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Market Structures
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The Degree of Competition
Classifying markets number of firms freedom of entry to industry nature of product nature of demand curve The four market structures perfect competition monopoly monopolistic competition oligopoly
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Features of the four market structures
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Perfect Competition Assumptions Short-run equilibrium of the firm
firms are price takers freedom of entry identical products perfect knowledge Short-run equilibrium of the firm price, output and profit
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Short-run equilibrium of industry and firm under perfect competition
Firm is a price taker. Price is given by the market. AC MC P O (b) Firm Q (thousands) S D AR D = AR = MR Pe AC O Qe Q (millions) (a) Industry 5
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Loss minimising under perfect competition
Loss is minimised where MC = MR. AC MC P S AC D1 = AR1 = MR1 AR1 Qe P1 D O O Q (millions) Q (thousands) (a) Industry (b) Firm 6
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Deriving the short-run supply curve
MC D1 = S D2 a D1 = MR1 D3 P1 b D2 = MR2 P2 c D3 = MR3 P3 O O Q (millions) Q (thousands) (a) Industry (b) Firm 7
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Perfect Competition Long-run equilibrium of the firm
all supernormal profits competed away LRAC = AC = MC = MR = AR
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Long-run equilibrium under perfect competition
Profits return to normal Supernormal profits New firms enter LRAC P S1 D Se P1 AR1 D1 PL ARL DL O O QL Q (millions) Q (thousands) (a) Industry (b) Firm 9
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Long-run equilibrium of the firm under perfect competition
LRAC Long-run equilibrium of the firm under perfect competition (SR)MC (SR)AC AR = MR DL LRAC = (SR)AC = (SR)MC = MR = AR O Q
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Perfect Competition Incompatibility of economies of scale with perfect competition Benefits of perfect competition price equals marginal cost prices kept low firms must be efficient to survive
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Monopoly Defining monopoly Barriers to entry economies of scale
economies of scope product differentiation and brand loyalty ownership/control of key factors ownership/control over outlets legal protection
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Monopoly The monopolist’s demand curve Equilibrium price and output
downward sloping MR below AR Equilibrium price and output Equilibrium output, where MC = MR Equilibrium price, found from demand curve
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Profit maximising under monopoly
MC AC AR AR AC MR O Qm Q
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Monopoly The monopolist’s demand curve Equilibrium price and output
downward sloping MR below AR Equilibrium price and output Equilibrium output, where MC = MR Equilibrium price, found from demand curve Profit Measuring profit
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Profit maximising under monopoly
MC Total profit AC AR AR AC MR O Qm Q
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Monopoly The monopolist’s demand curve Equilibrium price and output
downward sloping MR below AR Equilibrium price and output Equilibrium output, where MC = MR Equilibrium price, found from demand curve Profit Measuring profit Supernormal profit can persist in long run
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Monopoly Disadvantages of monopoly high prices / low output: short run
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Equilibrium of industry under perfect competition and monopoly: with the same MC curve
AR = D MR Monopoly P1 O Q1 Q
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Equilibrium of industry under perfect competition and monopoly: with the same MC curve
MC ( = supply under perfect competition) Comparison with Perfect competition P1 P2 AR = D MR O Q1 Q2 Q
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Monopoly Disadvantages of monopoly Advantages of monopoly
high prices / low output: short run high prices / low output: long run lack of incentive to innovate Advantages of monopoly economies of scale profits can be used for investment high profits encourage risk taking
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Monopolistic Competition
Assumptions of monopolistic competition Equilibrium of the firm short run
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Short-run equilibrium of the firm under monopolistic competition
MC AR = D MR AC Ps ACs O Qs Q
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Monopolistic Competition
Assumptions of monopolistic competition Equilibrium of the firm short run long run
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Long-run equilibrium of the firm under monopolistic competition
New firms entering the industry reduce demand for each individual firm. LRMC LRAC Price falls to PL. ARL = DL MRL PL O QL Q
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Monopolistic Competition
Assumptions of monopolistic competition Equilibrium of the firm short run long run underutilisation of capacity in the long run
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Long run equilibrium of the firm under perfect and monopolistic competition
Higher price and lower output (excess capacity) under monopolistic competition LRAC P1 P2 DL under perfect competition DL under monopolistic competition O Q1 Q2 Q 27
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Monopolistic Competition
Assumptions of monopolistic competition Equilibrium of the firm short run long run underutilisation of capacity in the long run Non-price competition The public interest comparison with perfect competition comparison with monopoly
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Oligopoly Key features of oligopoly Competition versus collusion
barriers to entry interdependence of firms Competition versus collusion Collusive oligopoly: cartels equilibrium of the industry
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Profit-maximising cartel
Industry profit maximised at Q1 and P1 Industry MC P1 Members must agree to restrict total output to Q1. Industry D = AR Industry MR O Q1 Q 30
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Oligopoly Key features of oligopoly Competition versus collusion
