Lecture six © copyright ： qinwang 2013 SHUFE school of international business

Market structure and firm behavior  Market structure  Perfect competition and firm decision  Pure monopoly and firm decision  Monopolistic competition and firm decision  Oligopoly and firm decision

Market structure  Market structure ： the competitiveness of the products or services 。  Market competitive analysis ： market rates; price competition; barriers to entry and barriers to exit; industrial growth rate; fixed cost and variable cost.

 Influence Factors ： Number of consumers and firms Difference of product Scale economies Entry barrier and exit barrier

 Market structure: competitiveweakerhigher Pure Competition Monopolistic Competition OligopolyMonopoly

Perfect (pure) market Many firms and consumers all making same product ( homogenization) Each firm ’ s output small relative to total No entry and exit barrier Complete information  Example:

Pure monopoly Market with a single seller Firm demand = market demand No substitution High entry and exit barrier  Example:

Monopolistic Competition  Large number of firms sell a differentiated product Products are close (not perfect) substitutes  Market is monopolistic Product differentiation creates a degree of market power  Market is competitive Large number of firms, easy entry  Example:

Oligopoly market  Number of firms is small  Products are same or different  High barriers to entry  Interdependence of firms  example:

Decision in pure market （ 1 ） Price strategy （ 2 ） Short-run decision Maximum of profit Shut-down point （ 3 ） Long-run decision: enter or exit

Pure competition ： Firms are price-takers

Demand for a Competitive Price-Taker  Demand curve is horizontal at price determined by intersection of market demand & supply Perfectly elastic  Marginal revenue equals price Demand curve is also marginal revenue curve (D = MR)  Can sell all they want at the market price Each additional unit of sales adds to total revenue an amount equal to price

price MC AC MR=P=AR Profit-maximization Q 0 product P 0 0 Profit-Maximization in the Short Run Profit = π = TR - TC

Example: A firm in pure market ProductTotal costACMC  If P=17 ， how many product should be supplied ？ What is the Profit of per unit ？ What is the total profit ？

 In the short run, the firm incurs costs that are: Unavoidable and must be paid even if output is zero Variable costs that are avoidable if the firm chooses to shut down  In making the decision to produce or shut down, the firm considers only the (avoidable) variable costs & ignores fixed costs Profit-Maximization in the Short Run

Profit Margin (or Average Profit)  Level of output that maximizes total profit occurs at a higher level than the output that maximizes profit margin (& average profit) Managers should ignore profit margin (average profit) when making optimal decisions

Shut down （ 3 ） if market price = P 3 price P 1 P2P2 MC AVC AC P3P3 Q 1 Q 2 Q 3 product 0 （ 1 ） if market price =P 1 （ 2 ） if market price = P 2

If TR LTC ， P > LAC ， then entry Long-run decision: Entry or exit ?

Long-Run Competitive Equilibrium  All firms are in profit-maximizing equilibrium (P = LMC)  Occurs because of entry/exit of firms in/out of industry Market adjusts so P = LMC = LAC

Long-run equilibrium

Ranidae is introduced from Cuba. It grows fast and is delicious. Some farmers in south of China began to breed Ranidae in 1985, until 1992, there were about 800 farmers and with 500 mu breeding area. Mr.Li,50 years old, began to breed Ranidae in 1986 and had earned 700,000 yuan until1992. Mr.Zhang,40 years old, earned in 1992 for selling tadpole. In 1993, local newspaper published a wrong news: the price of Ranidae in city A is 52 yuan/kg, sales of Ranidae in City A is about 700 kg. export price of Ranidae is yuan/kg. At that time, a lot of farmers tried to breed Ranidae. The number of farmer rised to 6471 and breeding area increased to 6021 mu. Ranidae ’ s price is only yuan/kg, less than half of the cost. what should the farmers do? Ranidae

 Discussion:  Cabbage in Shanghai and Watermelon in other provinces.

Perfect(pure) market  The firm supplies its product at the minimum of its long-run cost, so it gets efficiency.  Resources are allocated efficiently between products and firms.  The total of Consumer surplus and supplier surplus are maximized.

Monopolistic competition  Price strategy Short-run decision Short-run decision Long-run decision Long-run decision  Product strategy: differentiation  Competitive strategy

In short-run, When SMC = MR, Profit maximum Short-run decision

Long-run equilibrium

Market Power  Ability of a firm to raise price without losing all its sales Any firm that faces downward sloping demand has market power  Gives firm ability to raise price above average cost & earn economic profit (if demand & cost conditions permit)

Measurement of Market Power  Degree of market power inversely related to price elasticity of demand The less elastic the firm ’ s demand, the greater its degree of market power The fewer close substitutes for a firm ’ s product, the smaller the elasticity of demand (in absolute value) & the greater the firm ’ s market power When demand is perfectly elastic (demand is horizontal), the firm has no market power

 Lerner index measures proportionate amount by which price exceeds marginal cost: Equals zero under perfect competition Increases as market power increases Also equals –1/E, which shows that the index (& market power), vary inversely with elasticity The lower the elasticity of demand (absolute value), the greater the index & the degree of market power Measurement of Market Power

 If consumers view two goods as substitutes, cross-price elasticity of demand (E XY ) is positive The higher the positive cross-price elasticity, the greater the substitutability between two goods, & the smaller the degree of market power for the two firms Measurement of Market Power

Product strategy ： differentiation  Technology innovation ： higher quality, new function, new product (objective difference)  Advertising and promotion: (subjective difference)  Service strategy ： service system after sale

 Discuss: advertising Giving information or inducing Benefit to Competition or concentration Promoting efficiency or waste

Optimal advertising intensity  The marginal profit or contribution margin from an additional unit of output: PCM=P-MC  The marginal cost of advertising (MCA) Optimal level of advertising outlays: PCM=MCA

Competitive strategy  Low cost strategy Dell ’ s cost leadership in PC assembly  Differentiation strategy  Focus strategy