• Share
  • Email
  • Embed
  • Like
  • Save
  • Private Content
Gsb728   lecture note topic 2b

Gsb728 lecture note topic 2b






Total Views
Views on SlideShare
Embed Views



1 Embed 5

http://study.uneopen.com 5


Upload Details

Uploaded via as Microsoft PowerPoint

Usage Rights

© All Rights Reserved

Report content

Flagged as inappropriate Flag as inappropriate
Flag as inappropriate

Select your reason for flagging this presentation as inappropriate.

  • Full Name Full Name Comment goes here.
    Are you sure you want to
    Your message goes here
Post Comment
Edit your comment

    Gsb728   lecture note topic 2b Gsb728 lecture note topic 2b Presentation Transcript

    • Economics for Management GSB728 Topic 4: Firms and Competition 1
    • Note: This lecture note was prepared based on the teaching material provided by the publisher of the textbook Principles of Economics. 2
    • Learning Objectives 1. The degree of competition - How much competition does a firm face? 2. Perfect competition – What happens when there are very many firms all competing against each other? Is this good for us as consumers? 3. Monopoly – What happens when there is only one firm in the market? Do we as consumers suffer? 4. Monopolistic competition - Assumptions. 3
    • Learning Objectives (contd.) 5. Oligopoly - What happens if there are just a few firms that dominate the market? Will they compete or get together? 6. Price discrimination - In what situations will firms be able to charge different prices to different consumers? How will we or consumers benefit or lose from the process? 4
    • The Degree of Competition • Classifying markets accordingly to: – Number of firms. – Freedom of entry to industry. – Nature of product. – Nature of demand curve. 5
    • The Degree of Competition (contd.) • The basic market structures: – Perfect competition – Monopoly – Monopolistic competition – Oligopoly • Structure Conduct Performance 6
    • Four Market Structures Source: Sloman et al. (2014). 7
    • Market Structures and Product Differentiation Source: Krugman & Wells (2013). 8
    • Perfect Competition • Assumptions: – Firms are price takers. – Freedom of entry. – Identical product. – Perfect knowledge of the market. • Short-run equilibrium of the firm: – Price, output and profit. 9
    • Derivation of Short-Run Profit Under Conditions of Perfect Competition $ $ Profit S D = AR = MR AR AC Pe AC MC D 0 0 Q (millions) (a) Industry Source: Sloman et al. (2014). Qe Q (thousands) (b) Firm 10
    • Derivation of Short-Run Loss Under Conditions of Perfect Competition AC $ $ MC loss S AC AR Pe D = AR = MR D 0 0 Q (millions) (a) Industry Source: Sloman et al. (2014). Qe Q (thousands) (b) Firm 11
    • Derivation of the Short-Run Supply Curve S P $ MC = S a P1 b P2 c P3 D1 = MR1 D2 = MR2 D3 = MR3 D1 D3 O D2 O Q (millions) (a) Industry Source: Sloman et al. (2014). Q (thousands) (b) Firm 12
    • Perfect Competition: Long Run Equilibrium • Long-run equilibrium of the firm: – Supernormal profits eventually eliminated through competition as new firms enter the market. – LRAC = (SR)AC = MC = MR = AR 13
    • Long-Run Equilibrium Under Perfect Competition P New firms enter and supply moves to the right S1 to Se $ S1 Se At P1(=AR1 = D1) supernormal profits (P1 > LRAC) but entry of new firms forces price down to PL(=ARL= DL) and Supernormal profits are eventually eliminated. LRAC P1 ARL P1 PL D1 DL D 0 0 Q (millions) (a) Industry Source: Sloman et al. (2014). QL Q (thousands) (b) Firm 14
    • Perfect Competition Long-Run Equilibrium of the Firm (SR)MC $ (SR) AC LRAC D = AR = MR Equilibrium = LRAC = (SR)AC =(SR)MC = MR =AR 0 Source: Sloman et al. (2014). Q 15
    • Growth of an Industry After a Shift in Demand Source: Taylor and Frost (2009). 16
    • Perfect Competition (contd.) • Incompatibility of perfect competition and substantial economies of scale: When firms expand to achieve economies of scale they usually gain market power (undercut prices to decrease competition). • Is perfect competition good for consumers? – Price equals marginal cost (efficient). – Prices kept low (firms operate at minimum LRAC). – Firms must be efficient to survive. 17
