Market Structures Page |1 Objectives of Firms Traditional theory
Marginal Revenue (MR) 1.
MR = AR
Profit maximisation 1.
MC = MR
Alternative theories Managerial theories 1. 2. 3.
Manag Manageri erial al utilit utility y maxim maximisa isatio tion n Sale Sales s rev reven enue ue maxi maximi misa sati tion on Grow Growth th maxi maxim misat isatio ion n
Behaviourial theories 1. 2.
A vari variet ety y of goals goals,, eg. eg. prod produc ucti tion on,, sale sales, s, marke markett shar share, e, profit Aim to achiev achieve e a satisf satisfacto actory ry perfor performanc mance e for for each each goal goal
Total Revenue (TR) 1.
Stra Straig ight ht line line from from orig origin in
Perfect markets 1. 2.
Firms irms are are pric price e take takers rs No mark market et powe powerr for for firm firms s
Imperfect markets 1. 2.
Firms irms are are pric price e set sette ters rs Varying arying exten extentt of mark market et powe powerr of firms firms
Market structures differ in terms of 1. 2. 3. 4.
Natu Naturre of of pr produc oductt Ease of en entry Conc Concen entr trat atio ion n of fir firms ms Comp Compet etit itio ion n bet betwe ween en firm firms s
Equilibrium Output Marginal approach
Equilibrium output for all market structures at MC = MR Profits Normal profit 1. 2. 3.
TR = TC Zer Zero eco econo nomi mic c pr profit ofit No incen incentiv tive e for for firms firms to to leave leave or new ones ones to enter enter
Supernormal profits 1. 2. 3.
TR > TC Firms irms ear earns ns mor more e than than oppor opportun tunity ity cost costs s Entry Entry of of firm firms s will will depe depend nd on on ease ease of of entry entry a. If barr barrier iers s exist exist,, profi profitt level level rem remain ains s high high b. If no no entry entry barr barrier iers, s, pro profit fit leve levell goes goes down down to normal profit
1. 2.
MC = MR Since Since P = MR, P = MC. MC. Firm Firm is alloca allocative tive efficient efficient..
Total approach 1.
Point Point where where verti vertica call differ differenc ence e betwee between n TR and TC TC is the greatest
Subnormal profits 4. 5. 6.
TR < TC Firms irms mak makes es less less than than oppor opportun tunity ity cost cost Firms irms will will ceas cease e pro produc ductio tion n when when a. Reven evenue ue < Varia ariabl ble e Cost Cost,, firm firm leav leaves es in short run b. Revenue evenue > Vari Variabl able e Cost, Cost, fir firm m conti continue nues s in short run but leaves in long run
Perfect Competition Characteristics 1. 2. 3.
Homog omogen eneo eous us pr produc oducts ts No barri barriers ers to to entry, entry, hence hence a large large number number of small small firms firms Firms irms have have no mark market et power power,, price price tak takers ers
Short Run Profits Supernormal Profits
Revenue Curves Average Revenue (AR) 1. 2.
Same Same as dem deman and d curv curve e of of prod produc uctt Perfec rfectl tly y elas elasti tic c http://education.helixated.com An Open Source Education Project
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New firms will enter → Industry’s supply increases → Price falls until normal profit Normal Profits
Evaluation of Perfection Competition Pros 1.
Alloc Allocati ative ve effici efficient ent,, sum of consum consumer er surplu surplus s and produce producerr surplus is maximum
2. 3. 4.
Product Production ion at least least cost output, output, minim minimum um effic efficient ient scale scale Normal profit Ease Ease of of move moveme ment nt of of reso resour urce ces s
Subnormal Profits
Cons 1. 2. 3.
Soci Social al effi effici cien ency cy is not not atta attain inab able le with withou outt gove govern rnme ment nt intervention when externalities are present Litt Little le ince incent ntiv ive e to to inn innov ovat ate e Abse Absenc nce e of of pro produ duct ct vari variet ety y
Monopoly Firm’s objective shifts to loss minimisation. Long Run Profits 1. 2.
Normal profi t Price Price = Minimum Minimum of AC AC (minim (minimum um efficient efficient scale) scale)
Characteristics 1. 2. 3. 4.
No clos close e sub subst stit itut utes es Str Strong ong barr barrie iers rs to to ent entry ry Only firm Str Strong ong mar mark ket powe powerr
Barriers to Entry 1.
2. 3.
Cost co condition a. High Highly ly capi capita tall-in inte tens nsiv ive e b. Minim inimu um effic fficiient ent scal scale e occu occurs rs at high igh output Legal ba barriers Cont Contri rive ved d barr barrie iers rs a. Cont Contro roll of inpu inputt supp suppli lies es b. Brand loyalty
Revenue Curves
From supernormal profits to long run equilibrium, AR/MR moves down
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Different types of consumers (with different price elasticity of demand) charged differently Less Less elasti elastic c mark market et charg charged ed higher higher
Two effects:
Equilibrium Supernormal profits due to: 1.
P > MC
2.
Price discrimination
3. 4.
Lower Lower costs costs from from econom economies ies of scale scale Ince Incent ntiv ive e to to inn innov ovat ate e
1.
Absorp Absorptio tion n of consu consumer mer surplu surplus s by firm firm
2.
Allocatively efficient efficient as in 1st degree
Pros 1. 2. 3.
Highe Higherr consu consump mptio tion n level level made made poss possibl ible e Extr Extra a rev reven enue ue is rein reinve vest sted ed Enables Enables firms firms to to supply supply otherwise otherwise unprofita unprofitable ble goods goods
Evaluation of Monopoly Pros 1.
Cost ad advantage a. Econom Economies ies of of scale scale and and R&D R&D will will lead lead to lower lower MC MC b. Price Price can be lower lower and output output (MC (MC = MR) MR) can can be be higher than allocative efficient level of PC (P = MC)
2. 3.
