Market Structure Comparison and Evaluation

1. Market Structure Comparison and Evaluation Review!!

2. Perfect competition Assumptions: Firms are small and have little affect on impact on price (price takers) or total output Industry has lots of firms Identical products (no brand names) Perfect (symmetrical) information Entry/exit Easy (investment and sunk costs low)

3. Perfect competition Advantages: • Lower prices • Community Surplus • Allocative Efficiency • Productive (Technical) Efficiency

4. Perfect competition cont. Disadvantages: No incentive to innovate Lack of variety to consumer Given normal profits, price fluctuations occur due to resource (input) prices. No EOS: economies of scale

5. Monopolies: Assumptions One firm in the industry, No substitute goods. Barriers to entry exist, very high barriers associated with high capital costs (sunk costs) May be able to make abnormal profit in the long run because of the barriers to entry

6. Monopolies: Advantages • May Charge Lower Prices than firms in Perfect Competition • Since pure monopolies supply the whole market, their output is large -> they often achieve economies of scale and have lower costs • May invest more in research and development (which should benefit consumers) • Because they earn abnormal profits and can afford to • May be more efficient if can use abnormal profits to innovate and invest in technology that makes production efficient • Contestable Market theory

7. Monopolies: Disadvantages Productively and Allocatively inefficient -less incentive to be Can charge higher price for lower output Can useanti-competitive behavior to maintain power

8. Monopolies: Disadvantages Lower Prices to Suppliers - A monopoly may use its market power and pay lower prices to its suppliers. E.g. Supermarkets have been criticized for paying low prices to farmers. Worse products Lack of competition may lead to less product innovation. Charge Higher prices to producers Monopolies may use their supernormal profits to charge higher prices to producers of other products Diseconomies of Scale - It is possible that if a monopoly gets too big it may experience diseconomies of scale. - higher average costs because it gets too big

9. Oligopolies: Assumptions High Concentration Ratio-A few firms hold a high percentage of market share (there may be many small firms) Usually high barriers to entry Products may be identical (homogenous) or differentiated Firms are interdependent (Large enough to effect the market price)

10. Oligopolies: Advantages Economies of scale may be achieved, leading to lower costs Greater innovation through R & D because of supernormal profits Product development may lead to greater choice of products

11. Oligopolies: Disadvantages • No productive or allocative efficiency • Higher prices and lower output • Lack of competition may lead to higher costs and prices (x-inefficiency) • High advertising costs may exclude firms from entering • Advertising may add cost, but no true value • Advertising may create demand for unnecessary products

12. Collusive oligopoly • Acts like a monopolist in the market • Collusive oligopolies may crash if: • Great number of firms • Differentiated product • Production costs differ • Market demand is shrinking (fighting for survival)

13. Non-Collusive Oligopolies • Tend to: • Avoid price competition (sticky prices) • Avoid changing output • Use non-price competition • Non-price competition • Heavy advertising • Product differentiation • Gifts, coupons, volume discounts • service, store hours, warranties • Cover every market niche

14. P McDonald's Demand P McDonald's Demand P1 P1 D1 Assumptions: ·JB will match a price decrease by McD's so as to not lose market share ·JB will ignore a price increase by McD's so it can capture customers who will switch to JB. ·D1 represents demand when McD's increases price, D2 when it lower price. ·Put together, the demand curve faced by a oligopolist is kinked, highly elastic above current price and highly inelastic below current price D D2 MR1 Q1 Q Q1 Q MR2 MR

15. Price Discrimination • When producers sell the exact same item to consumers at different prices 3 Necessary Conditions • Producer must be price-maker to some extent (can’t be perfect competition) • Consumers must have different PEDs for the product (consumers with inelastic demand will pay ______prices) • Producer must be able to separate consumers so one consumer doesn’t buy the good at a low price and sell to another at a higher price

16. Price Discrimination: Advantages for firms • More revenue • May allow producer to produce more and gain economies of scale • Charging higher prices to market with inelastic PED might allow them to lower prices in markets with elastic PED and gain competitive edge • Illegal to “dump” (selling product below costs in foreign market)

17. Price discrimination: Advantages for customers Some poorer consumers get subsidized by wealthier consumers (like college tuition & financial aid) Sometimes entire groups of consumers can get lower prices because they are subsidized by another group (ex: domestic students get lower tuition because higher tuition for foreign students helps cover costs) Usually leads to higher output in the market which should lead to economies of scale and lower costs thus lower prices for consumers

19. Price Discrimination: Disadvantages Loss of consumer surplus for consumers Some consumers pay more than they would have at market equilibrium prices

20. Monopolistic Competition: Characteristics Small firms exist in the market Firms differentiate their product No great barriers to entry

21. Monopolistic Competition:Advantages Consumers enjoy a greater variety of products Prices are low… cannot be much higher than average costs

22. Monopolistic Competition: disadvantages • Normal profits in the long run • No allocative efficiency • No productive efficiency • Not soo much R&D • Too not tend to enjoy Economies of Scale

23. Alternatives to profit maximization: • Revenue maximize —produce where MR=O • Maximize sales —sell too much instead of decreasing output and increasing price • Maximize employment —may feel that more workers means the company is successful • Aim for Environment or Social goals —may pay more for inputs (fair trade coffee) or pay a fair wage above what is required by the labor market (local crafts) • Starbucks • Satisfice —many business owners work hard enough to make a living and get by or not get fired by shareholders

24. Short-run cost curves vs. Long –run cost curves Law of diminishing returns: Economies of scale