change, pressure on profit and costs and an
  increase in the level of competition

18
Sources of Monopoly Power

• Monopoly power is influenced by the following
  factors
• Barriers to entry
• Number of competitors
• Advertising
• Degree of product differentiation

19
Sources of Monopoly Power

• The larger and more expensive the barriers to
  entry the greater the monopoly power
• The smaller the number of competitors in the
  market the greater the monopoly power
• The greater the advertising spend and more
  recognisable the brand name the greater the
  monopoly power
• The larger the degree of product differentiation
  the greater the extent of the monopoly power

20
The Model Of Monopoly
21
Monopoly Model

• In the monopoly model the average revenue curve
  is the same as the demand curve
• Where total revenue exceeds total costs the firm
  is able to make supernormal profits

22
Collusive Oligopoly

• Collusion occurs where the firms work together to
  reduce uncertainty in the market
• Firms may become involved in price fixing or
  cartels to act as though they are the only firm
  in the market and therefore can set prices
• This is illegal in the UK and EU

23
Price fixing and collusion

• Price fixing is where all firms in the market try
  and control supply to achieve a monopoly like
  situation
• For this to happen producers need to have an
  influence over supply
• This is most likely when the market is dominated
  by a few large firms, demand is inelastic, market
  demand doesnt fluctuate and you can easily
  quantify the output of each firm

24
Price leadership and collusion

• Where one firm is dominant in the oligopoly they
  often take the role of price leader setting the
  price for the market
• Tacit collusion is where companies are engaging
  in behaviours which minimise the response of
  competitors
• In the UK the supermarket business could be seen
  as behaving in a way similar to tacit collusion

25
Non Collusive Oligopoly

• Oligopolies are markets which have the following
  features
• A few large firms
• Entry barriers
• Non price competition
• Product branding and differentiation
• Interdependence in decision making

26
Oligopolies

• Firms operating in oligopolies tend to invest
  heavily in new machinery and processes to try and
  reduce their cost structure and make more profits
  
• Research and development expenditure is also high
  as businesses try and differentiate their
  products from their competitors
• Businesses in oligopolies use advertising and
  marketing to build strong brand recognition which
  allows them to compete on factors other than
  price and acts as a barrier to entry for new
  firms

27
Non Price competition

• In oligopolies the majority of competition is
  non-price
• This aims to influence demand and build brand
  recognition
• Methods include
• Better customer service
• Discounts on upgrades
• Free deliveries and installation
• Extended warranties
• Credit facilities
• Longer opening hours
• Product branding
• After sales service

28
Price Wars

• Firms tend to compete on non price factors as
  competing on price can lead to price wars
• Price wars occur when one competitor lowers its
  price, then others will lower their prices to
  match . If one of the firms reduces their price
  below the original price cut, then a new round of
  reductions is begins.

29
Entry Barriers

• Oligopolies have a number of barriers to entry
• Size of the firms in the market means they can
  influence output and price
• Larger firms can exploit economies of scale
• Branding and brand recognition

30
Interdependence in Oligopolies Kinked Demand
Curve

• Firms in an oligopoly face a kinked demand curve
• If they raise price above P the demand curve is
  relatively elastic as people will switch to
  buying substitute products from competitors
• If they drop price below P they face an
  inelastic demand curve as other firms will also
  cut prices so few gains in quantity demanded
  occur

31
Interdependence in Oligopolies Game Theory

• Game theory looks at the players in a game or
  firms in a market
• In making decisions each player has a number of
  choices
• Each player is influenced by their own actions
  and the actions of other players
• Game theory can be used to illustrate the
  interdependence of firms in an oligopoly

32
Price Discrimination

• Price discrimination is where a firm charges
  different prices for the same product to
  different consumers
• The most common example is peak and off peak
  pricing for travel
• For price discrimination to work the following
  conditions are needed
• Differences in price elasticity of demand between
  markets
• Barriers to prevent consumers switching between
  suppliers

33
Price Discrimination

• Perfect Price Discrimination this is where the
  firm charges whatever the market will bear.
• This means the producer can transfer all of the
  consumer surplus to producer surplus.
• This could hypothetically happen if a monopolist
  was able to segment the market precisely however
  it is very unlikely to occur in real life

34
Price Discrimination

• 2. Second degree price discrimination where
  packages of products that are surplus to
  requirements are sold at lower prices
• This often happens with last minute holiday deals
  where businesses are selling off their spare
  capacity to gain some revenue
• In the low cost airline sector firms operate a
  strategy opposite to this where the cheapest
  flights are those you book the furthest in
  advance

