competition, market structures and business decisions

8/6/2019 Competition, Market Structures and Business Decisions

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A market consists of all firms andindividuals willing and able to buy or sell

a particular product at a given time andplace.



Competition, market structures and business decisions


Market structures

Market structures

Perfectcompetition

Perfect

competition

Oligopoly

Oligopoly

The firm in competitive markets

The firm in competitive markets

Monopoly

Monopoly

Non-perfect competition

Non-perfect competition

Monopolisticcompetition

Monopolisticcompetition



Identical productVery small share of the marketPrice-taker

Produces a homogeneous productPerfect informationNo barriers to entry (legal,

technological, or resource)

No technical progressOpportunity for normal profits in long

run equilibrium ie. P= MC andP=AR=AC



Examples of Competitive Markets Agricultural commodities. ( Milk market)

Unskilled labor market. Restaurant business. ( in USA there are 900,000

restaurants brings about 45o billion $ in annualsales with an avg of 500000$ per year. There is a

restaurant for every 300 people, with easy entryand exit and lots of buyer n sellers, goodinformation and standard food quality, so it isnext to impossible to make above normal profits)



Profit Maximization Imperative Normal profit is return necessary to attract and

maintain capital investment. Efficient firms can earn normal profit. Inefficient firms suffer losses.

Role of Marginal Analysis Set Mπ = MR – MC = 0 to maximize profits. MR=MC when profits are maximized.



Market structuresMarket structures “Perfect competition” – competitive markets

Long Run Normal Profit

EquilibriumWith a horizontal market

demand curve, MR=P.

P=MR=MC=ATC.

There are no economicprofits.

All firms earn a normalrate of return.



Market structuresMarket structures Monopoly

One firm in industry Profit-maximiser

Faces market demand curve One product No close substitutes Price-maker No restrictions on resources Blockaded entry and/or exit

Imperfect dissemination of information Opportunity for economic profits in long-run equilibrium.



Competition, market structures and business decisionsCompetition, market structures and business decisions


Profit Maximization in Monopoly Markets Price/Output Decisions

A monopoly firm is themarket.

Market and firm demandcurve slopes downward.

Monopoly demand curve

is always above themarginal revenue curve,P = AR > MR.

Monopoly position allowsabove-normal profits.

P > AC in long-runequilibrium.

Set Mπ = MR - MC = 0 tomaximize profits.

MR=MC at optimaloutput.



Economies of Scale

Monopoly is sometimes the natural result of vigorouscompetitive forces.

In natural monopoly, LRAC declines continuously and onefirm is most efficient.

Some real-world monopolies are government-created or government-maintained.

Invention and Innovation

Public policy sometimes confers explicit monopoly rights to

spur productivity.





Dilemma of Natural Monopoly

Monopoly has the potential for efficiency.

Unregulated monopoly can lead to economic profits andunderproduction.





Buyer Power

Oligopsony exists when there are only a

handful of buyers.Monopsony exists if there is only one

buyer.

Buyer power can be used to obtain less

than competitive market prices.





Bilateral Monopoly

IllustrationUnrestrained

monopoly getshigher thancompetitivemarket prices.

Unrestrainedmonopsony getslower thancompetitivemarket prices.

Monopoly/monopsony confrontationbreedscompromise.



C titi k t t t d b i d i i




Market structuresMarket structures In the “real life”

• A typical firm, if it is not a small one, is not owner-managed

• Separation of ownership, long-term strategic and short-runcurrent control (shareholders, board of directors, brunchmanagers) implies the segregation of objectives;

• Natural, economic and legal barriers• Diversification (non-homogenous product, more than one kind of

activity)

• Technical progress

• Different criteria for different time horizons (short-run operationvs long-run planning.

• Price-making

• Price/marketing strategies

• Imperfect information

• Investment lag

A “real” firm in a market place(compare to the “ideal” one):




Monopolistic Competition

Large number of sellers that offer differentiated products.

Normal profit opportunity in long-run equilibrium. Oligopoly

Few sellers.

Economic profits are possible in long-run equilibrium.

Dynamic Nature of Competition Timely market structure information is required for

managerial investment decisions


Market structuresMarket structures Oligopoly and Monopolistic Competition





Market structuresMarket structures Мonopolistic competition

• The market consists of n mono-product firms;

• The products are viewed by the buyers as close though notperfect substitutes for one another;

• Therefore, each of the sellers is a monopolist of its particular product variant with a limited degree of monopoly power.

