Market Structures

Market Structures

Objectives • Examine the models of market structure • Concept of an efficient market structure in terms of costs, prices, output and profit.

Economies of Scale • Define

Market Structure Importance: Degree of competition affects the consumer – will it benefit the consumer or not? Impacts on the performance and behaviour of the company/companies involved

4 Market Structures Perfect Competition Monopolistic Competition Oligopoly Monopoly

Market Structure Pure Monopoly Perfect Competition Monopolistic Competition Oligopoly Duopoly Monopoly The further right on the scale, the greater the degree of monopoly power as competition decreases

Characteristics • No. of firms • Size of firms • The Product • Barriers to entry • Price taker or maker • Concentration Ratio good indicator!

Market Outcomes Cost Price Output Profit Efficiency

Market Structure • Models – a word of warning! • Market structure deals with a number of economic ‘models’ • These models are a representation of reality to help us to understand what may be happening in real life • There are extremes to the model that are unlikely to occur in reality • They still have value as they enable us to draw comparisons and contrasts with what is observed in reality • Models help therefore in analysing and evaluating – they offer a benchmark

Market Structure Electric Guitar – Jazz Body Vodka Mercedes CLK Coupe Canon SLR Camera Bananas Characteristics: Look at these everyday products – what type of market structure are the producers of these products operating in? Remember to think about the nature of the product, entry and exit, behaviour of the firms, number and size of the firms in the industry. You might even have to ask what the industry is??

Characteristics Number of Firms Barriers to entry could be; Capital costs Sunk costs Scale economies & natural monopoly Natural cost advantages Legal barriers Marketing Restrictive practices Product – homogeneity & branding Knowledge Interrelationships (Profit Maximisation)

Efficiency • Why is this important in a market structure?

1.Productive Efficiency Firm operating at lowest point of SRAC Cost MC SRAC Output

2. Efficiencies of Scale • Lowest point of LRAC curve. Economies of Scale • Draw the diagram

3. Allocative Efficiency • Resources used effectively • producing the goods most wanted by consumers, given their cost of production. • Achieved where Price = Marginal Cost. The price the last consumer is prepared to pay is exactly equal to the cost of producing the last unit.

4.Dynamic Efficiency • It is necessary for firms to constantly introduce new technology and reduce their costs over time.

5. X inefficiency • Firms do not have incentives to cut costs. A firm’s AC curve will be higher than in a competitive market • Which market structure would you see this inefficiency?

Also, Normal Profit • Is the firm operating at normal profit? This represents an efficient market. • Abnormal profits – Consumers exploited • Losses – Firm should move industry

Efficiency & Markets THE THEORY - In an efficient market system: • Competition leads to • Productive efficiency in SR. • Efficiencies of Scale in LR • Price mechanism leads to allocative efficiency (P=MC) BUT – do markets operate efficiently?

Perfect Competition Purpose of a ‘perfect’ model Assumptions Many buyers and sellers – price takers Freedom of entry and exit Perfect knowledge Homogenous products

The Model Firm has no effect on the market Perfectly elastic demand curve – price taker Increase in price leads to zero demand No incentive to reduce price D=AR=MR

The Firm The Market P P S Pe D=AR=MR D Qe Q Q Pe

Short-run Profit Maximisation P MC SRAC Pe D=AR=MR Qe Q

Short-run Equilibrium The Firm The Market P P S1 MC S2 SRAC D1=AR=MR P1 P1 D2=AR=MR P2 D Q2 Q1 Q2 Q Q

Short-Run Outcomes Abnormal profit possible only in the very short run Normal profit in short run equilibrium Price lowered by competition – increase in consumer surplus Maximises productive and allocative efficiency

Establishing a Long-run Equilibrium Firms expand in order to take advantage of economies of scale and re-establish abnormal profits Further entry into the market erodes this abnormal profit The Firm The Market P P S1 SRAC1 MC1 S2 SRAC2 MC2 P1 P1 D1 P2 D2 P2 D Q1 Q1 Q2 Q2 Q Q

Long-run equilibrium P LRAC MC D=AR=MR Pe Qe Q

Long-Run Outcomes Maximising profit, productive and allocative efficiency Dynamically efficient Normal profit in long run Reduced price and increased output

Monopoly One firm Barriers to entry – natural monopoly

The Model Price maker – downward sloping demand curve £ MC AC Pe Abnormal Profit D=AR MR Qe Q

Outcomes Can make abnormal profits in short-run Barriers to entry prevent competition Can make abnormal profits in the long-run No incentive to max. efficiency Prices likely to be high

Discriminating Monopoly Types Time Place Income Age Conditions Different elasticities Separate markets

£ Appropriated Consumer Surplus PA Pe AR=D QA Qe Q

Oligopoly A few large firms Interdependence Significant barriers to entry Branded goods

The Model Abnormal profits in short-run Barriers to entry prevent competition: L-shaped AC curve Branding Collusion Abnormal profits in long-run Non-price competition & price rigidity £ AC MES Q

Kinked Demand Curve £ MC2 MC1 AR=D MR Q

Monopolistic Competition Large number of buyers and sellers No barriers to entry or exit Perfect knowledge Goods are differentiated

The Model Downward sloping demand – not price takers Demand likely to be elastic – little market power

Short-run Abnormal profit possible in the short-run Abnormal profits attract new entrants AR curve shifts inwards and profit is competed away £ MC AC Pe Abnormal Profit D=AR MR Q Qe

Long-run £ MC AC Pe D=AR MR Qe Q

Outcomes Normal profit in the long-run due to free entry & exit Cannot maximise efficiency (allocative or productive) Price lowered by competition

Additional Note: Production in the short-run Firms may continue to produce even when they are making losses. In the short-run they only need to cover variable costs. They may expect demand to rise in the long-run and cover fixed costs. Long-run production decisions are based on total costs. Firms will leave the market if they make losses in the long-run.

Market Structures