35
Price Discrimination

• 3. Peak and Off Peak pricing this is where a
  different price is charged due to the time of day
  / year
• During peak times there is more demand for the
  product so higher prices can be charged demand
  is likely to be more inelastic
• Examples of peak / off peak include rail travel,
  holidays and phone calls

36
Price Discrimination

• 4. Third degree price discrimination Charge
  different prices for different products to
  different market segments
• Markets are usually segmented by time or
  geographical area
• E.g. having one price for the UK and one for the
  USA

37
Advantages and Disadvantages of Price
Discrimination

• Advantages
• Increases profit for the firm
• Increase in size of producer surplus
• Firms may be able to exploit economies of scale
• Can be used to cross subsidise goods with high
  social benefits

• Disadvantages
• Reduction in size of consumer surplus

38
Consumer and Producer Surplus

• Consumer surplus This is the difference between
  what a person would be willing to pay and what
  they actually pay to buy a product.
• It is the area below the demand curve and above
  the price
• Producer surplus This is the difference between
  the price where a producer would be willing to
  provide a product and the actual price the
  product is soldat

39
Consumer Surplus

• The consumer surplus is shown by the shaded area
  on the diagram
• At a price P1 all consumers in the shaded area
  would pay more for the good and therefore they
  gain extra benefits from the lower price

40
Producer / Consumer Surplus and Efficiency

• If the market is perfectly competitive at
  equilibrium price and quantity consumer and
  producer surplus will be maximised
• This represents the most efficient output level

41
Price Discrimination and Producer / Consumer
Surplus

• If first degree price discrimination occurs then
  the consumer surplus is removed and transferred
  to producer surplus
• Other forms of price discrimination also reduce
  the consumer surplus and increase the producer
  surplus

42
Consumer Surplus and Monopoly

• In Monopolies the consumer surplus is reduced
• Some of this reduction is passed to producers in
  the form of the producer surplus

43
Contestable and Non Contestable Markets

• Contestability markets are where there is one
  firm (or a small number of firms) and due to
  freedom of entry and exit, the firm (or firms)
  face competition from potential new entrants and
  so operates like a perfectly competitive market
• In reality there are barriers to contestability
  to most markets
• The majority of markets are contestable to some
  extent
• The degree of contestability is dependent on
  barriers to entry

44
Conditions for Contestability

• The following conditions need to apply for pure
  market contestability
• Freedom of entry and advertisement
• Absence of sunk costs these are costs that a
  business has to pay to enter the industry that
  cant be recovered or recouped
• Perfect information
• Contestability means that businesses in a market
  will make pricing and output decisions based on
  the threat of competition
• Markets are become increasingly contestable due
  to globalisation

45
Market Structure, StaticEfficiency,
DynamicEfficiency and ResourceAllocation

• Productive efficiency is the level of
  production that makes the most cost effective use
  of the factors of production
• Allocative efficiency is the level of
  production where no resources are wasted, no one
  can be better off without anyone else being worse
  off
• Perfectly competitive markets exhibit productive
  and allocative efficiency
• .

46
Market Structure, StaticEfficiency,
DynamicEfficiency and ResourceAllocation

• Efficiency is influenced by a number of factors
  including
• research and development
• investment in human and non-human capital
• Technological change.
• Candidates should be able to compare and discuss
  the
• The more competitive a market is the greater the
  allocative efficiency of resources

47
Summary

• Monopolies operate where there is one firm in the
  market, they are able to set prices and have high
  barriers to entry
• Oligopolies have a few firms in the market, high
  brand recognition and heavy competition on non
  price factors
• Price makers are able to set the price for the
  market whereas price takers have to accept the
  market price
• Growth of firms firms grow internally and
  externally through organic growth or mergers,
  takeovers, joint ventures and management buyouts
• Outsourcing is increasingly being used by firms
  to grow their operations
• Monopolies have power as they are able to
  influence the price for the whole market
• The model of the monopoly shows how the
  monopolist takes the industry demand curve as
  their own
• Collusive and non collusive oligopoly collusive
  oligopolies work together to set prices, non
  collusive oligopolies do not
• Interdependence in oligopolistic markets
  companies take decisions based on the expected
  decisions of others, all decisions are influenced
  by those of others and influence them
• Price discrimination is where you charge a
  different price for the same product to different
  consumers
• Consumer and producer surplus show the extra
  benefits to producers and consumers of a certain
  price
• Contestability looks at the threat of entry of
  new firms to the market
• Market Structure influences the allocation of
  resources within an economy