market structures recap lecture (flt) 2
TRANSCRIPT
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Focused Learning Time
REVISION SERIES
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PJL
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SSSSPPPPEEEECCCCTTTTRRRRUUUUMMMMof competition
Perfect
Competition
MonopolyMonopolistic
Competition
Oligopoly
Degree of competition
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Structure
Conduct
Performance
influences
influences
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StructureKnowledgeof product
Nature ofproduct
Number ofsellers
Barriers toentry
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Features PerfectCompetition MonopolisticCompetition Oligopoly Monopoly
Number ofsellers
Many smallfirms, each withinsignificant
market share
Many smallfirms, each withinsignificant
market share
Few dominantand mutually
interdependentfirms, whotogether control
a significantportion of
market share
Single seller
Barriers toentry
No barriers toentry
Very lowbarriers to
entry
High barriers toentry
Very highbarriers to
entry
Type ofproduct
Homogeneousproducts
Differentiatedproducts
Usuallydifferentiatedproducts
Unique productwith no closesubstitutes
Knowledgeof product
Perfectknowledge
Imperfect knowledge
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Barriers to entry
Artificial Natural Very huge sunk costs
relative to mkt demand
natural monopoly
Exclusive control ofessential raw materials
Contrived barriers (e.g., cartel,mergers and acquisitions)
Legal barriers (e.g., patents,copyrights, tariffs)
Price war
Non-price competition
- Product differentiation- Advertising
anything that prevents or impedes the entry of firms intoan industry and thereby limits the amount of competition
faced by existing firms
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Reminder for Perfect Competition
Individual firms can sell all they want at the prevailing
market price, P*
P
Qty
Industry (Market)
P
Qty
Individual Firm
Mkt Ss
Mkt Dd
Price determined by mkt
Individual firms musttake the mkt price
Indvs Dd
P*P*
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Reminder for Monopolistic CompetitionReminder for Monopolistic CompetitionReminder for Monopolistic CompetitionReminder for Monopolistic Competition
No market demand curve
Firms have some degree ofmonopoly power over itsproducts
Contingent on productdifferentiation
Non-price competition
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Reminder for Monopoly
Firms DD curve =Industry DD curve
Contingent on the
maintenance of barriersto entry
Monopoly can influenceeitherprice oroutput, butnot both
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Something to Think AboutType of market structure depends on
definition of industry
EXAMPLE:
Restaurants
Restaurants in Vivocity Spanish restaurant in Vivocity
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ConductOthers (e.g., price
discrimination)
Non-pricecompetitionPricecompetition
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Conduct of PC Firm If firm sells its goods above the set
market price, consumers will simplybuy from any other firm
No incentive to lower price either,
since the seller can sell all hewants at the prevailing market price
Therefore, no price competition
Also no non-price competitioneither, since homogeneous product
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Conduct of Monopolistic Competition
Tend to avoid price competition
prices cannot be cut indefinitely +potential gain in market share issmall + no supernormal profits to
fall back on
Prefer non-price competition product promotion + product
development
Degree of non-price competition will
be less than oligopoly
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Product Differentiation Real physical differences
Imaginary differences
Different conditions of sale
LN P14
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Product Differentiation Increase demand
Demand more price inelastic
GIVE MEMORE!!!!!
I only want
this!!!!!
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Conduct of Oligopoly
Collusive
model
Competitive
model
VS
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CollusionCartel Price leadership
DominantPrice
Leadership
BarometricLeadership
formal informal/tacit
Act as one to determineprice by controllingcombined output
Predetermined market share
Incentive to cheat
Reduceunpredictability of
rivals reactions
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CompetitionKinked Demand Curve
D = AR
Quantity
MR
Firm will not match each others priceincrease perceive a price elasticdemand
Firms will match each othersprice reduction perceive a priceinelastic demand
Region ofindeterminacy
Price
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CompetitionKinked Demand Curve
D = AR
Quantity
Price
MR
Should MC fluctuate within thisregion, firm will absorb higher
costs same profit-maximising level
Significance of regionof indeterminacy
MC1
MC3MC2
Q*
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CompetitionKinked Demand Curve
Offers some insight as to why prices inoligopoly tend to be rigid (sticky)
However,
Model does not explain how the prices are set inthe first place
Price stability could be due to other factors
Menu costs
Fear of harming firms image
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Other Points to Note Degree of non-price competition
distinguishes oligopolies and MPC firms
- Real incentives for oligopolies compete
extensively using non-price competition potentially huge profits!
Behaviour of oligopolies maychange quite radically over time
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Conduct of Monopoly Monopoly will strive to
maintain its barriers to entry(e.g., through advertising,legal protection, R&D)
Price discrimination
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PriceDiscrimination
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Price discrimination occurs when
Same commodity at differentprices
For reasons other than differencesin cost of production
Examples:Different bus fares for adults and kids
Different movie prices for weekends
Definition
LN P21
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Definition
Price discrimination is nota resultof differences in cost of production
Price differentiation:
$2 chicken rice at hawker centre
vs
$3 chicken rice at foodcourt
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Market power
Market segmentation (no resale)
Each market has different PED
Conditions
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Charge the maximum price thecustomer is willing and able to
pay for each unit bought(reservation price)
aka perfect price discrimination Dd curve is now new MR curve incremental revenue earned from each additional unit is
simply the price paid for that unit
First Degree P.D.
