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Market Structures. The Degree of Competition Classifying markets  number of firms  freedom of entry to industry  nature of product  nature of demand.

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Presentation on theme: "Market Structures. The Degree of Competition Classifying markets  number of firms  freedom of entry to industry  nature of product  nature of demand."— Presentation transcript:

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

5 O £ (b) Firm Q (thousands) O (a) Industry P Q (millions) S D PePe MC AR D = AR = MR QeQe AC Short-run equilibrium of industry and firm under perfect competition Firm is a price taker. Price is given by the market.

6 QeQe P1P1 D 1 = AR 1 = MR 1 AR 1 OO (a) Industry P£ Q (millions) S D (b) Firm MC AC Q (thousands) Loss minimising under perfect competition Loss is minimised where MC = MR.

7 OO (a) Industry P£ P1P1 Q (millions) S D1D1 (b) Firm D 1 = MR 1 MC P2P2 D 2 = MR 2 D2D2 P3P3 D 3 = MR 3 D3D3 Q (thousands) Deriving the short-run supply curve a b c = S

8 Perfect Competition Long-run equilibrium of the firm  all supernormal profits competed away  LRAC = AC = MC = MR = AR

9 Profits return to normal OO (a) Industry P£ Q (millions) S1S1 D (b) Firm LRAC PLPL P1P1 QLQL SeSe AR 1 D1D1 AR L DLDL Q (thousands) Long-run equilibrium under perfect competition New firms enter Supernormal profits

10 £ Q O (SR)AC (SR)MC LRAC AR = MR DLDL LRAC = (SR)AC = (SR)MC = MR = AR Long-run equilibrium of the firm under perfect competition

11 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

12 Monopoly Defining monopoly Barriers to entry  economies of scale  economies of scope  product differentiation and brand loyalty  ownership/control of key factors  ownership/control over outlets  legal protection

13 Monopoly The monopolist’s demand curve  downward sloping  MR below AR Equilibrium price and output  Equilibrium output, where MC = MR  Equilibrium price, found from demand curve

14 £ Q O MC AC QmQm MR AR AC Profit maximising under monopoly AR

15 Monopoly The monopolist’s 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

16 £ Q O MC AC QmQm MR AR AC Profit maximising under monopoly AR Total profit

17 Monopoly The monopolist’s 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

18 Monopoly Disadvantages of monopoly  high prices / low output: short run

19 AR = D MC MR £ Q O Q1Q1 P1P1 Monopoly Equilibrium of industry under perfect competition and monopoly: with the same MC curve

20 £ Q O MC ( = supply under perfect competition) Q1Q1 MR P1P1 P2P2 Q2Q2 AR = D Comparison with Perfect competition Equilibrium of industry under perfect competition and monopoly: with the same MC curve

21 Monopoly Disadvantages of monopoly  high prices / low output: short run  high prices / low output: long run  lack of incentive to innovate Advantages of monopoly  economies of scale  profits can be used for investment  high profits encourage risk taking

22 Monopolistic Competition Assumptions of monopolistic competition Equilibrium of the firm  short run

23 £ Q O QsQs AR  D MC AC MR Short-run equilibrium of the firm under monopolistic competition PsPs AC s

24 Monopolistic Competition Assumptions of monopolistic competition Equilibrium of the firm  short run  long run

25 Long-run equilibrium of the firm under monopolistic competition AR L  D L MR L £ Q O QLQL PLPL LRAC LRMC New firms entering the industry reduce demand for each individual firm. Price falls to P L.

26 Monopolistic Competition Assumptions of monopolistic competition Equilibrium of the firm  short run  long run  underutilisation of capacity in the long run

27 Q2Q2 P2P2 D L under perfect competition Long run equilibrium of the firm under perfect and monopolistic competition £ Q O P1P1 LRAC D L under monopolistic competition Q1Q1 Higher price and lower output (excess capacity) under monopolistic competition

28 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

29 Oligopoly Key features of oligopoly  barriers to entry  interdependence of firms Competition versus collusion Collusive oligopoly: cartels  equilibrium of the industry

30 £ Q O Industry D  AR Industry MC Industry MR Q1Q1 P1P1 Industry profit maximised at Q 1 and P 1 Members must agree to restrict total output to Q 1. Profit-maximising cartel

31 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

32 Oligopoly Tacit collusion  price leadership: dominant firm  price leadership: barometric  rules of thumb

33 £ Q O AR  D market MC MR leader PLPL QTQT AR  D leader QLQL l t Leader maximises profit at Q L and thus sets price of P L. Price leader aiming to maximise profits for a given market share

34 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

35 Oligopoly The breakdown of collusion  factors to consider in deciding whether to break an agreement  how likely are rivals to retaliate?  who would win a price war?  importance of considering rivals’ reactions