• Such a monopolist is enjoying a monopoly power and makingeconomic profit during only a short period of time

• from the introduction of an unique product or technology

• until such a technology becomes available to rivals, or

• until a new “more innovative” product is introduced by arival.




Q

Short-run Monopoly Equilibrium

Monopolistically competitive firms take

full advantage of short-run monopoly.



Price

Costs

Quantity

MR Demand

MC AC

Qmc

Pmc

Competition market structures and business decisions



Long-run equilibriumsame costs, lowerdemand and excesscapacity – low output

high price decisionWith differentiated



riceosts

QuantityMR1

D1

MC AC

MR2

D2

Price

Costs

Quantity

MC AC

Pmc

Qmc

MRD

Entry of new firmsoffering

product substitutesshifts the demand



Oligopoly Market Characteristics

Few sellers.

Homogenous or unique products.

Blockaded entry and exit.

Imperfect dissemination of information.

Opportunity for above-normal (economic) profits in long-run equilibrium.

Examples of Oligopoly

National markets for aluminum, cigarettes, electricalequipment, filmed entertainment, ready-to-eat cereals, etc.

Local retail markets for gasoline, food, specializedservices, etc.


Market structuresMarket structures Oligipoly




Overt and Covert Agreements

Cartels operate under formal agreements.

Powerful cartels function as a monopoly.

Collusion exists when firms reach secret, covertagreements.

Enforcement Problem

Cartels are typically rather short-lived because

coordination problems often lead to cheating. Cartel subversion can be extremely profitable.

Detecting the source of secret price concessions can beextremely difficult.








Cartels and Collusion







Oligopoly Output-Setting Models

Cournot Oligopoly

Cournot equilibriumoutput is found bysimultaneously solvingoutput-reaction curvesfor both competitors.

Cournot equilibriumoutput exceedsmonopoly output but isless than competitiveoutput.







Stackelberg Oligopoly

• Stackelberg model posits a first-mover advantage.• Price wars severely undermine profitability for both leading

and following firms.

• Price signaling can reduce uncertainty in oligopoly markets.

• Price leadership occurs when firms follow the industryleader’s pricing policy.







Stackelberg Oligopoly• Price leader sets

the price at P2

• Profit is maximisedat Q1.

• The follower(s) will

supply thecombined output of Q4-Q1

• At P3- Follows will

supply everything

At P1 – the leader will

supply everythingat no economicprofit







Oligopoly Price-Setting Models

BertrandOligopoly:Identical Products

The Bertrandmodel focusesupon the price

reactions.

The Bertrandmodel predicts acompetitivemarket

price/outputsolution inoligopoly marketswith identicalproducts.







Oligopoly Price-Setting Models

BertrandOligopoly:Identical Products

The Bertrandmodel focusesupon the price

reactions. The Bertrand

model predicts acompetitivemarket

price/outputsolution inoligopoly marketswith identicalproducts.





Types of Games Zero-sum game: offsetting gains/losses.

Positive sum game: potential for mutual gain.

Negative-sum game: potential for mutual loss.

Cooperative games: joint action is favored.

Role of Interdependence Sequential games: moves in succession.

Simultaneous-move game: coincident moves.

Strategic Considerations


Market structuresMarket structures Game Theory Basics





Classic Riddle Rational behavior can give suboptimal result.

Rationality can hamper beneficial cooperation.

Business Application Dominant strategy gives best result regardless of moves

by other players.

Secure strategy gives best result assuming the worstpossible scenario.

Broad Implications

Competition, market structures and business decisionsp ,






Nash Equilibrium Concept Neither player can improve their payoff through a unilateral

change in strategy.

Nash equilibrium concept is broader than the concept of adominant strategy equilibrium.

– Every dominant strategy equilibrium is also a Nashequilibrium.

– Nash equilibrium can exist where there is no

dominant strategy equilibrium. Nash Bargaining







Role of Reputation Infinitely repeated games occur over and over again

without boundary or limit.

Firms receive sequential payoffs that shape current andfuture strategies.

Reputations for high quality give consumers confidencefor repeat transactions.

Product Quality Games In a one-shot game, poor quality can fool customers.

In an infinitely repeated game, poor quality is shunned bycustomers.