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First Degree P.D.
7
MR = Dd
Price
Qty
1 2 3
8
6
Firm can capture all of theconsumer surplus if o/pis divisible into infinitelysmall units
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Evaluation
In practice, almost impossible impractical
unknown reservation price
First Degree P.D.
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Charge different prices fordifferent blocks of the same
good according to how muchconsumer purchases
aka block pricing
Second Degree P.D.
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Second Degree P.D.
7
AR = Dd
Price
Qty
100 200 300
8
6
Additional revenue bythe monopoly = loss ofconsumer surplus
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Third Degree P.D.
Charge different prices for samegood according to different buyers
Higher price charged in market withmore price inelastic demand curve
Distribute o/p in each market suchthat MC = MR = same in both markets
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Third Degree P.D.
Market X Market Y Market X + Y
Price Price Price
Qty Qty Qty
9
7
5Dx Dy
MRTotal
MRx MRy
MC
1000 2000 3000
5 5
Note: higher price charged in the market with the less price elastic demand curve
Horizontal summation
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Oligopolist, arguably, will
engage in greater degreeof non-price
competition, as there is apossibility of capturing asignificant share of the
market (unlike themonopolisticallycompetitive firm)
ConductBecause of the mutual
interdependence of firms,oligopolists may choose
collude, compared to othermarket structures where such
conduct is unlikely.
Because of differentfeatures of the market
structures, firms in each ofthese markets maybehave differently
Both oligopolists andmonopolistically
competitive firms are likelyto avoid price
competition in favour ofnon-price competition
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Performance
EfficiencyPrice and
output levels
Profitability
EquityInnovationConsumer
Choice
Allocativeefficiency
Productiveefficiency
X-inefficiency
SR LR
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Profitability
Firms in all 4 market structures can earnsupernormal, normal and subnormalprofits in the SR
Firms in all 4 market structures earn atleast normal profits in the LR (i.e., cannot
make subnormal profits in the LR) Oligopolists and monopolists can earn
supernormal profits in the LR
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MC = MR
If MC < MRthe addition of the last unit of output
adds more to total revenue than it does to total cost
[YES! Produce that last unit]
If MC > MR
the addition of the last unit of output
adds more to total cost than it does to total revenue
[NO! Dont produce that last unit]
Hence, firm will product up to the point where MC = MR
Conditions for Profit-Maximisation
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Conditions for Profit-Maximisation
MR > MC MC > MR
For a perfectly
competitive firm
DD = MR = AR
P/C/R
Q
MC
Q
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Conditions for Profit-Maximisation
MR > MC MC > MR
For an imperfectlycompetitive firm
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SR Equilibrium In the SR, firms in all market structures
can make Supernormal profits
Normal profits Subnormal profits
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SR Equilibrium In the SR, PC firms can make
Supernormal profits
.
Price
Output0
ATC
MC
P = AR = MRP
q
AC
B
MC = MRTR = ?
TC = ?
TR > TC
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SR Equilibrium In the SR, PC firms can make
Normal profitsPrice
Output
0
ATC
MC
.
P = AR = MRP
q
B
MC = MR
TR = ?
TC = ?
TR = TC
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SR Equilibrium In the SR, PC firms can make
Subnormal profits
.
Price
Output
0
MC
.
P = AR = MRP
q
C
B
MC = MR
ATC
A
TR = ?
TC = ?
TR < TC
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SR Equilibrium In the SR, firms under imperfect market structure can make
Supernormal profits
Price
Output0
ATC
MCTR = ?
TC = ?
TR > TC
AR
MR
MC = MR
P
q
BC
A
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P
q
A
Price
Output0
TR = ?
TC = ?
TR = TC
AR
MR
MCATC
MC = MR
SR Equilibrium In the SR, firms under imperfect market structure can make
Normal profits
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Price
Output0
TR = ?
TC = ?
