Competition and Market

Structure

Frederick
University
2011
 Industry

Industry (market) – a collection of

firms, each of which is supplying products
that have some degree of substitutability,
to the same potential buyers
 Common buyers for sellers
 Common sellers for buyers
 Relatively homogeneous product
SCP Paradigm
Basic Conditions

Market Structure

Conduct

Performance
BASIC CONDITIONS
SUPPLY DEMAND
 raw material  price elasticity
 technology  rate of growth
 product durability  substitutes
 value/weight  marketing type
 business attitudes  purchase method
 unionization  cyclical and seasonal
character
 Market Structure

Market Structure – those characteristics of

the market that significantly affect the
behavior and interaction of buyers and sellers
MARKET STRUCTURE
 number and size of sellers and buyers
 type of the product
 conditions of entry and exit
 transparency of information
Perfect Competition - structure
 Many and small sellers, so that no one
can affect the market
 Homogeneous product
 Free entry to and exit from the industry
 Transparent and free information
Pure Monopoly- market
structure
 Only one producer in the industry
 The product does not have close
substitutes
 Blocked entry
Monopolistic competition -
structure
 Many and small sellers
 Differentiated product
 Free entry and exit
 Transparent and free information
Oligopoly – market structure
 A) Tight oligopoly – a few big firms in the
industry with comparable market shares/
B) Dominant firm oligopoly – one of the big
firms in the industry is recognized as the price
leader
 Homogeneous / Heterogeneous oligopoly
 Significant barriers to entry to and exit from
the industry
 Significant barriers to information
 Entry

Entry into an industry or to a segment of an industry can

occur because there is
•de novo entry.
•takeover from outside the industry
•the development of technologically similar firms who
develop their product range.
•the transference of brand names across sectors
•an increase in import penetration. Again, the scale of the
firm involved is important here.
Barriers to Entry
Structural barriers
 High capital cost
 Economies of scale
 Product differentiation and brand loyalty
 High switching cost
 Ownership/control of key factors or outlets
Strategic barriers
 Limit pricing
 Excess capacity
 Vertical integration
 Sleeping patents
 Predatory pricing
 Tying sales
Institutional barriers
 Patents
 Regulations
Alternative Market Structures
 The four market structures
 perfect competition
 monopoly
 monopolistic competition
 oligopoly
Features of the four market structures
Features of the four market structures
Features of the four market structures
Features of the four market structures
Features of the four market structures
Features of the four market structures
 Market Conduct
Market Conduct – a firm’s policies toward its
market and toward the moves made by its
rivals in that market
CONDUCT
 pricing behavior
 product strategy
 research and innovation
 advertising
 legal tactics
 Perfect competition - conduct
Firm’s market
Industry’s market P q TR MR
P D S 5 0 0 -
5 10 50 5
5 P 20 100 5

d
MR
Pe

Q Q 20
Qe 0 10
 Perfect competition – short
run “conduct”
p MC

AC

dd = MR

Economic profit = (P-AC) q

q Q
P = MR MC = MR
P>AC
 Perfect Competition – long run
“conduct”
Industry’s equilibrium
P S If P>AC, new firms start
D entering the industry and
the equilibrium price falls.

If Р < АС, the firms will

Pe start leaving the industry
and the equilibrium price
P’ will increase.

The industry is in a long run

equilibrium when P = AC
Qe Q
In the long run the firms make
normal profit
 Perfect Competition - Deriving the
short-run supply curve
P S
MC = S
a d1 = MR1
P1
b d2 = MR2
P2
c d3 = MR3
P3
D1
D2
D3

Q (millions) Q (thousands)
The firm’s short run supply curve is determined by its MC curve above AVC

(a) Industry (b) Firm

fig
Long-run equilibrium of the firm
under perfect competition
(SR)MC
(SR)AC

LRAC

DL
AR = MR

LRAC = (SR)AC = (SR)MC = MR = AR

Q
 Pure Monopoly - conduct
P Q TR MR
P MC 10 1 10 10
D 11 2 18 8
8 3 24 6

P
Economic P>MR
AC
Profit MC=MR

Qm Q
MR
Pure Monopoly and Perfect competition
Consumer surplus = ∑ (P –MWP)
P Under perfect competition = KLNMC
N Under pure monopoly = NRT
Producer surplus =
∑ (P-MC)
AC
Under pure monopoly the producer
surplus rises by KGTR at the expen
of the consumer surplus
R T
Pm
Pp.c.K GTL – the
G L portion of the
consumer
surplus,
J which is a
deadweight loss
ARthesociety
for D
JGL – the portion
of the producer
MR surplus, which is
a deadweight
Qp.c. loss for the
Qm Q
society
Monopolistic competition – conduct in
the short run P>MR
P MC MC = MR

