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Determinants of Market Structure
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Topics for Discussion
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The Debate
Economies of Scale
Product Differentiation
Absolute cost advantages
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The Debate
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Market structure and its implications to conduct andperformance especially to control prices has beenexplored
Market structure itself is a result of economic forces
S-C-P framework holds that market structure isdependent on the underlying technology and strategicbehaviour of firms
Chicago economists criticize this The essence of monopoly is the ability to prevent
expansion on capacity when price exceeds unit cost No theoretical link has been forged between the
structure of industry and the degree to which competitivepricing prevails
Market structure reflects something more than efficiency
(role of govt to keep the rivals from entering)
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Determinants of Market structure
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Bain identified three elements of market structureas the main determinants of the nature of entry
conditions
Economies of scale
Product differentiation
Absolute cost advantages of existing firms
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Economies of Scale
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Economies of scale and proportion of fixed cost intotal cost
Short run equilibrium
Long run Number of firms
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Market performance
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Changes in market performance and relation withfixed cost and economies of scale
Lower fixed cost, greater the number of firms in
LR equilibrium; closer the Eq. Price to MC and
less the degree of market power exercised by
individual firms
Trade off between FC and market performance-
Role of MES;
Thus, market concentration is expected to
increase with economies of scale but the market
performance is expected to worsen off
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Policy implications
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In LR, Market concentration would approach thelevel dictated by cost function; so there is little
policy makers can do about it
Strategic entry deterring behaviour of large firms
to maintain market share would make them
operate at scales that are inefficient (SCP)
Estimates of efficiency and MES flawed; the
market structure observed in real world is efficient
(Chicago)
When market economy is at work, size of firms
should not be a matter of concern
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Product Differentiation
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Methods of differentiatingAdvertising
Efforts of sales forces
Design changes
After sales etc
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Advertising
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Advertising affects demand curve
Advertising in turn affects profit as well as profit
maximizing output
Advertising influences price elasticity of demandAdvertising sales ratio is determined by two
factors
Price-cost margin: firms advertise more, the more
they make on the sale of the marginal unit Elasticity of demand with respect to advertising:
firms advertise more, the more sensitive is the
quantity demanded to advertsing
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Advertising and absolute cost
advantages
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Time lags If past advertising does not affect current demand,
then ads are not a barrier to entry for new firms
However, in reality, brand image is created by
incumbent firms and it creates an absolute costadvantage
Rate at which the effect of advertising on demand
depreciates varies from industry to industry
Cumulative affect of ad on sales of mature, frequentlypurchased, low-priced products occurs within 3-9 months of
ad
Ad effect/brand loyalty modest or enduring as
entry barrier thus varies
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Noise:Ad of incumbent firm interferes with that of new
firms
When there is noise in the market, one must shout
louder to be heard.puts the new firms at costdisadvantage as compared to existing firms
Market Penetration cost-entry barrier; market
power for existing firms
Avg. cost of production as well as of distribution willbe higher for new firms
Figure 8.3
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Product differentiation and
Economies of Scale
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Minimum amount of ad expense is needed before it startsmaking impact on public
This is FC of ad
Threshhold effect- it is the size of audience that must bereached that determines the expenditure, not the firms
sales (national market)
Ad exp of exiting firm and new entrant would be same;entrants output small as compared to existing firm, makingthe unit cost of ad higher for the former
Regional markets
Repetition effect-effectiveness of advertisement(experience effect)
Rate structures of advertising media (spot ad vs. networkad)
This limit price differential is independent of the gapcreated by market penetration cost
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Product differentiation and
welfare
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Figure 8.4
Monopolists advertise too much, from social point
of view because they take decisions based on
their private MR and MC; they do not consider
the additional cost incurred on consumer in the
form of higher prices
Oligopoly results in even more excessive
advertising; if they succeed in controlling price
competition, then they divert their rivalry in
marketing efforts
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Capital requirements
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Why firms might have a cost advantage overpotential entrants at all levels of outputindependent of scale differences and advertising
Patents, control of inputs will be important in
some industries more than others Working of financial capital market is cited as a
general source of absolute cost advantage ofestablished firms
Higher effective interest cost (cost of capital) Severe rationing of funds on potential entrants
Inefficient capital market/uncertainty/ asymmetricalinformation/reputation/
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Empirical findings
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MES (Martin)
Advertising : media impact/ (Mueller and Rogers)
Kessides: sunk cost/odds of successful entry
increase as ad per unit of sales grows
Results vary in different segments/industry to
industry