TR < TC
AR
MR
MC ATC
P
q
B
CA
MC = MR
SR Equilibrium In the SR, firms under imperfect market structure can make
Subnormal profits
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LR Equilibrium In the LR, PC firms can onlymake
normal profits, because of theassumption of no barriers to entry If supernormal profits are made, firms
enter the industry with ease and competein the industry supernormal profitseroded
If subnormal profits are made, firms leavethe industry with ease the remainingfirms return to normal profits
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LR EquilibriumP
Qty
Market
p
qty
Individual Firm
D
ATC
MC
d0P0 p0
S0
Q0 q0
S1
d1p1P1
Q1 q1
LN P8
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LR Equilibrium In the LR, the MPC firm can only make
normal profits Supernormal profits new firms enter
(ease of entry) Subnormal profits existing firms exit(ease of exit)
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LR Equilibrium Supernormal profits
new firms enter
potential substitutes
consumers have wider range of productsto choose from
dd falls and becomes more price elastic
for each firms product
normal profits in the LR
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LR Equilibrium In the LR, the monopoly can make
supernormal profits, as long as it isable to keep potential firms from
entering the industry In the LR, the monopoly will continue
production only if it can at least make
normal profits
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Price and Output
Compared to monopoly, PC has higheroutput and lower price
UNLESS monopoly can tap significant EOS(in which case, output may be higher, pricemay be lower)
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DD = AR
P/C/R
Q
MCMonopoly = SSPC industry
MR
QM QC
PM
PC
Assuming same cost conditions
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DD = AR
P/C/R
Q
MCMonopoly
MR
QC QM
PC
PM
Assuming different cost conditions
SSPC industry
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Efficiency
Condition: P = MC Only PC firm and monopoly that practices
perfect price discrimination is allocativelyefficient
All firms can be productively efficient if
they produce on LRAC Monopolist may be X-inefficient
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DD = AR
P/C/R
Q
MCMonopoly = SSPC industry
MR
QM QC
PM
PC
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Equity
PC firm is equitable, since consumer andproducer surpluses are maximised
Under monopoly, part of consumer surpluslost to producer, hence inequity
Monopoly which practices perfect price
discrimination is most inequitable, since allconsumer surplus transferred to producer
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DD = AR
P/C/R
Q
MCMonopoly = SSPC industry
MR
QM QC
PM
PC
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DD = MR
P/C/R
Q
MC Price discriminating monopoly
QM
PM
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Innovation
PC firm has neither incentive nor ability to innovate Monopoly has the ability to innovate since it can earn
supernormal profits, but level of innovation depends onthreat of potential competition
Oligopolist has greater ability and incentive to innovatethan a monopolistically competitive firm, since it canpotentially capture a significant market share
Level of innovation depends on many factors including Contestability of market
Extent and duration of government intervention
Other costs and benefits of innovation
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Consumer Choice
Homogeneous products lack of consumerchoice
Differentiated products greater consumer
choice May be a trade-off between consumer choice
and lower prices, since production of
homogenous products may allow for large scaleproduction and hence the tapping of EOS
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Performance by Industry
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Performance of PC Firm Profitability
SR: supernormal, normal and subnormal
profits LR: only normal profits
Efficiency
Allocatively efficient (P=MC)
Productively efficient (on LRAC) Equity equitable
R&D
Lack of ability: no supernormal profits in LR
Lack of incentive: others will copy (perfectknowledge)
Lack of consumer choice (homogeneous)
Performance of
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Monopolistic Competition Profitability
SR: supernormal, normal and subnormal profits
LR: can earn only normal profits Efficiency
Allocatively inefficient (P>MC)
Productively efficient (if on LRAC)
Equity
Reduced inequity as normal profits are made in the LR (i.e.,minimum necessary to keep firm in production)
R&D
No ability: no supernormal profits
Has more incentive than PC, but less than oligopoly andmonopoly
Wide consumer choice (product differentiation)
Wasteful competition (advertisement to create imaginary differences)
Performance of Oligopoly
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Performance of Oligopoly
Profitability
SR: supernormal, normal and subnormal profits
LR: can earn supernormal, at least normal profits Efficiency
Allocatively inefficient (P>MC)
Productively efficient (if on LRAC)
Equity
Economies of scale (less than monopoly) can keep costs, andhence prices, low
Extensive advertising may result in higher cost and hencehigher prices
R&D Has ability: earns supernormal profits in LR
Has considerable incentive: can capture large market share
Wide consumer choice (product differentiation)
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Performance of Monopoly Profitability
SR: supernormal, normal and subnormal profits
LR: can earn supernormal, at least normal profits Efficiency
Allocatively inefficient (P>MC)
Productively efficient (if on LRAC)
Could be X-inefficient
Equity inequitable as consumer surplus lost toproducer
R&D
Has ability: earns supernormal profits in LR
Incentive: depends on degree of threat ofpotential competition
Lack of consumer choice (no close substitutes)
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Loss of consumer surplus
Consumer may not have been able toafford the good if not for price
discrimination
Higher profits: for producer
for consumer if price increase
for consumer if reinvested in R&D to
improve products and lower costs in the LR
Performance of Monopolypractising price discrimination
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Producers may use high profitsfrom one market to withstandpossible price war in breaking into
another market Provision of goods that would
otherwise not be produced due tohigh costs
Performance of Monopolypractising price discrimination
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Quantity
ATC
Quantit
D = MR
q
ATCTC
A
0
PricePrice
P
C
E
MCMC
TR
Quantity
MR
q
ATC
A
B
D
Quantity
MR
q
ATC
LossesLosses
AA
BB
0
Performance of Monopolypractising price discrimination
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Structure
Conduct
Performance
influences
influences