    • Monopoly • Monopoly exists when: 1) there is only one firm in the industry 2) selling a particular product and 3) there are barriers to entry. • Barriers to entry: – Economies of scale. – Product differentiation and brand loyalty. – Lower costs for an established firm. – Ownership/control of key production factors. – Ownership/control over inputs or outlets. – Legal protection. – Mergers and takeovers. – Aggressive tactics. 18
    • Monopoly (contd.) • The monopolist’s demand curve is: – Downward sloping. – MR falls below AR. • Equilibrium price and output: – Equilibrium output achieved where MC = MR. – Equilibrium price given by the demand curve. 19
    • Profit Maximisation Under Monopoly $ MC P = AR AR 0 Source: Sloman et al. (2014). MR Qm Q 20
    • Monopoly (contd.) • Profit: – Supernormal profit can persist in long run. 21
    • Profit Maximisation Under Monopoly $ MC Total profit AC AR AC AR 0 Source: Sloman et al. (2014). MR Qm Q 22
    • Profit Maximisation Under Monopoly Source: Pindyck & Rubinfeld (2013). 23
    • Monopoly (contd.) • Monopoly versus perfect competition: which best serves the public interest? – Short-run price and output • Monopoly: high prices/low output: short run – Long-run price and output • Monopoly: high prices/low output: long run 24
    • Comparison of Industry Equilibrium: Monopoly and Perfect Competition Assuming same MC curve MC ( = supply under Monopoly equilibrium restricts output and maximises price. $ perfect competition) Equilibrium under perfect competition gives lower price and increased output. P1 P2 AR = D MR monopoly O Source: Sloman et al. (2014). Q1 Q2 AR=D=MR under perfect competition. Q 25
    • Monopoly (contd.) • Monopoly versus perfect competition: which best serves the public interest? – Costs under monopoly: • Costs may be higher - barriers to entry. • Costs may be lower - economies of scale. – Super-normal profit for research and development and investment. – Competition for corporate control. – Innovation and new products. 26
    • Comparison of Industry Equilibrium Monopoly and Perfect Competition Differing MC curves (I) $ MC monopoly P1 AR = D MR monopoly 0 Source: Sloman et al. (2014). Q1 Q 27
    • Comparison of Industry Equilibrium Monopoly and Perfect Competition Differing MC curves (II) $ MC perfect competition ( = supply) MC perfect competition ( = supply) MC monopoly Q1 Produced MC monopoly P2 Q3 Produced P1 P3 AR = D =MR perfect competition MR monopoly 0 Q2 Source: Sloman et al. (2014). Q1 Q3 Q4 Q 28
    • Theory of Contestable Markets • A perfectly contestable market has three main features: – No entry or exit barriers. – No sunk costs (costs that cannot be recouped). – Access to the same level of technology. 29
    • Theory of Contestable Markets (contd.) • Theory of contestable markets: – Relevance of potential competition (threat of competition). – How contestable is the market? (is there free and costless entry and exit). – Contestable markets and natural monopolies (economies of scales and size of the market affect contestability of markets). – Importance of costless exit (absence of sunk costs, which cannot be recouped). • Contestability and the consumer’s interest. 30
    • Monopolistic Competition • Assumptions of monopolistic competition: • Large number of firms. • Interdependence. • Freedom of entry. • Product differentiation. – Examples in Australia: • Petrol stations, hairdressers, restaurants, breakfast cereals, soft drinks, etc. 31
    • Monopolistic Competition Short-Run Equilibrium of the Firm MC $ AC Ps Economic profit ACs AR D MR 0 Source: Sloman et al. (2014). Qs Q 32
    • Monopolistic Competition Long-Run Equilibrium of the Firm $ LRMC LRAC PL AR D MR 0 Source: Sloman et al. (2014). QL Q 33