AC

Ps

ACs

AR  D

MR
Qs Q
Monopolistic competition – conduct in
the long run If P>AC new firms will enter
P the industry and the firm’s
market segment will shrink
- its individual demand curve
shifts leftwards
LRMC

LRAC

PL

ARL  DL

MRL Q
The long run equilibrium
QL is achieved at P = AC, however, АС is not minimized
– there is excess capacity
Long run equilibrium under perfect competition and under
monopolistic competition
P

LRAC

P1

P2
DL under perfect
competition

DL under
monopolistic
competition
Q1 Q2
fig
Q
Tight oligopoly - conduct
P

NFD
FD

Q
 The kinked demand curve under
P
the tight oligopoly

NFD
P1

FD
Q1 Q
fig
 P The kinked demand curve

P1

MRnf

a
D AR
b

Q1 Q
MRf
 Rigid prices under the tight
P
oligopoly

MC2

P1 MC1

а
D AR
b

Q1 Q
MR
Price leadership of the dominant firm
P

Sothers

Dleader Dindustry

Q
Price
P
leadership of the dominant firm
MCleader Sother firms

l f t
PL
Dindustry

Dleader

MRleader

QL QF QT Q
 Market Performance

Market Performance – how well does an

industry do what society might reasonably
expect it to do
PERFORMANCE
 profitability
 allocative efficiency
 static production efficiency
 dynamic efficiency - progress
 full employment
 equity
Perfect Competition -
Performance
 P = MR
 MC = MR
 P = MC
 P = AC
 AC = MC
 AC minimum
 Perfect Competition -
Performance
Static Efficiency

 Efficiency in allocation MC = P
 Efficiency in motivation AC = MC
 Efficiency in distribution AC = P
The Perfect Competition achieves static
efficiency
Dynamic Efficiency
There is NO potential and motivation for innovations and technological progress
The Perfect Competition does not achieve
dynamic efficiency
 Pure Monopoly - performance
Static efficiency

 Efficiency in allocation MC < P

 Efficiency in motivation excess capacity

 Efficiency in distribution AC < P

The pure monopoly does not achieve static efficiency

Dynamic efficiency
There is a potential and motivation for innovations and technological progress

The pure monopoly is motivated to achieve dynamic efficiency at

the presence of potential competition
 Monopolistic competition -
performance
Static Efficiency

 Efficiency in allocation MC < P

 Efficiency in motivation excess capacity
 Efficiency in distribution AC = P
Contestable Markets
Key characteristics:
 Firms’ behaviour influenced by the threat of

new entrants to the industry – if even the

industry is concentrated, the incumbent firms
behave as if they are perfect competitors
 Firms’ performance depends on the potential

competition
Contestable markets
 Ultra easy entry
 Ultra easy exit
 Zero sunk cost Contestable market
 “Hit and run”
strategy”
Oligopoly – non-collusive
behavior
 Game theory – the study of multi-person
decision problems (the reactions of a few
interdependent decision makers)
 Game - any situation that involves well-
defined rules and outcomes, where outcomes
are dependent on players’ strategic decisions
 Strategy – a complete plan, specifying the
game under any possible circumstances
The Prisoners’ dilemma
Two suspects, Valio and Georgy, are arrested by the police.
The police have insufficient evidence for a conviction, and,
having separated both prisoners, visit each of them to offer
the same deal: if one testifies for the prosecution against
the other and the other remains silent, the betrayer gets 3
months and the silent accomplice receives the full 10-year
sentence. If both stay silent, both prisoners are sentenced
to only 1 year in jail for a minor charge. If each betrays the
other, each receives a three-year sentence. Each prisoner
must make the choice of whether to betray the other or to
remain silent. However, neither prisoner knows for sure
what choice the other prisoner will make. So this dilemma
poses the question: How should the prisoners act?
The Prisoners’ dilemma

Valio’s alternatives
Does not confess Confesses

Georgy -
Does not confess 10 years
Everyone gets
1 year Valio -
Georgy’s 3 months
alterantives Georgy -
3 months Everyone gets
Confesses Valio- 10 years 3 years

fig
The Prisoners’ dilemma
The Prisoners’ dilemma is the duopoly’s
dilemma. Prisoners cannot coordinate their
confessions. Even though they both would
get less if they do not confess, they betray
the other player, because of the greater
payoff.
No matter what the other player does, one
player will always gain a greater payoff by
playing defect. Since in any situation playing
defect is more beneficial than cooperating, all
rational players will play defect.
Payoffs for firms A и B under different
pricing policies
A’s Price
2.00 1.80

2.00 10mil. for each 5 for В

12 for А
B’s Price

1.80 12 for В 8 for each

5 for А

fig
Collusive behavior
 How could the firms overcome the
prisoners’ dilemma?
 Collusive behavior will set higher
prices for the buyers!