36 Oligopoly Non-collusive oligopoly: assumptions about rivals’ behaviour  rivals produce fixed quantity: Cournot model  firms choose best output for remainder of the market

37 O Quantity DMDM MC A D A1 MR A1 Q A1 Q B1 Firm A’s profit- maximising output and price are Q A1 and P A. P A1 Cournot model: Firm A’s profit-maximising position Costs and revenue

38 O O £ Firm B’s output Quantity P A1 MC A DMDM (a) Firm A’s profit-maximising position (b) The two firms’ reaction functions D A1 MR A1 Q A1 Q B1 RARA Firm A’s output Q A1 x Firm A’s reaction function for each assumed output of B The Cournot model of duopoly Q B1

39 O O £ Firm B’s output Quantity MC A DMDM (a) Firm A’s profit-maximising position (b) The two firms’ reaction functions D A1 MR A1 Q A1 Q B1 RARA RBRB Firm A’s output Q A1 Q B1 Q Be Q Ae x e P A1 Equilibrium at point e, where the two reaction functions cross The Cournot model of duopoly

40 Oligopoly Non-collusive oligopoly: assumptions about rivals’ behaviour  rivals produce fixed quantity: Cournot model  firms choose best output for remainder of the market  profit will be less than under a cartel  but more than under perfect competition  rivals set a particular price: Bertrand model  the firm will undercut the rival  this will probably trigger a price war until all supernormal profits are eliminated

41 Oligopoly Non-collusive oligopoly: assumptions about rivals’ behaviour (cont.)  Nash equilibrium  when everyone makes a decision based on the alternatives rivals could adopt  Nash equilibrium worse for the individual firms than the collusive equilibrium  The kinked demand curve model  assumptions of the model  stable prices

42 £ Q O P1P1 Q1Q1 D D Kinked demand for a firm under oligopoly Assumption 1 If the firm raises its price, rivals will not. Assumption 1 If the firm raises its price, rivals will not. Assumption 2 If the firm reduces its price, rivals will feel forced to lower theirs too. Assumption 2 If the firm reduces its price, rivals will feel forced to lower theirs too.

43 £ Q O P1P1 Q1Q1 MC 2 MC 1 MR a b D  AR Stable price under conditions of a kinked demand curve MR is discontinuous between a and b. If MC is anywhere between MC 1 and MC 2, profit is maximised at Q 1.

44 Oligopoly Oligopoly and the consumer  advantages  incentive to develop new and better products  greater choice for consumers than under monopoly  disadvantages  less scope for economies of scale than under monopoly  more extensive advertising and other costly marketing  difficulties in drawing general conclusions

45 Game Theory Non-collusive oligopoly: game theory Single-move games  alternative strategies  maximax and maximin  simple dominant strategy games

46 £2.00£1.80 £2.00 £1.80 X’s price Y’s price A B C D £10m each £8m each £12m for Y £5m for X £5m for Y £12m for X Profits for firms A and B at different prices

47 Game theory Non-collusive oligopoly: game theory Single-move games  alternative strategies  maximax and maximin  simple dominant strategy games  the prisoners’ dilemma

48 Not confessConfess Not confess Confess Amanda's alternatives Nigel's alternatives A B C D Each gets 1 year Each gets 3 years Nigel gets 3 months Amanda gets 10 years Nigel gets 10 years Amanda gets 3 months The prisoners’ dilemma

49 Game Theory Non-collusive oligopoly: game theory Single-move games  alternative strategies  maximax and maximin  simple dominant strategy games  the prisoners’ dilemma  Nash equilibrium  non-dominant strategy games

50 Profit possibilities for Firm X

51

52 Game theory Repeated games  more complex non-dominant strategy games  multiple moves  the importance of threats and promises  credible threats  the importance of timing  decision trees

53 Boeing decides 500 seater 400 seater A decision tree Boeing –£10m Airbus –£10m (1) Boeing +£30m Airbus +£50m (2) Boeing +£50m Airbus +£30m (3) Boeing –£10m Airbus –£10m (4) Airbus decides B2B2 Airbus decides B1B1 A

54 Game Theory Repeated games  more complex non-dominant strategy games  multiple moves  the importance of threats and promises  credible threats  the importance of timing  decision trees  first mover advantage

55 Boeing decides 500 seater 400 seater A decision tree Boeing –£10m Airbus –£10m (1) Boeing +£30m Airbus +£50m (2) Boeing +£50m Airbus +£30m (3) Boeing –£10m Airbus –£10m (4) Airbus decides B2B2 Airbus decides B1B1 A

56 Game Theory Limitations of game theory  complex games with multiple players  the role of individuals’ morals and attitudes Potential for cycles of collusion and competition


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