1/48
4008AFE The Economics Environment of Business
Week 5: Market Structures
Dr Alban Asllani
Lecture Outline
1 Introduction
2 Perfect Competition
3 Monopolistic competition
4 Monopoly
5 Oligopoly
6 Market Structures Summary
7 Conclusion
2/48
Previously on 101LON
3/48
• Market Equilibrium.
• Every firm seeksto maximize profits and chooses the Q∗.
• Wedistinguish between the short-run (when at least one
factor is fixed) and the long-run (when everything canvary).
• Different types of cost (revenue, product) usedto analyse
different aspects of production.
Learning Outcome
4/48
• You will acquire an understanding of the different market
structures
• You will beable to distinguish and discussthe differences
between them
• Who setsthe price and what kind of profits the firms get.
Perfect Competition
5/48
Assumptions
• There aremany firms and none of them dominates the market.
• All firms produceidentical products (product is
homogeneous).
• No entry barriers. Firms arefreeto enter or leave the market.
• Perfect information. Firms and consumersknow everything
about themarket.
• The firms areprice takers, i.e. the demandcurve (for the
firm) is horizontal.
Perfect Competition
6/48
Unrealistic
• It is obvious that most of the assumptionsarenot realistic.
• Products areneveridentical, they havesomedegree of
differentiation, e.g. high endandroidphones.
• Also it is not completely freeto enter or leave the market.
• Imperfect information. Firms and consumersdo not know
everything about the market.
• Perfect competition is auseful tool that providesinsights into
how marketsoperate.
Perfect Competition
7/48
The long-run equilibrium of the firm
8/48
Perfect competition
9/48
Perfect competition is sociallyoptimal.
• Pricesequal marginal costs. P = MC
• Long-run production is at minimum averagecost and the firm
makesonly normal profits, i.e.zero.
• Survival of the fittest: Firms areencouraged to beasefficient as
possible.
• Goods areproduced at minimumcosts
• Consumersget maximum benefit from their income.
Under perfect competition resources areoptimally allocated in the
most efficient wayof production.
Economies of scale
10/48
As wediscussedin the previous lecture:
Economies of scale refer to reduced costsper unit that arisefrom
increasedtotal output of aproduct.
• lower long run averagecost
• gain market power, becomeprice maker
However for perfect competition:
• weneedMANY small firms (price takers)
• they operate for zero profit
Perfect Competition
11/48
• Perfect Competition is unrealistic.
• There are no real world examples.
• weneedit asatool to understand theprocess
Monopolistic Competition
12/48
• There are many producers and many consumers
• Competition exists but is not perfect
• Firms differentiate their products to beat their rivals.
• They havepower over prices
Monopolistic Competition
13/48
• Demand is highly elastic dueto many closesubstitutes
• Demandcurve is not horizontal.
• The barriers to entry and exit into and out of the market are
low
The long-run equilibrium of the firm
14/48
Monopoly
15/48
• Just onecompany operating in the market
• Restricted entry into the industry or evencompletely blocked,
by law or otherwise
• Unique product, e.g. Water, train or ferry routes, etc.
• Product differentiation, brand loyalty
Monopolies
16/48
• Competitive firms areprice takers.
• Monopoly firm is aprice setters.
• Price setter: downward sloping demandcurve, rather inelastic
Monopolies
17/48
• Lower costsfor established firms, i.e. Economies of Scale
• can achievesupernormalprofits
• The fundamental causeof monopoly is barriers to entry.
Barriers to entry
18/48
• Legal Barriers to Entry: Competition and entry are restricted
by the concentration of ownership of anatural resourceor by
the granting of apublic franchise, government license,patent,
or copyright.
Example: Microsoft, railway, postal system.
• Natural Barriers to Entry: Production technology allows
onefirm to meet the entire market demandat alower price
than two or more firms could.
Example: The monopoly hasthe control of akeyresource.
DeBeerscontrols about 80% of diamonds.
Natural Monopolies
Definition
William Baumol (1977): ”An industry in which multi-firm
production is more costly than production by a monopoly” (p.
810).
• A natural monopoly could be the result of the high fixed costs or
startup costsof operating a business in aspecific industry,
e.g supply of electricity.
• And/or extremely high fixed costsof distribution, suchasexist
when large-scale infrastructure is required to ensure supply.
19/48
Regular vs Natural Monopolies
20/48
What is the difference between aregular and anatural monopoly?
• Average Total Cost (ATC) isflatter.
• ATC minimized at a higher quantity.
• A natural monopoly hasahigher advantagein cost.
Cost – Price
21/48
• Price is set when: MR = MC
• Social optimum: D = MC
• The natural monopoly can chargean evenhigher price than
the socialoptimum.
Rule of thumb: If D intersects ATC while it is still downward
sloping ⇒ Natural Monopoly, i.e. there is not enough demand
to justify another firm.
Monopoly
22/48
Monopoly
23/48
Monopoly
24/48
Monopoly
25/48
Monopoly
26/48
Monopoly vs Perfect Competition
27/48
Monopolies tend to
• Produce less
• For higher prices
• Natural monopoly hasasignificant advantagein the
production of the good (e.g. control of a key resource).
