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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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Features of the four market structures
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Features of the four market structures
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Features of the four market structures
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Features of the four market structures
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Features of the four 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 Structure conduct performance
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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
AC MC P O R (b) Firm Q (thousands) S D AR D = AR = MR Pe AC O Qe Q (millions) (a) Industry
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Loss minimising under perfect competition
AC MC P R S AC D1 = AR1 = MR1 AR1 Qe P1 D O O Q (millions) Q (thousands) (a) Industry (b) Firm
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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 The short-run supply curve of the firm
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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
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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 New firms enter Supernormal profits LRAC P R S1 D Se P1 AR1 D1 PL ARL DL O O QL Q (millions) Q (thousands) (a) Industry (b) Firm
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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 R (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 lower costs for an established firm ownership/control of key factors ownership/control over outlets legal protection mergers and takeovers aggressive tactics intimidation
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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
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Profit maximising under monopoly
MC R 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
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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 high prices / low output: short run
high prices / low output: long run
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Monopoly Disadvantages of monopoly high prices / low output: short run
high prices / low output: long run lack of incentive to innovate
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Monopoly Disadvantages of monopoly high prices / low output: short run
high prices / low output: long run lack of incentive to innovate X-inefficiency
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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 X-inefficiency Advantages of monopoly
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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 X-inefficiency Advantages of monopoly economies of scale
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Equilibrium of industry under perfect competition and monopoly: with different MC curves
MCmonopoly P1 AR = D MR O Q1 Q
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MC ( = supply)perfect competition
Equilibrium of industry under perfect competition and monopoly: with different MC curves R MC ( = supply)perfect competition MCmonopoly P2 P1 x P3 AR = D MR O Q2 Q1 Q3 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 X-inefficiency Advantages of monopoly economies of scale profits can be used for investment
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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 X-inefficiency Advantages of monopoly economies of scale profits can be used for investment high profits encourage risk taking
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Monopoly Contestable markets
importance of potential competition a perfectly contestable market contestable markets and natural monopolies importance of costless exit Contestable markets and the public interest
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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 R 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
LRMC LRAC 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
LRAC P1 P2 DL under perfect competition DL under monopolistic competition O Q1 Q2 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 Non-price competition
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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
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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
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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 D = AR O Q
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Profit-maximising cartel
Industry MC P1 Industry D = AR Industry MR O Q1 Q
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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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Oil prices Impending war with Iraq Iraq invades Iran OPEC’s first
quotas Iraq invades Kuwait Revolution in Iran World-wide recovery First oil from North Sea World-wide slowdown Cease-fire in Iran-Iraq war New OPEC quotas Recession in Far East Yom Kippur War: Arab oil embargo
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Oil prices Impending war with Iraq Iraq invades Iran OPEC’s first
quotas Iraq invades Kuwait Revolution in Iran World-wide recovery First oil from North Sea World-wide slowdown Cease-fire in Iran-Iraq war New OPEC quotas Recession in Far East Yom Kippur War: Arab oil embargo
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Oligopoly Tacit collusion price leadership: dominant firm
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Price leader aiming to maximise profits for a given market share
Assume constant market share for leader AR = D market MR leader AR = D leader O Q
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Price leader aiming to maximise profits for a given market share
MC l t PL QL QT AR = D market AR = D leader MR leader O Q
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Oligopoly Tacit collusion price leadership: dominant firm
price leadership: barometric
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Oligopoly Tacit collusion price leadership: dominant firm
price leadership: barometric rules of thumb
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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
Non-collusive oligopoly: game theory alternative strategies maximax and maximin simple dominant strategy games
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Profits for firms A and B at different prices
X’s price R2.00 R1.80 A B R5m for Y R12m for X R2.00 R10m each Y’s price C D R12m for Y R5m for X R1.80 R8m each
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Oligopoly The breakdown of collusion
Non-collusive oligopoly: game theory alternative strategies maximax and maximin simple dominant strategy games Nash equilibrium
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Profits for firms A and B at different prices
X’s price R2.00 R1.80 A B R5m for Y R12m for X R2.00 R10m each Y’s price C D R12m for Y R5m for X R1.80 R8m each
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Oligopoly The breakdown of collusion
