UI AgEc 302 Spring 2008

Lecture #6

Market Structures
and Market Power

Instructor:
Yuliya Bolotova
yuliyab@uidaho.edu
 Introduction
• Types of market structures
– Perfectly competitive markets
– Imperfectly competitive markets
• Seller market power: monopoly, oligopoly
• Buyer market power: monopsony, oligopsony
• Behavior of the firms acting in these markets
– production strategies
– pricing strategies
• Government policies regulating firms’
behavior
– antitrust policy, merger policy
2
 Introduction (cont.)
The most important elements of any market
• Traded product (good, service)
• Buyers & Sellers
• Agreement on price & quantity
• Rules of transactions
– Many are common knowledge
– Legal regulation
• Differences in these and other elements of
the market environment explain differences
in the types of market structures 3
 Types of Market Structures
Perfect Competition Imperfect Competition
• many sellers & many • one or few seller(s)
buyers or buyer(s)
• firms are price- • firms are price-
takers
makers
• imperfect information
• perfect information
• very costly entry/exit
• free entry/exit
• high barriers to
• no barriers to entry/exit
entry/exit • differentiated
• homogenous product (unique) product
4
 Market Environment: Pricing Strategies
Price-Taking Behavior
• Market price is pre-determined
• Firms can not influence the price level
• Quantity traded is a function of price
– Ordinary demand: Q(P)  elasticity for demand analysis
Price-Making (-Setting) Behavior
• Quantity is pre-determined
• Firms do influence the price level
– They choose either the price-setting or quantity-setting
strategies
• Market price is a function of quantity produced
– Inverse demand: P(Q)  flexibility for demand analysis 5
 Market Environment: Information
Perfect Information
• Firms know each other production and marketing
costs
• Consumers and firms can easily obtain any price
information
• Demand is known
Imperfect Information
• Firms do not know each other costs of production
and marketing
• Firms know demand and consumers
• Consumers are not aware of the price-setting
process
6
 Market Environment: Entry/Exit
• Barriers to entry/exit
– Costs that a firm has to incur to enter/exit a
market (patents, unique technology, high fixed
costs to build a plant)

• No barriers to entry/exit
– Free entry/exit

• High barriers to entry/exit

– Costly entry/exit
7
 Market Environment:
Product Characteristics
Homogeneous product
• All firms produce the same product ; there
are no major differences in the products
– potatoes, wheat, milk
Differentiated product
• Firms produce outputs that are different
– different brands of potato chips, breakfast
cereals, yogurt
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 Legal Environment

• Regulations common to all markets

– Contract law
– Tax law
– Property law
– International trade law
– Antitrust law
• Market- or Product-specific regulations
– Food safety
– Environmental regulation
9
 Market & Legal Environment: Summary
Firms take all these and other factors
into consideration when they decide
• To enter/exit the market
• To develop or modify
– production strategies
– marketing strategies

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 Types of Market Structures: Summary

Handout #1
Food supply chain: types of market structures
Handout #2
Market structures: the most important differences
• Perfect competition
• Imperfect competition
– Monopoly (seller market power; 1 seller)
– Monopsony (buyer market power; 1 buyer)
– Oligopoly (seller market power; few sellers)
– Oligopsony (buyer market power; few buyers)
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 Number of Firms & Pricing Strategies
• Monopsony
– many sellers & 1 buyer; input price-setting behavior
• Oligopsony
– many sellers & few buyers; input price-setting behavior
• Perfect Competition
– many sellers & many buyers; input- and output price
taking behavior
• Oligopoly
– few sellers & many buyers; output price-setting behavior
• Monopoly
– 1 seller & many buyers; output price-setting behavior
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 Profit-Maximizing FOC: MR=MC (HO#3)