    • Monopolistic Competition • Non-price competition: • Product development/differentiation. • Advertising. • The public interest: – Comparison with perfect competition: • Less will be sold and at a higher price. • Firms will not be producing at the least-cost point (due to excess of capacity). • Difference in price expected to be small. • Variety of products to choose from. – Comparison with monopoly: • More will be sold at lower prices (more competition). 34
    • Perfect and Monopolistic Competition Long-Run Equilibrium of the Firm Contrasted $ Long-run equilibrium under monopolistic competition Long-run equilibrium under perfect competition LRAC P1 P2 DL perfect competition DL monopolistic competition 0 Source: Sloman et al. (2014). Q1 Q2 Q 35
    • Oligopoly • Key features of oligopoly: – Barriers to entry. – Interdependence of the firms. • Examples in Australia: – Motor vehicle industry, banking industry, supermarket . 36
    • Is the Australian’s Banking Sector Under Oligopoly? Banks’ % Share of Total Bank Assets Bank Commonwealth National Australia Westpac ANZ Sub-total – four largest banks All other banks Total – all banks Source: Sloman et al. (2014). % 18.6 18.2 15.2 14.6 66.7 33.3 100.0 37
    • Oligopoly (contd.) • Decision: Competition or collusion. • Non-Collusive oligopoly: Oligopolists have no agreement between themselves, formal, informal or tacit. • Collusive oligopoly: Oligopolists agree formally or informally to limit competition between them. – They must set quotas, fix prices, limit product promotion or development, or agree to respect each other’s market share. – Cartel: Formal collusive agreement. 38
    • Profit-Maximising Oligopolistic Cartel $ MC industry P1 D industry AR industry MR industry 0 Q1 Source: Sloman et al. (2014). Q 39
    • Oligopoly (contd.) • Cartels: – Equilibrium of the industry: Similar to monopoly. Quantity will be reduced to increase prices and profits of members of the cartel. How? – Allocating and enforcing quotas (production or sell quota set by a cartel): Output that each member of a cartel is allowed to produce or sell. – Example: The Organisation of Petroleum Exporting Countries (OPEC). 40
    • Oligopoly (contd.) • Tacit collusion: – Dominant firm price leadership. – Barometric firm price leadership. – Other forms of tacit collusion: • Average cost pricing. • Price benchmark (reference price). 41
    • Oligopolistic Price Leader Aims to Maximise Profits for a Given Market Share (I) $ Price leader has major market share and sets market price EL PL MC leader Market follows price leader EM D market = AR market D leader = AR leader MR leader 0 Source: Sloman et al. (2014). QL QM Q 42
    • Oligopolistic Price Leader Aims to Maximise Profits for a Given Market Share (II) $ Leader drops price MC leader PL (=M) EL EM Market may retaliate price war! EL1 PL1 D market = AR market D leader = AR leader Leader increases market share MR leader 0 Source: Sloman et al. (2014). Q L Q L1 QM Q 43
    • Oligopoly (contd.) • Factors favouring collusion: – Few firms. – Open with each other about costs and production methods. – Similar production methods and average costs. – Similar products. – There is a dominant firm. – Significant entry barriers. – The market is stable. – No government measures to stop collusion (Antitrust laws in US, Europe and Australia’s Competition and Consumer 44 Commission – ACCC: http://www.accc.gov.au/).
    • Oligopoly (contd.) • Non-collusive oligopoly: firms decide do not cooperate. • Game theory – Alternative strategies including: • Maximin (choosing the strategy whose worst possible outcome is the least bad) and Maximax (choosing the strategy that has the best possible outcome). – Simple dominant strategy games: • The prisoners’ dilemma. • Nash equilibrium (position resulting from everyone making their optimal assumptions about their rival’s decisions). – The importance of threats and promises. – The importance of timing of decisions. • Decision trees/First mover advantage/disadvantage. 45
    • Game theory: Profits for Firms X and Y at Different Prices X’s price $2.00 B A $2.00 $1.80 $5m for Y $12m for X $10m each Y’s price D C $1.80 Source: Sloman et al. (2014). $12m for Y $5m for X $8m each 46
