13

A2 ECONOMICS

THE PRICE SYSTEM & THE MICRO ECONOMY

(INTRODUCTION TO MARKET STRUCTURES)

Dr. Sylvain Hours - sylvainh@ssfbc.com.cn - Wechat: sylvainhoursCN - sylvainhours.wixsite.com/home

MARKET STRUCTURE
 A market is a place where buyers and sellers meet, at a given point in time, to
trade goods and services.

 The market structure refers to the characteristics of a market (i.e. the way a
market is organized).

 The definition of a market structure must specify:

 The number of buyers and sellers as well as their respective market shares.
 The size of the barriers to entry or exit
 Whether the goods offered are identical or differentiated
 The extent to which sellers have control over price

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CONCENTRATION RATIOS

 To get a better picture of market structure, economists often compute n-firm

concentration ratios.

 The n-firm concentration ratio measures the combined market shares of the
n largest firms.

 Nb: Concentration ratios may be calculated on the basis of either shares in

output or shares in employment.

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CONCENTRATION RATIOS

 A high concentration ratio indicates that a few firms produce most of the
industry output.

 Therefore, a high concentration ratio usually signals substantial market

power and low competition.

 Yet, one should be mindful that competition can be extremely aggressive, even
in a very concentrated market (e.g. Bertrand competition).

 Nb: Concentration ratios fail to account for the distribution of market shares
among the top firms.

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PRACTICE TIME!
Task: Compute the 4-firm concentration ratio in Market 1 & 2. Comment.
MARKET 1 MARKET 2

COMPANY MARKET SHARE COMPANY MARKET SHARE

Firm A 65% Firm J 20%
Firm B 5% Firm K 20%
Firm C 5% Firm L 20%
Firm D 5% Firm M 20%
Firm E 5% Firm N 20%
Firm F 5%
Firm G 5%
Firm H 5%
Firm I 5%

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THE HERFINDAHL-HIRSCHMAN INDEX ONE STEP
FURTHER
 The Herfindahl-Hirschman Index (HHI) is the square of each firm’s market share
summed over the industry.

HHI =

where si is the market share of firm i and N is the number of firms in the industry.

 By squaring the market share of each firm, the HHI gives more weight to larger
firms.

 The HHI ranges from 10,000 / N to 10,000.

 An HHI below 1,500 indicates low concentration.
 An HHI between 1,500 and 2,500 indicates moderate concentration.
 An
Dr.HHI above
Sylvain 2,500
Hours indicates high concentration.
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PRACTICE TIME! ONE STEP
FURTHER

Task: Compute the HHI in Market 1 & 2. Comment.

MARKET 1 MARKET 2
COMPANY MARKET SHARE COMPANY MARKET SHARE
Firm A 65% Firm J 20%
Firm B 5% Firm K 20%
Firm C 5% Firm L 20%
Firm D 5% Firm M 20%
Firm E 5% Firm N 20%
Firm F 5%
Firm G 5%
Firm H 5%
Firm I 5%

Dr. Sylvain Hours - sylvainh@ssfbc.com.cn - Wechat: sylvainhoursCN - sylvainhours.wixsite.com/home

PRACTICE TIME!
Task: Compute the 4-firm concentration ratio. Comment.

Shares of China’s B2C Online Shopping Websites by GMV in Q2 2016

COMPANY MARKET SHARE

Tmall.com 48.5%
JD.com 33.8%
Suning.com 4.0%
Vip.com 3.3%
Gome.com.cn 1.3%
Yihaodian 1.0%
Amazon.cn 0.8%
Dangdang.com 0.7%

Dr. Sylvain Hours - sylvainh@ssfbc.com.cn - Wechat: sylvainhoursCN - sylvainhours.wixsite.com/home

PRACTICE TIME!
Task: Compute the 4-firm concentration ratio. Comment.

China’s smartphone market share in April 2016

COMPANY MARKET SHARE

MI 26.0%
HONOR 15.7%
Letv 10.5%
Apple 8.2%
Huawei 8.0%
Meizu 7.0%
360 4.5%
Samsung 3.2%

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PRACTICE TIME!
Task: Compute the 4-firm concentration ratio. Comment.