barriers to entry interdependence of firms Competition versus collusion Collusive oligopoly: cartels equilibrium of the industry allocating and enforcing quotas
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Oligopoly Tacit collusion price leadership: dominant firm
price leadership: barometric rules of thumb
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Price leader aiming to maximise profits for a given market share
MC l t PL QL QT AR = D market Leader maximises profit at QL and thus sets price of PL. AR = D leader MR leader O Q 33
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Oligopoly Factors favouring collusion few firms open with each other
similar production methods and average costs similar products dominant firm significant entry barriers stable market no government measures to curb collusion
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Oligopoly The breakdown of collusion
factors to consider in deciding whether to break an agreement how likely are rivals to retaliate? who would win a price war? importance of considering rivals’ reactions
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Oligopoly Non-collusive oligopoly: assumptions about rivals’ behaviour
rivals produce fixed quantity: Cournot model firms choose best output for remainder of the market
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Cournot model: Firm A’s profit-maximising position
MCA Firm A’s profit-maximising output and price are QA1 and PA. Costs and revenue PA1 QA1 DA1 DM MRA1 O QB1 Quantity 37
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The Cournot model of duopoly
Firm A’s reaction function for each assumed output of B RA MCA Firm B’s output PA1 QB1 x QA1 DM DA1 MRA1 O QA1 O QB1 Quantity Firm A’s output (a) Firm A’s profit-maximising position (b) The two firms’ reaction functions 38
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The Cournot model of duopoly
Equilibrium at point e, where the two reaction functions cross RA MCA Firm B’s output PA1 e RB QBe QAe QB1 x DM DA1 MRA1 O QA1 O QA1 QB1 Quantity Firm A’s output (a) Firm A’s profit-maximising position (b) The two firms’ reaction functions 39
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Oligopoly Non-collusive oligopoly: assumptions about rivals’ behaviour
rivals produce fixed quantity: Cournot model firms choose best output for remainder of the market profit will be less than under a cartel but more than under perfect competition rivals set a particular price: Bertrand model the firm will undercut the rival this will probably trigger a price war until all supernormal profits are eliminated
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Oligopoly Non-collusive oligopoly: assumptions about rivals’ behaviour (cont.) Nash equilibrium when everyone makes a decision based on the alternatives rivals could adopt Nash equilibrium worse for the individual firms than the collusive equilibrium The kinked demand curve model assumptions of the model stable prices
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Kinked demand for a firm under oligopoly
Assumption 1 If the firm raises its price, rivals will not. D Assumption 2 If the firm reduces its price, rivals will feel forced to lower theirs too. P1 D O Q Q1 42
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Stable price under conditions of a kinked demand curve
MC2 MR MR is discontinuous between a and b. If MC is anywhere between MC1 and MC2, profit is maximised at Q1. MC1 P1 a b D = AR O Q Q1 43
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Oligopoly Oligopoly and the consumer advantages disadvantages
incentive to develop new and better products greater choice for consumers than under monopoly disadvantages less scope for economies of scale than under monopoly more extensive advertising and other costly marketing difficulties in drawing general conclusions 8 44
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Game Theory Non-collusive oligopoly: game theory Single-move games
alternative strategies maximax and maximin simple dominant strategy games 6 45
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Profits for firms A and B at different prices
X’s price £2.00 £1.80 A B £5m for Y £12m for X £2.00 £10m each Y’s price C D £12m for Y £5m for X £1.80 £8m each
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Game theory Non-collusive oligopoly: game theory Single-move games
alternative strategies maximax and maximin simple dominant strategy games the prisoners’ dilemma 6
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The prisoners’ dilemma
Amanda's alternatives Not confess Confess A B Nigel gets 10 years Amanda gets 3 months Not confess Each gets 1 year Nigel's alternatives C D Nigel gets 3 months Amanda gets 10 years Each gets 3 years Confess
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Game Theory Non-collusive oligopoly: game theory Single-move games
alternative strategies maximax and maximin simple dominant strategy games the prisoners’ dilemma Nash equilibrium non-dominant strategy games 6
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Profit possibilities for Firm X
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Profit possibilities for Firm X
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Game theory Repeated games more complex non-dominant strategy games
multiple moves the importance of threats and promises credible threats the importance of timing decision trees 6
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A decision tree Airbus decides Boeing decides Airbus decides (1) B1
Boeing –£10m Airbus –£10m (1) 500 seater Airbus decides B1 500 seater 400 seater Boeing +£30m Airbus +£50m (2) Boeing decides A 400 seater Boeing +£50m Airbus +£30m (3) 500 seater Airbus decides B2 400 seater Boeing –£10m Airbus –£10m (4)
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Game Theory Repeated games more complex non-dominant strategy games
multiple moves the importance of threats and promises credible threats the importance of timing decision trees first mover advantage 6 54
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A decision tree Airbus decides Boeing decides Airbus decides (1) B1
Boeing –£10m Airbus –£10m (1) 500 seater Airbus decides B1 500 seater 400 seater Boeing +£30m Airbus +£50m (2) Boeing decides A 400 seater Boeing +£50m Airbus +£30m (3) 500 seater Airbus decides B2 400 seater Boeing –£10m Airbus –£10m (4)
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Game Theory Limitations of game theory
complex games with multiple players the role of individuals’ morals and attitudes Potential for cycles of collusion and competition 6 56
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