• Monopolies are inefficient in allocating production resources.
compared with prefect competition
Oligopoly
28/48
• Small number of large firms
• Interdependenceof firms
• Barriers to entry
• Collusive oligopoly: Firms club together and behave like a
monopoly (informal or formal asa“cartel”)
• Non-collusive oligopoly: Firms compete against eachother
Oligopoly
29/48
• The main reason oligopolies exist arebarriers to entry.
• In many casesalargeinvestment is neededto start abusiness
• Or the legal framework actsasabarrier.
• Example: Oil companies (OPEC) needalargeinvestment to
start drilling.
• Example: Google vsMicrosoft for office softwareapplication.
Collusive Oligopoly
30/48
• Only very few firms with power over the market
• Firms areopen to each other
• Similar products
• Similar production methods and AC
Collusive Oligopoly
31/48
• There is adominant firm
• Barriers to entry exist, thus little fearof disruption by new
firms
• The market is stable
• The governmentdoesnot intervene
• Collusive oligopoly acts like a Monopoly
Collusive Oligopoly
32/48
Non-Collusive Oligopoly
33/48
• Not many factors favouringcollusion
• Breakdown of acollusive oligopoly
• Gametheory: what is the best strategy?
Game Theory
34/48
• Game theory is ”the study of mathematical models of conflict
and cooperation between intelligent rational decision-makers”,
(Myerson, 1991)
• We can use it to understand how firms decide what, how and
when.
• If we reduce prices or produce more, what will the competitors
do?
• Two players,decidewhat is their best strategy.
• NashEquilibrium: Every player plays his best strategy.
Nash Equilibrium
35/48
• To find aNash Equilibrium you needto ask
• Knowing the strategies of the other players, and treating the
strategies of the other playersasset in stone, can I benefit by
changing mystrategy?
• If any playersanswerYES⇒ it is not aNashequilibrium as
they can chooseadifferent strategy and improve their
outcome.
• If all playersanswer NO ⇒ Nash Equilibrium
• NashEquilibrium: Every player plays his best strategy.
Prisoner’s Dilemma
36/48
• Two people, Amelia and Bill, aresuspected of committing a
crime and arebeing interrogated in separate rooms.
• Both want to minimize their jail sentences
• Both of them facethe same scenario
• They can chooseto blamethe other party or denythe crime
Prisoner’s Dilemma
37/48
Player Amelia
Blame Deny
Player Bill
Blame
Deny
| –5,–5 | –10,0 |
| 0,–10 | –1,–1 |
AssignmentTutorOnline
Prisoner’s Dilemma
38/48
Amelia’s beststrategy
Player Amelia
Blame Deny
Player Bill
Blame
Deny
| –5,–5 | –10,0 |
| 0,–10 | –1,–1 |
Prisoner’s Dilemma
39/48
Bill’s Best Strategy
Player Amelia
Blame Deny
Player Bill
Blame
Deny
| –5,–5 | –10,0 |
| 0,–10 | –1,–1 |
Prisoner’s Dilemma
40/48
Nash Equilibrium
Player Amelia
Blame Deny
Player Bill
Blame
Deny
| -5,-5 | –10,0 |
| 0,–10 | –1,–1 |
Prisoner’s Dilemma
41/48
• Cooperation (denying the crime) rather than awar would
havebenefited bothplayers.
• Even if they did collude both would still betempted to cheat
and cut sentences.
• This type of gamesareknown asprisoner’s dilemma.
Non-Collusive Oligopoly
42/48
Oligopoly
43/48
• Collusive Oligopolies tend to havethe samedisadvantages as
monopolies
• And mayhaveevenlessscopefor economiesof scale
• engagein morecostly advertising
• However they havemore incentives for innovation than
monopolies
• Non-price competition maylead to morechoice
Market Structures Compared
Table: Market Structures Compared
| Product | |||||
| Competition | (approx.) | is a price taker | |||
| Monopolistic A lot | Almost | Differentiated Restaurants Downward sloping, |
|||
| Competition | Unrestricted | but relatively elastic | |||
| Oligopoly | Few | Restricted | Either | Oil, | Downward sloping |
| broadband Utilities, train |
Relatively inelastic Downward sloping: more inelastic than oligopoly. Firm has considerable control over price |
Monopoly | One | Blocked | Unique |
| Type | # of firms |
Entry Barrier s |
Nature of | Example | Implications |
| Perfect | Many | Unrestricted | Homogeneous | Cabbages | Horizontal: firm |
44/48
Conclusion
45/48
• Review today’s lesson.
• Readthe relevant chapters in the book (Ch. 14,15, and 16,
including all boxes and case studies)
• Searchonline for moresources.
• Ask questions in seminar if anything isunclear.
• Do self-test questions at the endof the chapter and online.
Thank youfor your attention.
Questions?
46/48
48/48
The post Market Structures appeared first on My Blog.