Airline market share on China-US flights (1Q217)

COMPANY MARKET SHARE

United Airlines 20.0%
Air China 18.7%
China Eastern Airline 17.6%
China Southern Airlines 10.4%
Hainan Airlines 9.1%
Delta Airlines 7.9%
American Airlines 7.8%
Air Guilin 2.3%

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BARRIERS TO ENTRY
 Barriers to entry are obstacles which deter or prevent new firms from
entering a particular market to compete with incumbent firms.

 Examples of barriers to entry:

 High startup costs (i.e. access to capital, for instance in aircraft, pharmaceutical or
electricity industries)
 Monopoly access to raw materials, components or retail outlets (e.g. Ferrero’s
vertical integration, De Beers’ diamond monopoly, etc.)
 Economies of scale (i.e. incumbent firms benefit from a cost advantage as they
produce at a lower average cost than those just starting up.)
 Legal barriers (i.e. copyrights, patents, licenses, public monopolies, etc.)

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BARRIERS TO ENTRY
 Examples of barriers to entry (cont’d):
 High sunk costs (i.e. costs such as R&D or advertising that a firm incurs and
which cannot be recovered if the firm exits the market.)
 Limit pricing (i.e. incumbent firms set a low price to deter entry.)
 Marketing barriers (i.e. incumbent firms invest in advertising to create brand
loyalty and make consumers captive.)
 Network externalities (i.e. the value of the product increases with the number of
users so new entrants may fail to reach critical mass.)

 New firms will only enter the market if they think that their economic returns
will be greater than the cost of breaking down the barriers to entry.

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BARRIERS TO EXIT
 Barriers to exit are obstacles which prevent a firm from leaving a market
quickly and at little cost.

 Examples of barriers to exit:

 High redundancy costs (i.e. costs of making employees redundant)
 High investment in non-transferable fixed assets (i.e. capital equipment which is
specific to one task.)
 Contract contingencies with suppliers or buyers (i.e. breaking the contract may
trigger the payment of a large penalty.)

 An entrepreneur making subnormal profit will be better off staying in the

market rather than leaving if the barriers to exit are high enough (i.e. If the exit
costs are larger than the profit loss incurred in the market).

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PRODUCT DIFFERENTIATION
 Product differentiation refers to a situation where the firms operating in a
particular market produce goods or services that are similar but NOT identical.

 Examples: Seiko vs Orient watches ; Mercedes Benz vs BMW cars, Pepsi vs Coke,
etc.

 On the contrary, if all the firms in a particular market produce an identical

product, then the industry output is said to be standardized.

 On the one hand, if the industry output is standardized, then the goods or
services sold in the market are regarded as perfect substitutes by the
consumers so price is the only selection criterion.

 That is, consumers will buy the good or service from the firm that charges the
lowest price.
Dr. Sylvain Hours - sylvainh@ssfbc.com.cn - Wechat: sylvainhoursCN - sylvainhours.wixsite.com/home
PRODUCT DIFFERENTIATION
 On the other hand, in the case of product differentiation, the goods or services
sold in the market are regarded as imperfect substitutes by the consumers so
price is NOT the only selection criterion.

 That is, some consumers may choose to purchase from Firm A rather than from
Firm B even if Firm A charges a higher price, simply because they prefer Firm
A’s product.

 Therefore, product differentiation creates market power and reduces the

intensity of competition by decreasing the PED.

 This all means that product differentiation gives each individual firm some
scope for influencing price (i.e. individual firms have a certain amount of
market power).
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PRICE-TAKING FIRM
 A price-taking firm is one whose actions can NOT affect the market price of
the good or service it sells.

 In particular, the quantity of output sold by a price-taking firm has no influence

on the market price (i.e. price-taking firms face a perfectly price-elastic
individual demand curve).

 As we shall see, perfect competition is the only of the 4 primary models of

market structure in which firms are price-takers.