Uncertain Final Period Finitely repeated games have limited duration.

With end point uncertainty, a finitely repeated game

mirrors an infinitely repeated game. End-of-game Problem

Enforcing end-of-game performance is difficult.

Solution: simply extend the game!

First-mover Advantages Benefits earned by the player able to make the initial move

in a sequential move or multistage game.

Competition, market structures and business decisionsp







Competitive strategies in Imperfectly competitivemarkets


s Not all industries offer the samepotential for sustained profitability;

s Not all firms are equally capable of exploring the profit potential that isavailable.

s An effective competitive strategy inimperfectly competitive markets must befounded on the firms competitiveadvantage.

s Not all industries offer the samepotential for sustained profitability;

s Not all firms are equally capable of exploring the profit potential that isavailable.

s An effective competitive strategy inimperfectly competitive markets must befounded on the firms competitiveadvantage.








s A competitive advantage is a unique or rare ability to

create, distribute or service valued by customers.s It is a business-world analogue to what economists

call comparative advantage or when one nation or region of the country is better suited to theproduction of one product than to the production of

some other products Above-normal rate of return require a competitive

advantage that cannot easily be copied

In production;

In distribution; or In marketing

s A competitive advantage is a unique or rare ability to

create, distribute or service valued by customers.s It is a business-world analogue to what economists

call comparative advantage or when one nation or region of the country is better suited to theproduction of one product than to the production of

some other products Above-normal rate of return require a competitive

advantage that cannot easily be copied

In production;

In distribution; or In marketing








sReasons for competitive advantage:

sAccess to a unique resources(Exclusive) Access to a mineral deposit

s(Exclusive) Access to a material

sEfficient energy source

sUnique climatic condition

sUnique technology

sUnique (specially qualified or very talented) labour force; or

sAccess to a unique market

sA university bookshop

sThe rice market in Japan

s

etc

sReasons for competitive advantage:

sAccess to a unique resources(Exclusive) Access to a mineral deposit

s(Exclusive) Access to a material

sEfficient energy source

sUnique climatic condition

sUnique technology

sUnique (specially qualified or very talented) labour force; or

sAccess to a unique market

sA university bookshop

sThe rice market in Japan

s

etc






Non-price competition.Non-price competition.

Product differentiationProduct differentiation

Product differentiation refers to the

increase in time of the number of product categoriessupplied and the number of items in each category

Product differentiation refers to the

increase in time of the number of product categoriessupplied and the number of items in each category

s Historically, a step from oligopolistic to monopolisticcompetition

s Historically, a step from oligopolistic to monopolisticcompetition







Product differentiationProduct differentiation

A simple model of the reason for product differentiation

Price

QuantityQ

P

P*

• Considers constantquantity as well as non-changing AC and MCcorresponding to thisquantity

• Producing a little bitdifferent product a firmmight hope to charge a

higher price





p ,


Barriers to entryBarriers to entry

Price

Quantity Q

P

P*

LAC

LAC*

Absolute cost advantages:

Ability of established firms to

produce any given level of output

at lower unit costs than potential entrants

Q*





Price

Quantity Q*

P

Economies of scale:

Ability of established firms

* To produce any given level of output

greater than a certain level Q* at

lower unit costs and * To restrict potential entrants who are

not able to invest in that level of

production

D

LAC

p ,







Price

QuantityQ*

P*

Product differentiationadvantages:

Variety of demand curves

and common LAC.

Some firms have advantage of

technology or specialisation and

are facing demand curves to the

right of the critical one.

D1

LAC

D2 D2

p ,







Appear as the result of

• Ability to affect prices and

• Separation of ownership and managerial control

Appear as the result of

• Ability to affect prices and

• Separation of ownership and managerial control

* Managers’ aim at stability and increase in salaries

Stability may be achieved through the increase in thescale of operations Increase in sales (not in profit) affectsmanager’s remuneration Banks and retailers wouldprefer to deal with firms increasing the volume of sales

p

Non-profit-maximising competition.Non-profit-maximising competition.





DMR

AC

MC

Q

P, Cost

Profitmaximising

decision

Non-profit-maximisingcompetition.