Non-collusive oligopoly: game theory alternative strategies maximax and maximin simple dominant strategy games Nash equilibrium the prisoners’ dilemma
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A B C D The prisoners' dilemma Amanda's alternatives Nigel's
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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Oligopoly The breakdown of collusion
Non-collusive oligopoly: game theory alternative strategies maximax and maximin simple dominant strategy games the prisoners’ dilemma Nash equilibrium more complex non-dominant strategy games
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Oligopoly The breakdown of collusion
Non-collusive oligopoly: game theory alternative strategies maximax and maximin simple dominant strategy games the prisoners’ dilemma Nash equilibrium more complex non-dominant strategy games the importance of threats and promises
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Oligopoly The breakdown of collusion
Non-collusive oligopoly: game theory alternative strategies maximax and maximin simple dominant strategy games the prisoners’ dilemma Nash equilibrium more complex non-dominant strategy games the importance of threats and promises the importance of timing of decisions
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Oligopoly The breakdown of collusion
Non-collusive oligopoly: game theory alternative strategies maximax and maximin simple dominant strategy games the prisoners’ dilemma Nash equilibrium more complex non-dominant strategy games the importance of threats and promises the importance of timing of decisions decision trees
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A decision tree Airbus decides Boeing decides Airbus decides (1) B1
Boeing –R10m Airbus –R10m (1) 500 seater Airbus decides B1 500 seater 400 seater Boeing +R30m Airbus +R50m (2) Boeing decides A 400 seater Boeing +R50m Airbus +R30m (3) 500 seater Airbus decides B2 400 seater Boeing –R10m Airbus –R10m (4)
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Oligopoly Non-collusive oligopoly: the kinked demand curve theory
assumptions of the model
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Kinked demand for a firm under oligopoly
Current price and quantity give one point on demand curve P1 Q1 O Q
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Kinked demand for a firm under oligopoly
Q Q1
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Oligopoly Non-collusive oligopoly: the kinked demand curve theory
assumptions of the model stable prices
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Stable price under conditions of a kinked demand curve
MC2 MR MC1 P1 a b D = AR O Q Q1
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Oligopoly Non-collusive oligopoly: the kinked demand curve theory
assumptions of the model stable prices limitations of the model
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Oligopoly Non-collusive oligopoly: the kinked demand curve theory
assumptions of the model stable prices limitations of the model Oligopoly and the public interest
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Oligopoly Non-collusive oligopoly: the kinked demand curve theory
assumptions of the model stable prices limitations of the model Oligopoly and the public interest advantages
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Oligopoly Non-collusive oligopoly: the kinked demand curve theory
assumptions of the model stable prices limitations of the model Oligopoly and the public interest advantages disadvantages
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Oligopoly Non-collusive oligopoly: the kinked demand curve theory
assumptions of the model stable prices limitations of the model Oligopoly and the public interest advantages disadvantages difficulties in drawing general conclusions
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Price Discrimination Meaning of price discrimination First degree
Second degree Third degree (the most common form)
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Third-degree price discrimination
Revenue from a single price P1 200 O Q
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Third-degree price discrimination
Increased revenue from price discrimination A higher discriminatory price is now introduced P2 150 P1 D O Q 200
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Price Discrimination Meaning of price discrimination
First degree Second degree Third degree (the most common form) Conditions necessary for price discrimination
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Price Discrimination Meaning of price discrimination
First degree Second degree Third degree (the most common form) Conditions necessary for price discrimination Advantages to the firm
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Price Discrimination Profit maximising prices and output under price discrimination
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Profit-maximising output under third degree price discrimination
DX O O O MRX (a) Market X
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Profit-maximising output under third degree price discrimination
DY DX MRY O O O MRX (a) Market X (b) Market Y
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Profit-maximising output under third degree price discrimination
DY DX MRY MRT O O O MRX (c) Total (markets X + Y) (a) Market X (b) Market Y
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Profit-maximising output under third degree price discrimination
MC DY DX MRY MRT O O O MRX (c) Total (markets X + Y) (a) Market X (b) Market Y
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Profit-maximising output under third degree price discrimination
MC DY DX MRY MRT O O O 3000 MRX (c) Total (markets X + Y) (a) Market X (b) Market Y
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Profit-maximising output under third degree price discrimination
MC 5 DY DX MRY MRT O O O 3000 MRX (c) Total (markets X + Y) (a) Market X (b) Market Y
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Profit-maximising output under third degree price discrimination
MC 5 DY DX MRY MRT O O O 1000 3000 MRX (c) Total (markets X + Y) (a) Market X (b) Market Y
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Profit-maximising output under third degree price discrimination
MC 5 DY DX MRY MRT O O O 1000 2000 3000 MRX (c) Total (markets X + Y) (a) Market X (b) Market Y
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Profit-maximising output under third degree price discrimination
MC 9 5 DY DX MRY MRT O O O 1000 2000 3000 MRX (c) Total (markets X + Y) (a) Market X (b) Market Y
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Profit-maximising output under third degree price discrimination
MC 9 7 5 DY DX MRY MRT O O O 1000 2000 3000 MRX (c) Total (markets X + Y) (a) Market X (b) Market Y
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Price Discrimination Profit maximising prices and output under price discrimination Price discrimination and the public interest competition
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Price Discrimination Profit maximising prices and output under price discrimination Price discrimination and the public interest competition profits
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