Market

1
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

3
Features of the four market structures
4
Features of the four market structures
5
Features of the four market structures
6
Features of the four market structures
7
Features of the four market structures
8
Features of the four market structures
9
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

10
Perfect Competition

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

11
Short-run equilibrium of industry and firm under
perfect competition
P
O
Qe
Q (millions)
(a) Industry
12
Loss minimising under perfect competition
P

S
D
O
O
Q (thousands)
Q (millions)
(a) Industry
(b) Firm
13
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

14
Deriving the short-run supply curve
P

S
D1 MR1
D2 MR2
D3 MR3
O
O
Q (thousands)
Q (millions)
(a) Industry
(b) Firm
15
Perfect Competition

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

16
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
17
Long-run equilibrium of the firm under perfect
competition

O
Q
18
Perfect Competition

• Incompatibility of economies of scale with
  perfect competition
• Benefits of perfect competition
• price equals marginal cost
• prices kept low
• firms must be efficient to survive

19
Monopoly

• Defining monopoly
• Barriers to entry
• economies of scale
• economies of scope
• 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

20
Monopoly

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

21
Profit maximising under monopoly

Qm
O
Q
22
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

23
Profit maximising under monopoly

MC
MR
Qm
O
Q
24
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

25
Profit maximising under monopoly

MC
MR
Qm
O
Q
26
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

27
Monopoly

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

28
Equilibrium of industry under perfect
competition and monopoly with the same MC curve

Monopoly
P1
Q1
O
Q
29
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
30
Monopoly

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

31
Monopoly

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

32
Monopoly

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

33
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

34
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

35
Equilibrium of industry under perfect
competition and monopoly with different MC curves

MCmonopoly
P1
AR D
MR
O
Q
Q1
36
Equilibrium of industry under perfect
competition and monopoly with different MC curves
MC ( supply)perfect competition

MCmonopoly
P2
P1
x
P3
AR D
MR
O
Q2
Q3
Q
Q1
37
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

38
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

39
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

40
Monopolistic Competition

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

41
Short-run equilibrium of the firmunder
monopolistic competition

Ps
ACs
O
Q
Qs
42
Monopolistic Competition

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

43
Long-run equilibrium of the firmunder
monopolistic competition

PL
O
Q
QL
44
Monopolistic Competition

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

45
Long run equilibrium of the firm under perfect
andmonopolistic competition

LRAC
P1
DL under monopolistic competition
O
Q1
Q2
Q
46
Monopolistic Competition

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

47
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

48
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

49
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

50
Oligopoly

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

51
Profit-maximising cartel

O
Q
52
Profit-maximising cartel

P1
Industry D AR
Industry MR
Q1
O
Q
53
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

54
Oil prices
Impending war with Iraq
Iraq invades Iran
OPECs first quotas
Iraq invades Kuwait
Revolution in Iran
World-wide recovery
First oil from North Sea
World-wide slowdown
Cease-fire in Iran-Iraq war
New OPEC quotas
Recession in Far East
Yom Kippur War Arab oil embargo
55
Oil prices
Impending war with Iraq
Iraq invades Iran
OPECs first quotas
Iraq invades Kuwait
Revolution in Iran
World-wide recovery
First oil from North Sea
World-wide slowdown
Cease-fire in Iran-Iraq war
New OPEC quotas
Recession in Far East
Yom Kippur War Arab oil embargo
56
Oligopoly

• Tacit collusion
• price leadership dominant firm

57
Price leader aiming to maximise profits for a
given market share

O
Q
58
Price leader aiming to maximise profits for a
given market share

MC
AR D market
AR D leader
MR leader
O
Q
59
Oligopoly

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

60
Oligopoly

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

61
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

62
Oligopoly

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

63
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
64
Oligopoly

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

65
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
66
Oligopoly

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

67
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
68
Oligopoly

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

69
Oligopoly

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

70
Oligopoly

• The breakdown of collusion
• Non-collusive oligopoly game theory
• alternative strategies
• maximax and maximin
• simple dominant strategy games
• the prisoners dilemma
• Nash equilibrium
• more complex non-dominant strategy games
• the importance of threats and promises
• the importance of timing of decisions

71
Oligopoly

• The breakdown of collusion
• Non-collusive oligopoly game theory
• alternative strategies
• maximax and maximin
• simple dominant strategy games
• the prisoners dilemma
• Nash equilibrium
• more complex non-dominant strategy games
• the importance of threats and promises
• the importance of timing of decisions
• decision trees

72
A decision tree
Boeing decides
A
73
Oligopoly

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

74
Kinked demand for a firm under oligopoly

Current price and quantity give one point on
demand curve
Q
O
75
Kinked demand for a firm under oligopoly

D
P1
D
Q
O
Q1
76
Oligopoly

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

77
Stable price under conditions of a kinked demand
curve

P1
D AR
Q
O
Q1
78
Oligopoly

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

79
Oligopoly

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

80
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

81
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

82
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

83
Price Discrimination

• Meaning of price discrimination
• First degree
• Second degree
• Third degree (the most common form)

84
Third-degree price discrimination
P
Revenue from a single price
Q
O
85
Third-degree price discrimination
P
Increased revenue from price discrimination
A higher discriminatory price is now introduced
P1
D
Q
O
200
86
Price Discrimination

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

87
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

88
Price Discrimination

• Profit maximising prices and output under price
  discrimination

89
Profit-maximising output underthird degree price
discrimination
DX
O
O
O
MRX
(a) Market X
90
Profit-maximising output underthird degree price
discrimination
DY
DX
MRY
O
O
O
MRX
(b) Market Y
(a) Market X
91
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
92
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
93
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
94
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
95
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
96
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
97
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
98
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
99
Price Discrimination

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

100
Price Discrimination

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