DMR

Q

P, Cost

Profitmaximising

decision

Salesmaximisingdecision

Increasing sales, the firm ismoving to the right anddownward the demand

curve and, therefore,decreases price,

The limitation is AC curve.Some profit should beearned anyway







DMR

AC

MC

Q

P, Cost

Profitmaximising

decision





N fi i i i



Old sales maximising decision is a profitmaximising decision at a new levelof average cost

Old profitmaximisin

gdecision

New profitmaximisin

gdecision

DMR

AC

MC

Q

P, Cost





M t f k t t t



Measurement of market structuresMeasurement of market structures

Seller concentrationSeller concentration

Seller concentration refers to the degree to which production for aparticular market or or in a particular industry

is concentrated in the hand of few large firms

Seller concentration refers to the degree to which production for aparticular market or or in a particular industry

is concentrated in the hand of few large firms

• number of firms in the market

• size distribution of firms in the market

Measurement of concentration



M t f k t t t





8140.0.55.001 Industry

Concentration Statistics

The

Australian

Bureau of Statistics



M t f k t t t





C2542 - Paint Manufacturing in Australia

KEY COMPETITORS (www.ibisworld.com.au/static/iwabout/SamIndPart.asp)

MAJOR PLAYERS

7.00% - 9.00%(2003)

Akzo Nobel Industries Limited

9.00% - 11.00%

(2004)

Barloworld Australia Pty Limited

17.00% - 19.00%(2004)

Wattyl Limited

22.00% - 25.00%(2004)

Orica Limited

Market Share

RangeMajor Player

Table: Market Share



Meas rement of market str ct res

http://www.ibisworld.com.au/static/iwabout/SamIndPart.asp

http://www.ibisworld.com.au/enterprise/detail.asp?enterprise_id=300










http://www.ibisworld.com.au/static/iwabout/SamIndPart.asp



Thefirmsintheindustryaresorted

accordingtothesizeof their output. X

i - theoutput of thefirm

X - theoutput of industry

X

X

i

- theshareof thefirmintheindustry

output

Theratioof r lagest firmsintheindustry

output

C X

X

X

X

X

X

X

X

r

i

i

r

r = = + ++=

∑1

1 2. . .






Concentration Ratios Group market share data are called concentration ratios. CRi = ∑ Xi, where Xi is market share of the ith leading firm.

– CRi = 100 for monopoly.

– CRi ≈ 0 for a perfectly competitive industry. Herfindahl-Hirschmann Index Calculated in percentage terms, the HHI is the sum of squared

market shares for all competitors. HHI = ∑ Xi2, where Xi2 is squared market share of the ith firm.

– HHI = 10,000 for monopoly. – HHI ≈ 0 for a perfectly competitive industry.

Limitations of Census Information Slow reports hinder usefulness. National statistics obscure local markets.



Measurement of market structures



N


Diagrammatic

approach

No of firms cumulated from the largest

Cumula t

ive%

ofoutput

100%

The curve of equal

distribution of shares

of the market among

firms

The curve of real (not equal distribution

This distance measures

concentration





M lti ti l i V ti l d h i t l di ti



Multinational companies. Vertical and horizontal coordination.Multinational companies. Vertical and horizontal coordination.

DiversificationDiversification

Vertical coordinationVertical coordination

Multinational companyMultinational company



M lti ti l i V ti l d h i t l di ti



Invest in production

facilities to produce

a product D A firm X producing

a good A

Buys shares of

a firm Y producing a good B

Invents a new

product C


DiversificationDiversification



M ltinational companies Vertical and hori ontal coordination



A firm X producing

a good A





Multinational companies Vertical and horizontal coordination




facilities or buys shares

of or coordinate activities

with a firm producing an

input D

A firm X producing

a good A












input D

A firm X producing

a good A

Invest in facilities or

buys shares of or

coordinate activities

with a firm providing

professional training

for employees












input D

A firm X producing

a good A


buys shares of or




for employees

Invest in production facilities or buys shares

of or coordinate

activities with a firm using

A as an input












input D

A firm X producing

a good A


buys shares of or




for employees

Invest in production facilities or buys shares

of or coordinate

activities with a firm using

A as an input

Invest in or buys shares


with a firm specialising in

the selling of product A





M l i i l i V i l d h i l di i




A firm producing a good A in a

home country

Establishes

branches in other

countries

Buys share of

analogous firms

in other countries

Undertake

vertical

coordination

measures abroad

Conduct

diversification

practices abroad


Multinational companyMultinational company

competition, market structures and business decisions

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