Dr. Sylvain Hours - sylvainh@ssfbc.com.cn - Wechat: sylvainhoursCN - sylvainhours.wixsite.com/home

PRICE-MAKING FIRM
 A price-making firm is one holding some degree of market power and whose
actions can affect the market price of the good or service it sells.

 In particular, the more output a price-making firm sells, the lower the market
price (i.e. price-making firms face a downward sloping demand curve).

 As we shall see, monopoly, monopolistic competition and oligopoly are 3

market structures in which firms are price-makers.

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THE 4 PRIMARY MODELS OF MARKET
STRUCTURE
 In this course, we will study the 4 primary models of market structure:
 Perfect Competition
 Monopoly
 Monopolistic Competition
 Oligopoly

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THE 4 PRIMARY MODELS OF MARKET
STRUCTURE

Dr. Sylvain Hours - sylvainh@ssfbc.com.cn - Wechat: sylvainhoursCN - sylvainhours.wixsite.com/home

THE 4 PRIMARY MODELS OF MARKET
STRUCTURE

NUMBER PRODUCT FIRMS’ CONTROL BARRIERS TO

OF FIRMS DIFFERENTIATION OVER PRICE ENTRY OR EXIT

PERFECT
COMPETITION

MONOPOLY

MONOPOLISTIC
COMPETITION

OLIGOPOLY

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THE 4 PRIMARY MODELS OF MARKET
STRUCTURE

NUMBER PRODUCT FIRMS’ CONTROL BARRIERS TO

OF FIRMS DIFFERENTIATION OVER PRICE ENTRY OR EXIT

PERFECT
Many No None None
COMPETITION

MONOPOLY

MONOPOLISTIC
COMPETITION

OLIGOPOLY

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THE 4 PRIMARY MODELS OF MARKET
STRUCTURE

NUMBER PRODUCT FIRMS’ CONTROL BARRIERS TO

OF FIRMS DIFFERENTIATION OVER PRICE ENTRY OR EXIT

PERFECT
Many No None None
COMPETITION

MONOPOLY One N/A Considerable Prohibitive

MONOPOLISTIC
COMPETITION

OLIGOPOLY

Dr. Sylvain Hours - sylvainh@ssfbc.com.cn - Wechat: sylvainhoursCN - sylvainhours.wixsite.com/home

THE 4 PRIMARY MODELS OF MARKET
STRUCTURE

NUMBER PRODUCT FIRMS’ CONTROL BARRIERS TO

OF FIRMS DIFFERENTIATION OVER PRICE ENTRY OR EXIT

PERFECT
Many No None None
COMPETITION

MONOPOLY One N/A Considerable Prohibitive

MONOPOLISTIC
Many Yes Some None
COMPETITION

OLIGOPOLY

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THE 4 PRIMARY MODELS OF MARKET
STRUCTURE

NUMBER PRODUCT FIRMS’ CONTROL BARRIERS TO

OF FIRMS DIFFERENTIATION OVER PRICE ENTRY OR EXIT

PERFECT
Many No None None
COMPETITION

MONOPOLY One N/A Considerable Prohibitive

MONOPOLISTIC
Many Yes Some None
COMPETITION

OLIGOPOLY A few Yes / No Varies Considerable

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 ONE STEP
MARKET STRUCTURES FURTHER

SELLERS

ONE A FEW MANY

Bilateral Contested
ONE Monopsony
Monopoly Monopsony
Contested Bilateral
BUYERS A FEW Oligopsony
Monopoly Oligopoly
Perfect
MANY Monopoly Oligopoly
Competition

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 ONE STEP
MARKET STRUCTURES FURTHER

ARE THE PRODUCTS

DIFFERENTIATED?

NO YES
Multiproduct
ONE Monopoly
Monopoly
HOW MANY
Homogeneous Differentiated
SELLERS A FEW
Oligopoly Oligopoly
ARE THERE?
Perfect Monopolistic
MANY
Competition Competition

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MCQS

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MCQS

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