• Perfect Competition: many sellers & many

buyers
– MR = MC; P = MC
• Oligopoly: few sellers & many buyers
– MR = MC;  i 

P 1   MCi
  Q,P 
 
• Monopoly: 1 seller & many buyers
– MR = MC;  1 

P 1   MC
  Q,P 
 
13
 Profit-Maximizing FOC: MR=MC (cont.)
• Monopsony: many sellers & 1 buyer
– MR = MC;  1 

P  W 1 
  Q ,W 
 
• Oligopsony: many sellers & few buyers
– MR = MC;   
P  W 1  i 
  
 Q ,W 
• Perfect Competition: many sellers & many
buyers
– MR = MC; P = MR = MC
14
 Measures of Seller Market Power:
Lerner Index (Mark-Up)
• Perfect Competition: many sellers & many
buyers P  MC
L   0
P
• Oligopoly: few sellers & many buyers
i
L   f P ,Q i
 Q,P
• Monopoly: 1 seller & many buyers
1
L   f P ,Q
 Q,P
15
Measures of Buyer Market Power: Mark-Down

• Monopsony: many sellers & 1 buyer

P W 1
MD    W ,Q 
W  Q ,W

• Oligopsony: many sellers & few buyers

P W i
MD    W ,Q i 
W  Q ,W

• Perfect Competition: many sellers & many

buyers P  MC
MD  0
MC 16
 Measures of Market Power (cont.)
P  MC
• Lerner Index L 0
P
Range [0; 1] or [0%; 100%]
– perfect competition L = 0
– oligopoly 0<L<1
– monopoly 0<L<1
• The same market
L competition < L oligopoly < L monopoly
• Buyer market power --- similar measure
17
 Measures of Market Concentration (HO#4)
• Concentration ratio (CR) is a market share held
by a group of the largest firms in the industry
n

 Firm Salesi
CRn  i 1
 100%
Industry Sales
– i = refers to an individual firm
– n = is the number of the largest firms in a market
• CR falls in the range (0;100].
• CR4 (top four firms concentration ratio) is the most
popular measure
18
 Measures of Market Concentration (cont.)
• Herfindahl-Hirschmann Index (HHI) is the
sum of the squared market shares of the
largest firms in a market
– accounts for the size inequality among the firms
n
HHI  S
i 1
1
2
 S  S  ...  S
2
2
2
3
2
n

• n = is the number of the largest firms in a market.

• The i-th firm market share is
Firm' s Sales
Si   100%
Industry Sales
19
Measures of Market Concentration: Source
• US Census Bureau http://www.census.gov/
• Economic Census: Concentration Ratios
Reports
http://www.census.gov/epcd/www/concent
ration.html
• Economic Census reports
– CR4, CR8, CR20, and CR50
– HHI only for the 50 largest companies
– Market Shares are calculated using
• Value of Shipments OR
• Value Added
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 Measures of Market Concentration:
Applications for Merger Analysis
• Antitrust Authorities (FTC and DOJ)
– prevent mergers that harm consumers
– allow mergers that create substantial benefits
• Procedure
– to define relevant product & geographic market
– to determine the market concentration before
and after a merger using HHI
• to assess whether a merger will have a competitive
or anticompetitive effect on the market
21
 Horizontal Merger Guidelines

General Standards
• Unconcentrated markets
– Postmerger HHI < 1,000
• Mergers are approved
• Moderately concentrated markets
– Postmerger 1,000 < HHI < 1,800
• Significant competitive concerns  a merger will be
carefully examined
• Highly concentrated markets
– Postmerger HHI > 1,800
• Mergers are usually not approved 22
Handout #5
Perfectly & Imperfectly Competitive Markets:
Graphical Representation
Handout #8
Average revenue and marginal revenue for a linear
inverse demand curve
Handout #9
Selected Problems

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 Welfare Analysis
• Consumer Surplus
– The difference between the maximum amount
a consumer is willing to pay for a product and
the amount he actually pays
– The area between the demand curve and the
market price
• Producer Surplus
– A monetary measure of the benefits that
producers derive from producing a good at a
particular price
– The area between the supply curve and the
market price 24
 Welfare Analysis (cont.)
• Deadweight Loss
– A reduction in net economic benefits (total
surplus) due to an inefficient allocation of
resources
• due to market power
• other market inefficiencies (market failures) –
externalities
• Externalities
– Uncompensated benefits or costs tied to
production or consumption
• environmental pollution is a negative externality

25
• Handout #6-7
• A welfare transfer problem
• Text-Book page 391-394

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