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Industrial Economics: Introduction
Industrial economics is concerned with the behavior of firms in industries:
• the policies of firms toward rivals and toward customers prices, advertising, R&D
• firms in industries that are competitive as well as less than competitive
Industrial Economics: Introduction
theory of the firm; price theory: focus on simple market structures (competition and monopoly)
industrial economics: oligopoly; the real world
industrial economics: public policy toward business; role of government
SCP: Structure-Conduct-Performance
Structure Conduct Performance
Market structure determines the behavior of the firms in the market, and the behavior of the firms detrmines the various aspects of market performance
Structure
• number and size distribution of sellers
• number and size distribution of buyers
• product differentiation
• entry conditions
Conduct
• collusion
• strategic behavior
• advertising
• research and development
Performance
• profitability
• efficiency
• progressiveness
Interactive SCP framework
progressiveness
technology
profitability
perfomance
structure
strategy
conductdemand
sales effort
Interactive SCP framework
technology
perfomance
structure
conductFreedom of entry
The welfare consequences of market power
The consequences of market power
The ability of firms to influence the price or the product they sell
the economics of compettive market
monopoly
welfare
Competition
Formal assumption of the competitive model:
• many small buyers and sellers
• standardized product
• free and easy entry and exit
• complete and perfect knowledge
Inputs and costs: fixed and variable
• fixed inputs past investment decission
• variable inputs level of output
• fixed costs services of fixed factors
• variable costs variable factors of production
variable factor: labor
fixed factor: capital
opportunity cost, rental cost of capital services
normal profit: (average cost-AVC)
economic profit: (price-average cost)
Costs curves: typical firm & market
AC: average cost
AVC: average variable cost
MC: marginal cost
S1, S1 : short-run supply curves
D: demand curve
(qSD , pSD): shutdown point minimizes losses
(qLR , pLR): long-run equilibrium for a typical firm
(QLR , PLR): market long-run equilibrium
Cost curves under competition
price MC
qSD
The firm’s supply decission: to maximize profit
Firm is a price taker choose the ouput that MC=P1 q1
typical firm
AC
AVC
qLR q1
PSD
PLR
P1
S1
S2
D
Q1 QLRfirm output
market output
market
Short-run and Long-run equilibrium: Competition
S1 : short-run supply curves
D: demand curve
P1 : initial short-run equilibrium price
Q1 : market output in the short-run
q1 : firm’s output in the short-run equilibrium
Firm’s profit economic profit attract new firms
S1 S2
PLR : long-run equilibrium price
QLR : market output in the long-run
qLR : firm’s output in the long-run equilibrium
Economies and diseconomies of scale
price
MC
QMES : minimum efficient scale outpout
ACConstant return to
scale
0QMES output
AC
MC
Monopoly
only one supplier
entry is blockaded
price maker
A
quantity
price
C
E
P1
P2
0Q1 Q2 F
Monopoly: output decission
MC=MR
maximize profit
quantity
price
MCPm
0q1 Qm F
MR D
Welfare consequences of market power
Consumers’ surplus
quantity
price
P1
0
1 F
D
2 3
P2
P3
Welfare consequences of market power
Deadweight welfare loss
quantity
price
Pm
0
Qm
F
GPc
B
E
Qc
Income transfer to monopolist
Spending shifted to other industries
c=marginal cost
Monopoly restrict output and raise price, compared with the price of competitive industry
The Dominant Firm (DF)
• Many industries supplied by a large firm and a fringe of smaller rivals (including new entrants)
• Many of these DFs have maintained their leadership positions for generations
• Difference between DF and monopoly dominant firm must take into account the reaction of its fringe competitors;
If monopolist raises price some customers leave the market
If DF raises some customers begin to buy froms its rivals
Monopolist How much it will produce, what it will charge, implications of its market power
DF + How a DF acquires its position and how it keeps it
Behavior of DF: A Static Limit Price Model
DF can keep the price so low that entry by new firms or expansions by existing fringe firms is not profitable
P
market demand curve
Pe
0
qe
Q
MR
AC entrant
Residual demand curve
ACe
qd
Residual marginal revenue curve
MC entrant
Entrant’s profit
The entrant’s output decission
Behavior of DF: A Static Limit Price Model
P
market demand curve
PL
0Q
MR
AC entrant
Residual demand curve
qL
Residual marginal revenue curve
MC entrant
Limit output (qL) and limit price (PL)
The more the DF’s output, the closer will the residual demand curve to the origin
below entrant’s AC
A natural monopoly government regulation
P
market demand curve
Pm
0Q
AC entrant
MC df
Blockaded entry
If the market is very small and entry costs are
very high it will not profitable for new
entrant
qm
Dynamic limit pricing
