1. Managerial Economics and Organizational Architecture, 5e Managerial Economics and Organizational Architecture, 5e Chapter 6: Market Structure Copyright © 2009 by The McGraw-Hill Companies, Inc. All Rights Reserved. McGraw-Hill/Irwin

2. Managerial Economics and Organizational Architecture, 5e 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 6-2

3. Managerial Economics and Organizational Architecture, 5e Market Structure Perfect competition Monopoly Monopolistic competition Oligopoly 6-3

4. Managerial Economics and Organizational Architecture, 5e Perfect Competition Characteristics Many buyers and sellers Product homogeneity Low cost and accurate information Free entry and exit Best regarded as a benchmark 6-4

5. Managerial Economics and Organizational Architecture, 5e Firm Demand Curve Perfect Competition Price (in dollars) Quantity (market)Quantity (firm i) Q QiQi D S $ $ P* D i = MR i = AR i 6-5

6. Managerial Economics and Organizational Architecture, 5e Firm Supply Short run –Marginal cost curve above average variable cost –P* = SRMC Long run –Long-run marginal cost curve above long-run average cost 6-6

7. Managerial Economics and Organizational Architecture, 5e The Firm’s Short-Run Supply Curve Quantity (firm i) Costs per unit of output (in dollars) $ SRMC i ATC i AVC i QiQi 6-7

8. Managerial Economics and Organizational Architecture, 5e The Firm’s Long-Run Supply Curve Quantity (firm i) QiQi Cost per unit of output (in dollars) LRMC i LRAC i $ 6-8

9. Managerial Economics and Organizational Architecture, 5e Competitive Equilibrium Price and cost per unit of output (in dollars) P*0P*0 P*1P*1 Q* i1 Q* i0 Quantity (firm i) LRMC i LRAC i $ P*0P*0 P*1P*1 QiQi $ S0S0 S1S1 D0D0 Q*0Q*0 Q*1Q*1 Quantity Q 6-9

10. Managerial Economics and Organizational Architecture, 5e 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 6-10

11. Managerial Economics and Organizational Architecture, 5e Monopoly Single seller in an industry Strong barriers to entry Profit maximization –faces market demand and sets MR=MC Unexploited gains from trade 6-11

12. Managerial Economics and Organizational Architecture, 5e Monopolist Faces Market Demand Price and cost per unit of output Quantity $ MR MC = AC Q Q*=95 P*= 105 D Profits Lost gains from trade 6-12

13. Managerial Economics and Organizational Architecture, 5e Monopolistic Competition Multiple firms produce similar products Firms face downward sloping demand curves Profit maximization occurs where MC=MR With free entry and exit, firms compete away economic profits Examples – toothpaste, shampoo, restaurants, banks 6-13

14. Managerial Economics and Organizational Architecture, 5e Monopolistic Competitor in the Long Run Price and cost per unit of output (in dollars) P* i Q* i MR i Quantity (firm i) QiQi LRMC i LRAC i DiDi 6-14

15. Managerial Economics and Organizational Architecture, 5e 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 Examples – steel, autos, colas, airlines 6-15

16. Managerial Economics and Organizational Architecture, 5e 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 6-16

17. Managerial Economics and Organizational Architecture, 5e Determining the Nash Equilibrium $20 $200 $250 $40 $0 $400 $200 Low Price Low Price High Price High Price TuInc WonCo 6-17

18. Managerial Economics and Organizational Architecture, 5e The Cournot Model Duopolists A and B face industry demand P=100-Q, Q=Q A +Q B Each firm takes the other’s output as fixed E.g., P A =(100-Q B *)-Q A Marginal revenue for A is MR A =(100-Q B *)-2Q A If MC=0, the optimal output for A for the given output for B is Q A =50-.5Q B which is the reaction curve for firm A 6-18

19. Managerial Economics and Organizational Architecture, 5e Cournot Equilibrium Quantity of output by Firm A Firm A’s reaction curve Quantity of output by Firm B a = Competitive equilibrium b = Cournot equilibrium c = Collusive (monopoly) equilibrium 25 33.33 50 100 QBQB 33.3350100 QAQA Firm B’s reaction curve a b c 6-19

20. Managerial Economics and Organizational Architecture, 5e Comparison of Prices and Output Among Different Equilibria MC = 0 0 33.34 50 100 Quantity 50 66.66100 Collusion Cournot Competition Q Price (in dollars) MR $ 6-20

21. Managerial Economics and Organizational Architecture, 5e The Classic Prisoners’ Dilemma 2 months Avi—No confession Avi—Confession 18 months 0 months 12 months Bea—No confession Bea—Confession 6-21

22. Managerial Economics and Organizational Architecture, 5e Cartels Occur when firms agree to set price and output levels Generally illegal in the U.S. Self interest results in failure of the cartel Repeated interaction increase the incentives to cooperate 6-22

23. Managerial Economics and Organizational Architecture, 5e The Cartel’s Dilemma $500 AVInc—Low output AVInc—High output $150 $600 $200 BeaCo—Low output BeaCo—High output 6-23