2 Industry vs. FirmThe INDUSTRY are all companies that compete with each other.The FIRM is an individual company.Sometimes firms act independently from the industry.
3 How do firms think? Firms think in: The short run: the period of time long enough for producers to change one input to affect productionThe medium run: the period of time when you can change both capital and labor inputsThe long run: the period of time in which you can change any and all inputs in production.These are hard to define by time, but easy to define by behavior.
4 How do firms behave?Market structure influences how a firm behaves regarding:PricingSupplyBarriers to EntryEfficiencyCompetition
5 Market Structures Based on degree of competition in the industry High levels of competition: Perfect competitionLimited competition: MonopolyDegrees of competition in between: imperfect (monopolistic/differentiated) competition, oligopoly
6 Determinants of Market Structure Freedom of entry and exitNature of the product – homogenous (identical), differentiated?Control over supply/outputControl over priceBarriers to entry
7 Market Structure Perfect Competition: Free entry and exit to industry Homogenous product – identical so no consumer preferenceLarge number of buyers and sellers – no individual seller can influence priceSellers are price takers – have to accept the market pricePerfect information available to buyers and sellers
8 Market Structure Examples of perfect competition: Financial markets – ex. stock exchange, currency markets, bond marketsAgricultureHot dog cartsIce Cream TrucksTo what extent?
9 Market Structure Advantages of Perfect Competition: High degree of competition helps allocate resources to most efficient usePrice = marginal costsNormal profit made in the long runFirms operate at maximum efficiencyConsumers benefit
10 Market Structure What happens in a competitive environment? New idea? – firm makes short term economic profitOther firms enter the industry to take advantage of economic profitSupply increases – price fallsLong run – normal profit madeChoice for consumerPrice sufficient for normal profit to be made but no more!
14 Market Structure Imperfect or Monopolistic Competition Many buyers and sellersProducts differentiatedRelatively free entry and exitEach firm may have a tiny ‘monopoly’ because of the differentiation of their productFirm has some control over priceExamples – restaurants, professions – lawyers, etc., building firms – plasterers, plumbers, etc.
16 Market Structure Oligopoly – Competition amongst the few Industry dominated by small number of large firmsMany firms may make up the industryHigh barriers to entryProducts could be highly differentiated – branding or homogenousNon–price competitionPrice stability within the market - kinked demand curve?Potential for collusion?Economic profitsHigh degree of interdependence between firms
18 Market Structure Measuring Oligopoly: Concentration ratio – the proportion of market share accounted for by top X number of firms:E.g. 5 firm concentration ratio of 80% - means top 5 five firms account for 80% of market share3 firm CR of 72% - top 3 firms account for 72% of market share
19 Market Structure Price Kinked Demand Curve D = elastic Kinked D Curve £5The intention of this slide is to demonstrate the principle of the kinked demand curve. The slide starts with the vertical and horizontal axes. A demand curve appears – relatively elastic and a price of £5 and q 100 appear. The explanation at this point would imply asking students what would happen if the producer increased price but nobody else in the industry followed? Hopefully students will see that the demand would fall significantly. By this stage students should be aware of the impact on total revenue as a result of this action. The next assumption rests on the firm facing an inelastic demand curve; in this case the firm believes that firms will follow suit in reducing price – the effect is to lead to only a small gain in sales – total revenue would again fall. Assuming the two characteristics would suggest a kinked demand curve and price stability existing in the industry with the likely outcome being non-price comptition.D = elasticKinked D CurveD = InelasticQuantity100
21 Market Structure Duopoly: Industry dominated by two large firms (ex. DC and Marvel, Intel and AMD)Possibility of price leader emerging – rival will follow price leaders pricing decisionsHigh barriers to entryEconomic profits likely
22 Market Structure Monopoly: Pure monopoly – industry is the firm! Actual monopoly – where firm has >25% market shareNatural Monopoly – high fixed costs – gas, electricity, water, telecommunications, rail
23 Market Structure Monopoly: High barriers to entry Firm controls price OR output/supplyEconomic profits in long runPossibility of price discriminationConsumer choice limitedPrices in excess of MC
24 Market Structure Advantages and disadvantages of monopoly: Advantages: May be appropriate if natural monopolyEncourages R&DEncourages innovationDevelopment of some products not likely without some guarantee of monopoly in productionEconomies of scale can be gained – consumer may benefit
25 Market Structure Disadvantages: Exploitation of consumer – higher pricesPotential for supply to be limited - less choicePotential for inefficiency –X-inefficiency – complacency over controls on costs