Competition and Market Structure

1. Competition and Market Structure Frederick University 2011

2. Industry Industry (market) – a collection of firms, each of which is supplying products that have some degree of substitutability, to the same potential buyers • Common buyers for sellers • Common sellers for buyers • Relatively homogeneous product

3. SCP Paradigm Basic Conditions Market Structure Conduct Performance

4. SUPPLY raw material technology product durability value/weight business attitudes unionization DEMAND price elasticity rate of growth substitutes marketing type purchase method cyclical and seasonal character BASIC CONDITIONS

5. Market Structure Market Structure – those characteristics of the market that significantly affect the behavior and interaction of buyers and sellers

6. MARKET STRUCTURE • number and size of sellers and buyers • type of the product • conditions of entry and exit • transparency of information

7. Perfect Competition - structure • Many and small sellers, so that no one can affect the market • Homogeneous product • Free entry to and exit from the industry • Transparent and free information

8. Pure Monopoly- market structure • Only one producer in the industry • The product does not have close substitutes • Blocked entry

9. Monopolistic competition - structure • Many and small sellers • Differentiated product • Free entry and exit • Transparent and free information

10. Oligopoly – market structure • A) Tight oligopoly – a few big firms in the industry with comparable market shares/ B) Dominant firm oligopoly – one of the big firms in the industry is recognized as the price leader • Homogeneous/ Heterogeneous oligopoly • Significant barriers to entry to and exit from the industry • Significant barriers to information

11. Entry • Entry into an industry or to a segment of an industry can occur because there is • de novo entry. • takeover from outside the industry • the development of technologically similar firms who develop their product range. • the transference of brand names across sectors • an increase in import penetration. Again, the scale of the firm involved is important here.

12. Barriers to Entry Structural barriers • High capital cost • Economies of scale • Product differentiationand brand loyalty • High switching cost • Ownership/control of key factors or outlets Strategic barriers • Limit pricing • Excess capacity • Vertical integration • Sleeping patents • Predatory pricing • Tying sales Institutional barriers • Patents • Regulations

13. Alternative Market Structures • The four market structures • perfect competition • monopoly • monopolistic competition • oligopoly

14. Features of the four market structures

15. Features of the four market structures

16. Features of the four market structures

17. Features of the four market structures

18. Features of the four market structures

19. Features of the four market structures

20. Market Conduct Market Conduct – a firm’s policies toward its market and toward the moves made by its rivals in that market

21. CONDUCT • pricing behavior • product strategy • research and innovation • advertising • legal tactics

22. Perfect competition - conduct Firm’s market Industry’s market • P q TR MR • 5 0 0 - • 5 10 50 5 • 5 20 100 5 P D S P d MR Pe Q 20 Q Qe 0 10

23. Perfect competition – short run “conduct” p MC AC dd = MR Economic profit= (P-AC) q q Q P = MR MC = MR P>AC

24. Perfect Competition – long run “conduct” Industry’s equilibrium S If P>AC, new firms start entering the industry and the equilibrium price falls. P D If Р < АС, the firms will start leaving the industry and the equilibrium price will increase. Pe P’ The industry is in a long run equilibrium when P = AC Qe Q In the long run the firms make normal profit

25. S MC a P1 b P2 c P3 D1 D2 D3 Perfect Competition - Deriving the short-run supply curve P = S d1 = MR1 d2 = MR2 d3 = MR3 Q (thousands) Q (millions) The firm’s short run supply curve is determined by its MC curve above AVC (a) Industry (b) Firm fig

26. (SR)MC (SR)AC LRAC DL AR = MR LRAC = (SR)AC = (SR)MC = MR = AR Long-run equilibrium of the firm under perfect competition Q

27. Pure Monopoly - conduct • P Q TR MR • 1 10 10 • 2 18 8 • 8 3 24 6 P MC D P P>MR Economic Profit AC MC=MR Q Qm MR

28. MC AC AR =D MR Pure Monopoly and Perfect competition Consumer surplus = ∑ (P –MWP) Under perfect competition=KLN Under pure monopoly=NRT L P N Producer surplus= ∑ (P-MC) Under pure monopoly the producer surplus rises byKGTR at the expense of the consumer surplus R T Pm GTL – the portion of the consumer surplus, which is a deadweight loss for the society JGL – the portion of the producer surplus, which is a deadweight loss for the society Pp.c. K G J Qp.c. Qm Q TLJ – total deadweight loss for the society