Resea esearc rch h and and deve develo lopm pmen entt Lower Lower cost cost despit despite e not not produc producing ing at at minimu minimum m effici efficient ent scale scale as MC is lower
c. Shaded area = Supernormal Supernormal profits
Lower MC → Larger consumer surplus
Price Discrimination
Cons
A practi practice ce of firms firms chargi charging ng differ different ent prices prices for for the same same products, unsupported by cost reasons
1. 2.
Allo Alloca cati tive vely ly inef ineffi fici cien entt High Higher er pric price, e, lowe lowerr out outpu putt a. Produ Producti ction on at MC = MR MR and and not P = MC b. Loss Loss of cons consum umer er surp surplu lus s
3.
Inco ncome ineq inequ uali ality
Conditions Necessary 1. 2. 3.
Mark arkets ets ar are sep separ arab able le Differin Differing g price price elasticit elasticities ies of deman demand d betwee between n mark markets ets Resal esale e of pro produ duct ct not not pos possi sibl ble e
1st Degree Price Discrimination 1. 2. 3.
Diffe Differen rentt pric price e for for every every custom customer er No cons consum umer er surp surplu lus s left left Allo Alloca cati tive vely ly eff effic icie ient nt (P (P = MC) MC)
2nd Degree Price Discrimination 1.
Charging Charging differen differently tly acco accordin rding g to blocks blocks of of consum consumption ption
Theory of Contestable Markets 1. 2. 3.
Price, Price, output output and behaviour behaviour in an industry industry is determ determined ined by the threat of competition Monop Monopoli olies es forc forced ed to be more more effic efficien ientt and lower lower price price to prevent new entrants Factors actors favour favouring ing contes contestab tabili ility ty:: a. Free tra trade poli olicy b. Der Deregul egulat atio ion n tren trend d
Controlling Monopolies 3rd Degree Price Discrimination
1.
Regulat egulation ion on pricin pricing g and output output
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Transferri ransferring ng monop monopoly oly to to govern government ment (national (nationalisati isation) on) Taxes Legis Legislat lation ions s and and anti-t anti-trus rustt polic policies ies
Monopolistic Competition Characteristics 1. 2. 3. 4.
Slight Slightly ly differ different entiat iated ed produ products cts Entr Entry y of fir firms ms is is rela relati tive vely ly eas easy y Many any small all fir firms Mild market market power power due to to slight slight product product differen differentiati tiation on
Revenue Curve 1.
Same Same as mono monopol poly, y, with with lower lower price price elas elastic ticity ity
Short Run Profit 1.
Supe Supern rno ormal rmal prof profit its s Monopolistic Competition leads to: 1. 2. 3.
Higher pr price Lower ou output Higher AC
Compa Comparis rison on Monopoly 1. 2.
2.
betw betwee een n
Monop Monopol olist istic ic
Comp Competi etiti tion on
and
Lack Lack of of R&D R&D due to norma normall pro profit fits s Monop Monopoli olisti stic c competi competitio tion’s n’s small smaller er scale scale leads leads to higher higher costs
Oligopoly
Normal pr profi ts ts
Characteristics 1. 2. 3. 4.
Diff Differ eren enti tiat ated ed prod produc ucts ts Restr estric icte ted d entr entry y of of new new firm firms s Few la large fi firms a. Two firm firms s - Duop Duopol oly y Inte Interd rdep epen ende denc nce e amon among g firm firms s
Alternative Theories of Oligopoly’s Price-Output Non-collusive 1. 3.
Price Price rigidi rigidity ty with with kin kinke ked d dem demand and
Subno ubnorm rmal al pr profit ofits s a. AC above AR
Long Run Profit
1.
Decrease in demand for firms → MR and AR shifts to the left and become more elastic Normal pr profi ts ts Outp Output ut fall falls s sho short rt of MES MES
Evaluation of Monopolistic Competition
b.
Rise in price → others others do not follow follow → revenue revenue falls → demand is elastic
1. 2. 3. 4.
Cartel Domi Domina nant nt fir firm m pric price e lead leader ersh ship ip Baro Baromet metric ric firm firm price price leader leadershi ship p ‘Rul ‘Rule e of of thum thumb’ b’ pric pricin ing g
➢
Collusion best when: I. Few firms II. II. Iden Identi tica call prod produc ucts ts III. Awaren Awareness ess of methods methods and common common costs IV. No new new comp compet etit itio ion n
Pros 1.
Smal Smalll mar margi gin n of of P > MC MC
2.
Economies of scale → lower LRAC, lower MC, higher output
3.
Produc oductt vari variet etiies
Evaluation of Oligopoly Pros
Cons 1. 2. 3.
Drop Drop in price price → others others follow → revenue revenue falls → demand is inelastic
Collusive
Supernormal profits → entry of new firms
a.
2. 3.
a.
1. 2.
Allo Alloca cati tive ve ine ineff ffic icie ient nt (P (P > MC) MC) Exces Excess s capaci capacity ty betwe between en LR outp output ut ant ant MES outp output ut Lack of R&D
Compa Comparis rison on betwe between en Perfect Competition
Monop Monopoli olisti stic c
Compe Competit tition ion
R&D Prod Produc uctt diff differ eren enti tiat atio ion n
Cons and
1. 2. 3. 4.
Alloc Allocati ativel vely y ineffi inefficie cient nt (P > MC) MC) Wasta astage ge of reso resour urce ces s Smaller Smaller scale scale of of produ productio ction n compa compared red to monopoly monopoly Firms irms may may collu collude de and and behave behave as as a monop monopoly oly
Non-Price Competition
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Produ Product ct develo developme pment nt and innova innovatio tion n Marketing
