1. MARKET STRUCTURE AND POWER Chapter 13.1

2. Market Structure  Market structure: establishes the overall environment within which each firm operates.  Number and size distribution of buyers and sellers  Type of product for sale Whether firms in the same industry produce standardized products or differentiated products Differentiated products are less substitutable  Barriers to entry These reflect any increased costs that new firms must incur relative to existing firms when entering a particular market High costs deter entry  Whether any asymmetry of information exists between buyer and sellers

3. Market Structure vs Market Power  Market structure affects market power  Market power refers to the firms ability to restrict output (or quality and thereby raise the price) will dictate to some extent how firms behave

4. Market Structure vs. Market Power Degree of Market Power 0% ……………………………………..100% Perfect Competition Monopolistic Competition OligopolyMonopoly No. sellersMany FewOne Individual firm mkt. share TinySmallLarge100% Type of productHDH or DH Barriers to entryNone SubstantialComplete Consumer info. PerfectSlight Imperfect Perfect or Imperfect H=Homogenous D=Differentiated

5. Measuring Market Concentration  Market concentration: reflects the number and size distribution of firms in an industry  E.g. perfect competition has a large number of firms with small market shares  Want to capture this structure with a statistics  Two measures of market concentration  Concentration ratio  Herfindahl-Hirschman Index

6. Measuring Market Concentration  Concentration ratio  % of industry output produced by the largest firms in the industry Industry output measured in terms of sales or volume of output Four-Firm Concentration Ratio (CR 4 ) % of industry output produced by 4 larges firms 60% indicates that the four large firms account for 60 percent of industry output <40% competitive 40-60% monopolistic competition 60+ oligopoly

7. Measuring Market Concentration  Limitations Only considers number and size distribution of firms when determining market structure Does consider barriers to entry Does not consider the distribution of output among the largest firms Firms more likely to be price competitive when similarly sized compared to when one firm dominates the industry and others are much smaller

8. Measuring Market Concentration  Herfindahl-Hirschman Index (HHI)  Takes into account the relative size of the largest firms in the concentration ratio Si is the % of market share or % industry output produced by the ith firm. N is the total number of firms in the industry 0 many firms, 10,000 one firm

9. Measuring Market Concentration  Market structure and HHI No specific cut offs that reflect structure of the market using HHI Department of justice has some guidelines concerning when the level of HHI triggers concern about the potential exploitation of market power HHI<1000: reasonably competitive 1000>HHI<1800: mildly concentrated HHI>1800: highly concentrated market