    • The Prisoners’ Dilemma Sue's alternatives Not confess Not confess Bill's alternatives Confess Source: Sloman et al. (2014). Confess B A Each gets 1 year C Bill gets 3 months Sue gets 10 years Bill gets 10 years Sue gets 3 months D Each gets 3 years 47
    • Decision Tree Boeing –$10m Airbus –$10m Boeing decides A (3) Boeing –$10m Airbus –$10m (4) or or B2 Airbus decides Source: Sloman et al. (2014). (2) Boeing +$50m Airbus +$30m B1 (1) Boeing +$30m Airbus +$50m Airbus decides or 48
    • Kinked Demand for an Oligopolistic Firm (I) $ Current price and quantity give one point on demand curve. P1 D market O Source: Sloman et al. (2014). Q1 Q 49
    • Kinked Demand for an Oligopolistic Firm (II) $ P1 a Lowering price below market equilibrium ‘a’ will cause other firms to follow thus reducing elasticity of demand. D market O Source: Sloman et al. (2014). Q1 Q 50
    • Kinked Demand Curve Promotes Price Stability $ MC2 E1 P1 MC1 a D b O Source: Sloman et al. (2014). Q1 MR AR Q 51
    • Oligopoly (contd.) • Oligopoly and the consumer: – Collusion is negative for consumers. Some disadvantages like less scope for economies for economies of scale. – Some advantages are: • Oligopolists could use part of their abnormal profits for research and product development/Non-price competition. Also price stability. – Countervailing power (market power of a seller is offset by powerful buyers who can prevent the price to raise. – Difficult to draw general conclusions. 52
    • Price Discrimination • Price discrimination: A firm sells the same product at different prices. – First degree • Approximate examples in Australia could include bargaining at market stalls, and some services. – Second degree • Examples in Australia include water, electricity, bulk buying. – Third degree (the most common form) • Examples in Australia include cinema tickets, airline tickets, rail and bus tickets. 53
    • Price Discrimination (contd.) • Conditions necessary for price discrimination: • Firms must be able to determine own price (not price takers). • Separate markets (not possibility of resell or arbitrage). • Differing demand elasticities between markets. 54
    • Third-Degree Price Discrimination (I) $ Revenue from a single Price 200 x $10 = $2,000 10 D O Source: Sloman et al. (2014). 200 Q 55
    • Third-Degree Price Discrimination (II) $ A high discriminatory price of $20 is now introduced at which 150 units are sold, giving revenue of 150 x $20 = $3, 000 20 With price discrimination, total revenue is increased from $2,000 to $3,500 10 D Revenue from previous price now (200-150) x 10 = $500 O Source: Sloman et al. (2014). 150 200 Q 56
    • Price Discrimination (contd.) • Advantages of Price discrimination to the firm: • Higher revenue. • Used to drive competitors out of business in specific markets. • Used to subsidise predatory pricing (selling at a price below average variable cost in order to drive competitors out of the market) in a particular market. 57
    • Profit-Maximising Output Under Third-Degree Price Discrimination Total revenue with price discrimination = $23,000 $ MCY MCX MCT 9 7 DY 5 MRX 0 1,000 0 (a) Market X TR = $9 x 1,000 = $9,000 Source: Sloman et al. (2014). MRT MRY DX 2,000 (b) Market Y 0 3,000 (c) Markets X + Y TR = $7 x 2,000 = $14,000 58
    • Price Discrimination (contd.) • Price discrimination and the consumer: – Not clear-cut decision can be made (some consumers might benefit while other might loose). 59
    • References Krugman, P. and Wells, R. (2013). Economics (3rd ed.). New York: Worth Publishers. Morales, L. E., Simons, P. and Valle de Souza, S. (2014). GSB728: Economics for Management [Topic Notes]. Armidale, Australia: University of New England, Graduate School of Business. Pindyck, R. and Rubinfeld, D. (2013). Microeconomics (8th ed.). New Jersey: Pearson. 60
    • References (contd.) Sloman, J., Norris, K and Garratt, D. (2014). Principles of Economics (4th ed.). French Forest, Australia: Pearson. Taylor, J. and Frost, L. (2009). Microeconomics (4th ed.). Milton, Australia: John Wiley & Sons. 61