The static model ignores the fact that entry takes time trade off between current and future profit
the difference between the limit profit if it sets a low price and the larger short run profit if it sets a higher price
the rate at which DF loses market share (profit) to the fringe if the fringe begins to expand
the discount rate
Strategy to achieve and maintain dominance
Dominance is a power relation between two agents in which the dominator restricts the action of the dominatedDF’s weapon: its output level which influence the price
DF is giving up the profit to maintain position
STRATEGIC BEHAVIOR:
MERGER
DIRECT COST-BASED STRATEGIES: increasing rival’s costs
TECHNOLOGY-BASED STRATEGIES: capacity expansion, vertical integration
MARKETING-BASED STRATEGIES: product differentiation, access to consumers
Summary
Firms may achieve a dominant position
By superior competitive performance
By merger
By strategic behavior design to exclude competitors and prevent competition on the merits
PUBLIC POLICY
toward
DOMINANT FIRMS
OligopolyOligopoly: The recognition of interdependence: The recognition of interdependence
Competititve market each firm is so small price taker Monopolist has no rival price maker
Dominant firm does consider the reaction of fringe firms one sided recognition no recognition if entry cost is low give up mkt share fringe firms approach the size of DF OLIGOPOLY
supplied by few firms,
which recognize their mutual interdependence
OligopolyOligopoly: measuring fewness: measuring fewness
percentage of industry sales the largest 4, the largest 10 when the largest 4 40% of supply
each must be aware of the others OLIGOPOLY
concentration ratio summary index of fewness
the Herfindahl Index
combining information about market shares of all firms in the market
OligopolyOligopoly: the decision making: the decision making
decide how much to produce
let the market determine the price
sunk cost
set the price
sell whatever quantity demanded at that price
the technology allows rapid changes in the rate of output
P
OligopolyOligopoly: the quantity-setting: the quantity-setting
market demand curve
Q
Residual demand curve
Residual marginal revenue curve
MC = AC
Cournot Duopoly a market supplied by two identical firms
q2
q1(q2)
OligopolyOligopoly: the quantity-setting: the quantity-setting
Firm’s 1 reaction curve
Firm’s 2 output
qc
Firm’s 2 reaction curve
Firm’s 1 outputqm
qm
qc
A
B
q1,A
q2’,B
q2,A
The ouput each firm will choose
depends on what it thinks the other firm will do
OligopolyOligopoly: price-setting: price-setting
homogenous product differentiated product
public policy toward oligopoly conspiracy to monopolize
COLLUSION
The determinants of market structure The determinants of market structure
3 faktor penting dalam struktur pasar
entry condition
economies of scale product differentiation absolute cost advantages of existing firms
The determinants of marketThe determinants of market
If there is economies of scale
average cost falls as output increases
for constant MC = c
C (q) = F = cq
AC(q) = c + (F/q)
Function coefficient: economies of scale
FC = AC/MC = (c+(F/q)/c = 1 + F/cq
Economies of scale becomes more important as fixed cost increases
market demand curve: P=a-bQ
PSR
Short-run equilibrium, n-firm Cournot oligopolyShort-run equilibrium, n-firm Cournot oligopoly
Q
Residual demand curve
Residual marginal revenue
MC = c
SqSR
AC=(F/q)+cACSR
a
Short-run equilibrium, n-firm Cournot oligopolyShort-run equilibrium, n-firm Cournot oligopoly
Firm i’s MR
Firm i’s revenue will change as firm i changes its output
MRi = P + qi( Pi/ qi) = P-bqi = a – bQ – bqi
maximizing profit by picking the output level that
MR=MC atau a – bQ – bqi = c atau Q + qi = (a-c)/b
a natural measure of market size = S = (a-c)/b
All firms produce the same output in equilibrium: Q=Nq
qSR = S/(n+1)
PSR = c + (bS/(n+1))
market demand curve: P=a-bQ
Long-run equilibrium, Cournot oligopolyLong-run equilibrium, Cournot oligopoly
Q
Residual demand curve
MC = c
SqLR
AC=(F/q)+cPLR = ACLR
a
Number of firmsNumber of firms
In SR equilibrium, each firm earns a profit:
SR = b (S/(N+1))2 – F
the LR equilibrium number of firms SR firm’s profit = 0
nLR= (S/(F/b)) – 1
number of firms market concentration fixed cost
The market ought to be more concentrated in the long run, the greater the economies of large scale production
The determinants of marketThe determinants of market
Differentiation
Advertising
Efforts of sales forces
Design changes
Oligopolist behavior market power
If output is restricted, price is rised above MC rivals will come in, expand capacity, and force price down to a competititve level
Entrants will not come unless can make profit
Minimum efficient scale (MES)
The determinants of firm structure The determinants of firm structure
The separation of ownership and control in modern corporation firms may be managed to pursue the interests of
managers rather than owners
Firms may expand horizontally, ……………… market power vertically, or ……………… market imperfection … costs into unrelated markets …. conglomerate mergers … risk