Chapter 6: Market Structure Brickley, Smith, and Zimmerman, Managerial Economics and Organizational Architecture, 4th ed.

Market structure objectives Students should be able to Differentiate among the four standard market structures Distinguish between price takers and price searchers

Market structure What is a market? All firms and individuals willing and able to buy or sell a particular product What is market structure? Defined by attributes of the market environment

Market structures Perfect competition Monopoly Monopolistic competition Oligopoly

Perfect competition characteristics Many buyers and sellers Product homogeneity Low cost and accurate information Free entry and exit

Firm demand curve perfect competition (Figure 6.1)

Firm supply Short run –Marginal cost curve above average variable cost Long run –Long-run marginal cost curve above long-run average cost

The firm’s short-run supply curve (Figure 6.2)

The firm’s long-run supply curve (Figure 6.3)

Shut-down Analysis If Price (P) > Average Cost (AC) Stay Open (this applies to both short run and long run) What if Price (P) < Average Cost (AC)? Then we need to do more analysis

Shut-down Analysis If Price (P) < Average Variable Cost (AVC) Shut down immediately

Shut-down Analysis What if Average Total Cost (ATC)> Price (P) > Average Variable Cost (AVC)? Short run: stay in business Long run: shut down

Competitive equilibrium (Figure 6.4)

Barriers to entry Incumbent reactions Specific assets Economies of scale Excess capacity Reputation effects Incumbent advantages Precommitment contracts Licenses and patents Learning-curve effects Pioneering brand advantages

Monopoly Strong barriers to entry  single supplier Profit maximization –faces market demand and sets MR=MC Unexploited gains from trade

Monopolistic competition Multiple firms produce similar products Firms face downsloping demand curves Profit maximization occurs where MC=MR In the limit, firms compete away economic profits

Oligopoly A few firms produce most market output Products may or may not be differentiated Effective entry barriers protect firm profitability Firm interdependence requires strategic thinking

The Nash equilibrium An oligopolist does the best it can, given expectations of rival behavior Behaviors are noncooperative Duopolists considering a low price or a high price must consider rival’s response Nash equilibrium occurs when each firm does the best it can given rival’s actions

Determining the Nash equilibrium

The classic prisoners’ dilemma

The cartel’s dilemma