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Market Structures
Market Structures
Perfect Compe22on
Monopolis2c Compe22on
Oligopoly
Monopoly
Characteris+cs to look at
• Number of firms • Type of product • Control over price • Condi7ons of entry • Non price compe77on
Market Structures
Most Compe++ve
Least Compe++ve
Perfect Compe++on Monopoly Monopolis+c Compe++on Oligopoly
Condi2ons for Perfect Compe22on
Large # small independent producers
Firms produce iden2cal product (Standardized)
No barriers to entry or exit
Firms are ‘price takers’
No NON PRICE Compe22on
EX: Agricultural Commodi2es
Condi2ons for Monopolis2c Compe22on
Large independent producers
Firms produce differen2ated product
Fairly easy entry or exit
Firms have some control over price with narrow limits
Emphasis on adver2sing, brand names, & trademarks
EX: Retail: Shoes, clothing, health & beauty products
Condi2ons for Oligopoly
Few firms or large producers control significant share of mkt
Standardized or differen2ated product
Barriers to entry: Start up costs/regula2ons
Price control limited by mutual interdependence/ Possible collusion
Adver2sing used for product differen2a2on
EX: Retail: Steel, automobiles, household appliances, banks
Condi2ons for Monopoly
Single firm w/unique product
no subs2tutes
Many barriers to entry: Economies of scale/start up costs/regula2ons
Considerable control over price: price maker
Adver2sing used for public rela2ons
EX: Public U2li2es
P
Q
P
Q
S
D
q
P
q
MC
ATC
AVC
P=MR=D
market firm
Market Individual Firm
Compe22ve Firm in Long Run Equilibrium, firms maximize profits by producing where MR=MC
Total Revenue = p*q = Total Cost = ATC*q = 0 Economic Profit
Market price = Marginal Revenue for firm = Demand for firm
Total Revenue = Total Cost
= 0 Economic Profit
P
Q
P
Q
S
D
q
P
q
MC
ATC
AVC
P=MR=D
market firm
Market Individual Firm
Compe22ve Firm Experiencing Short Run Economic Profits
Total Revenue – Total Cost = Economic Profit
(P*q) – (ATC*q) = Π
D
P=MR=D
Q market firm q
P ATC
Economic Profit
Total Cost Total Revenue = Total Cost
= 0 Economic Profit
P
Q
S
q
P MC
ATC
AVC
Market Individual Firm
Long Run Adjustment to Economic Profits in Perfect Compe22on – New firms enter the market in response to economic profits un2l economic profits = 0.
D
P=MR=D
Q market firm q
P ATC
Economic Profit
Total Cost
S
P
Q market
P=MR=D
Total Revenue = Total Cost
= 0 Economic Profit
q firm
Adjustment to short-‐run losses & the decision to shut down.
P
Q
P
Q
S
D
q
P
q
MC
ATC
AVC
P=MR=D
market firm
Market Individual Firm
Firms will operate at a loss (TC > TR) in the short run as long as P equals or exceeds AVC
If P < AVC, then firm shuts down and q = 0
As firms exit industry, industry supply will decrease and the market price will increase
Total Revenue = Total Cost
= 0 Economic Profit
D
P=MR=D
ATC
Q market
P
ATC
firm q
Economic Loss
Total Revenue
Monopoly
Condi2ons for Monopoly
One Producer
Unique product with no close subs2tutes
Significant barriers to entry
Market Power… ‘price maker’
P
Q
P
Q
S
D
q
P
q
MC
ATC
AVC
P=MR=D
market firm
Market Individual Firm
The market and the firm are one. But like in perfect compe22on MR=MC maximizes profit
Marginal Revenue is different from demand.
Monopolists operate in the elas2c por2on of the market demand curve
P
Q
P
Q
D
MC
ATC
AVC
Monopoly
The market and the firm are one. But like in perfect compe22on MR=MC maximizes profit
Marginal Revenue is different from demand.
Monopolists operate in the elas2c por2on of the market demand curve
MR
ATC
Total Cost
Π
P
Q
P
Q
D
MC
ATC
AVC
Monopoly
MR
ATC
Total Cost
Π DWL
Monopolist produces Q at a point where ATC > minimum ATC (produc2vely inefficient)
P > MR=MC , therefore monopoly is alloca2vely inefficient
Q mon. < Q comp., P mon. > P comp., Monopoly creates deadweight loss
Pcomp.
Qcomp.
Monopolis+c Compe++on
Condi2ons for Monopolis2c Compe22on
Rela2vely large number of producers
Product differen2a2on
Few barriers to entry
Adver2sing used to maintain profit
P
Q
P
Q
D
MC
ATC
AVC
Monopolistic Competition
Like in perfect compe22on MR=MC maximizes profit, which in short run > 0
Marginal Revenue is different from demand.
Monopolis2c Compe2tors face more elas2c demand curve because of close subs2tutes
MR
ATC
Total Cost
Π
P
Q
P
Q
D
MC
ATC
AVC
Monopolistic Competition
MR
ATC
Total Cost
Π DWL
Qcomp.
Pcomp.
Monopolist comp. produces Q at a point where ATC > minimum ATC (produc2vely inefficient)
P > MR=MC , therefore monopolis2c comp. is alloca2vely inefficient
Q mc< Q comp., P mc > P comp., Monopolis2c Comp. creates deadweight loss
P
Q
P
Q
D
MC
ATC
AVC
Monopolistic Competition
In the long run compe22on reduces demand for monopolis2c compe2tors product
Reduced demand leads to 0 economic profits
Monopolis2c Compe22on creates inefficient excess capacity
MR
ATC
Total Cost
Π
P
Q
P
Q
D
MC
ATC
AVC
Monopolistic Competition
In the long run compe22on reduces demand for monopolis2c compe2tors product
Reduced demand leads to 0 economic profits
Monopolis2c Compe22on creates inefficient excess capacity Qmc < Q min ATC
MR
ATC
Total Cost
Π Total Cost
= Total Revenue
= 0 Economic
Profit
Q
P =
Oligopoly
Condi2ons for Oligopoly
A few large producers
Product differen2a2on or standardiza2on across industry
Barriers to entry
Economic Interdependence
Strategic Behavior
Unlike other market structures, oligopoly is characterized by interdependent strategic behavior.
Because of the small number of firms in oligopolis+c markets, individual firms produc+on decisions reflect their strategic response to their compe+tors decisions.
Whether or not firms can collude is important in understanding the outcomes of oligopolists decisions.
Instead of supply and demand analysis, game theory provides a beLer insight into oligopoly.
Applica+on of Game Theory to Oligopoly
• Assume that two firms, A & B, are the only gas sta+ons in a small town.
• Use the payoff matrix below to determine their profit maximizing pricing strategy and their dominant, non-‐collusive pricing strategy.
A – Hi: $1000 B – Hi: $1000
A – Lo: $1200 B – Hi: $ 500
A – Hi: $ 500 B – Lo: $1200
A – Lo: $ 750 B – Lo: $ 750
Applica+on of Game Theory to Oligopoly
• Given the opportunity to collude and coordinate pricing, then both firms would ra+onally choose to set a high price and maximize profits at $1000 per firm.
• However, because firms must act independently of other firms, then their dominant strategy is to set a low price. From each firm’s perspec+ve, they can ra+onally expect to make at most $1200 and at least $750 by se\ng a low price, which is a beLer set of outcomes than is found by se\ng prices high.
A – Hi: $1000 B – Hi: $1000
A – Lo: $1200 B – Hi: $ 500
A – Hi: $ 500 B – Lo: $1200
A – Lo: $ 750 B – Lo: $ 750