29. MC AC AR =D MR Monopolistic competition – conduct in the short run P>MR P MC = MR Ps ACs Qs Q

30. LRMC LRAC ARL=DL MRL Monopolistic competition – conduct in the long run IfP>AC new firms will enter the industry and the firm’s market segment will shrink - its individual demand curve shifts leftwards P PL Q The long run equilibrium is achieved at P = AC, however, АС is not minimized – there is excess capacity QL

31. P2 DL under perfect competition Long run equilibrium under perfect competition and under monopolistic competition P LRAC P1 DL undermonopolistic competition fig Q1 Q2 Q

32. Tight oligopoly - conduct P NFD FD Q

33. The kinked demand curve under the tight oligopoly P NFD P1 FD Q Q1 fig

34. a b MRf The kinked demand curve P P1 MRnf D = AR Q Q1

35. MC2 MC1 а b MR Rigid prices under the tight oligopoly P P1 D = AR Q Q1

36. Price leadership of the dominant firm P Sothers Dindustry Dleader Q

37. MCleader l f t MRleader Price leadership of the dominant firm P Sother firms PL Dindustry Dleader QT QF QL Q

38. Market Performance Market Performance – how well does an industry do what society might reasonably expect it to do

39. PERFORMANCE • profitability • allocative efficiency • static production efficiency • dynamic efficiency - progress • full employment • equity

40. Perfect Competition - Performance • P = MR • MC = MR • P = MC • P = AC • AC = MC • AC minimum

41. Perfect Competition - Performance Static Efficiency • Efficiency in allocation MC = P • Efficiency in motivation AC = MC • Efficiency in distribution AC = P The Perfect Competition achieves static efficiency Dynamic Efficiency There is NO potential and motivation for innovations and technological progress The Perfect Competition does not achieve dynamic efficiency

42. Pure Monopoly - performance Static efficiency • Efficiency in allocation MC < P • Efficiency in motivationexcess capacity • Efficiency in distributionAC < P The pure monopoly does not achieve static efficiency Dynamic efficiency There is a potential and motivation for innovations and technological progress The pure monopoly is motivated to achieve dynamic efficiency at the presence of potential competition

43. Monopolistic competition - performance Static Efficiency • Efficiency in allocation MC < P • Efficiency in motivationexcess capacity • Efficiency in distribution AC = P

44. Contestable Markets Key characteristics: • Firms’ behaviour influenced by the threat of new entrants to the industry – if even the industry is concentrated, the incumbent firms behave as if they are perfect competitors • Firms’ performance depends on the potential competition

45. Contestable markets Contestable market • Ultra easy entry • Ultra easy exit • Zero sunk cost • “Hit and run” strategy”

46. Oligopoly – non-collusive behavior • Game theory – the study of multi-person decision problems (the reactions of a few interdependent decision makers) • Game - any situation that involves well-defined rules and outcomes, where outcomes are dependent on players’ strategic decisions • Strategy – a complete plan, specifying the game under any possible circumstances

47. The Prisoners’ dilemma Two suspects, Valio and Georgy, are arrested by the police. The police have insufficient evidence for a conviction, and, having separated both prisoners, visit each of them to offer the same deal: if one testifies for the prosecution against the other and the other remains silent, the betrayer gets 3 months and the silent accomplice receives the full 10-year sentence. If both stay silent, both prisoners are sentenced to only 1 year in jail for a minor charge. If each betrays the other, each receives a three-year sentence. Each prisoner must make the choice of whether to betray the other or to remain silent. However, neither prisoner knows for sure what choice the other prisoner will make. So this dilemma poses the question: How should the prisoners act?

48. The Prisoners’ dilemma Valio’s alternatives Does not confess Confesses Georgy - 10 years Valio - 3 months Does not confess Everyone gets 1 year Georgy’s alterantives Georgy - 3 months Valio- 10 years Everyone gets 3 years Confesses fig

49. The Prisoners’ dilemma The Prisoners’ dilemmais the duopoly’sdilemma. Prisoners cannot coordinate their confessions. Even though they both would get less if they do not confess, they betray the other player, because of the greater payoff. No matter what the other player does, one player will always gain a greater payoff by playing defect. Since in any situation playing defect is more beneficial than cooperating, all rational players will play defect.

50. Payoffs for firms A и B under different pricing policies A’s Price 2.00 1.80 5 for В 12 for А 2.00 10mil. for each B’s Price 12 for В 5 for А 1.80 8 for each fig