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Market Structure

A. Tony Prasetiantono Week 5

Competitor Identification and Market Definition
Most managers can readily identify their competitors.  Antitrust agencies (in Indonesia KPPU) must determine whether merging firms will achieve market power and raise prices, and whether existing monopolists are abusing their power.

Putting Competitor Identification into Practice
At an intuitive level, products tend to be close substitutes when three conditions hold:  They have the same product performance characteristics  They have the same occasions for use  They are sold in the same geographic market

Mercedes Benz Vs Volvo
These two luxurious cars have the performance characteristics in common:  Seat five comfortably  High “curb appeal” and prestigious name  High reliability  Powerful acceleration and sure handling and braking  Plenty of features, such as leather seats and a compact disc player

Substitute and Competition in Postal Service
    

Postal service: government-regulated, government-monopolist Australia, the Netherlands have fully privatized in postal service Tight competition vs. DHL, FedEx, UPS, TNT, airline cargo, etc. Current trend: providing other services, including banking services. „Competitors‟: internet (email), VoIP (voice over internet protocol), mobile phone.

Measuring Market Structure
If four-firm concentration ratio in the soft drink industry is about .90, it indicates that the combined market share of the four largest soft drink manufacturers is about 90 percent.  Herfindahl-Hirschman index (HII) equals the sum of the squared market shares of all the firms in the market. HII =Σi (Si)2.

Herfindahl-Hirschman index (HII)

In a market with two firms that each have 50 percent market share, the Hirfindahl index equals .52 + .52 = .5.

Intensity of Price Competition
Nature of competition
Perfect competition Monopolistic competition Oligopoly Monopoly

Range of Herfindahls
Below .2 Below .2

Intensity of Price Competition
Fierce Depending on product differentiation Depending on inter-firm rivalry Light

.2 to .6 .6 and above

Perfect Competition
There are many sellers  Consumers perceive the product to be homogeneous  There is excess capacity  No producer can set the price (price taker)

A monopolist enjoys no competition in its output market.  Competition, if it exists, comes from fringe firms—small firms that collectively account for no more than about 30 to 40% market share and do not threaten to erode the monopoly‟s share.

Cartel: the OPEC
Oil booms in 1970s: Gulf war in 1971, 1973 and 1979  Oil crash in 1986: due to new producers outside OPEC  World‟s new price record: US$40 in September 1990, due to Gulf war  New world‟s record: US$78 in July 2006, due to......?

Monopolistic Competition (1)

There are many sellers. For example, there are many clothing sellers in Chicago. If any one seller were lower its prices, it is doubtful that other sellers would react. Even if some sellers did notice a small drop-off in sales, they would probably not alter their prices just to respond to a single competitor.

Monopolistic Competition (2)

Each seller sell a differentiated product. Unlike under perfect competition, where products are homogeneous, a differentiated seller that raises its price will not lose all its customers.

Vertical Vs Horizontal Differentiation (1)
A product is vertical differentiated when it is unambiguously better or worse than competing products.  A producer of a household cleaner, such as Colgate-Palmolive‟s Ajax, engages a vertical differentiation when it enhances the cleaning effectiveness of its product.

Vertical Vs Horizontal Differentiation (2)

An important source of horizontal differentiation is geography, because consumers prefer stores that are convenient to reach. For example, consumers living in Brooklyn will tend to frequent stores in Brooklyn, whereas consumers in Manhattan will tend to frequent stores in Manhattan.

Pricing in the Airline Industry
Why the US airline industry collapses?  Why Garuda and Merpati making losses, while its competitors (Lion, Adam) making profits?  Government failure vs. market failure