Market structures


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Market structures

  2. 2. Market • Market refers to the interaction between sellers and buyers of a good at a mutually agreed upon price.
  3. 3. Classification of Markets Based on Place • Local • National • International Based on Time • Very short period or Market period • Short Period • Long Period Based on Competition • Perfect Competition • Imperfect Competition
  4. 4. Imperfect Competition Markets • Monopoly • Monopolistic competition • Oligopoly • Oligopsony • Monopsony
  5. 5. MARKET STRUCTURE • What are the main criteria which are used to distinguish the different market structure? • The number and size of producers and consumers • The type of goods and services • The information • Freedom to Enter into or Exit from the Market
  6. 6. Four market types
  7. 7. PERFECT COMPETITION • • • Definition of Perfect competition: A market in which there are many small firms, all producing homogeneous goods. No single firm has influence on the price of the product it sells.
  8. 8. PERFECT COMPETITION • Feature of Perfect competition • • • • Many buyers / Many sellers Homogeneous Products Low-entry / exit barriers Perfect information – For both consumers and producers • Firms aim to maximize
  9. 9. • Examples: Perfect Competition • agricultural products • financial instruments • precious metals • petroleum
  10. 10. Pricing and output decisions in perfect competition • Basic business decision: entering a market using the following questions: • how much should we produce? • if we produce such an amount, how much profit will we earn? • if a loss rather than a profit is incurred, will it be worthwhile to continue in this market in the long run (in hopes that we will eventually earn a profit) or should we exit?
  11. 11. Pricing and output decisions in perfect competition • Key assumptions of the perfectly competitive market: • the firm is a price taker • the firm makes the distinction between the short run and the long run • the firm’s objective is to maximize its profit (or minimize loss) in the short run • the firm includes its opportunity cost of operating in a particular market as part of its total cost of production
  12. 12. Normal Profit, Economic Profit, and Economic Loss Cost of goods sold Rs. 300.000 General and administrative expenses Rs. 150,000 Total accounting cost Rs. 450,000 Foregone salary for being s store manager Rs 45,000 Foregone returns from investments (10%) Rs. 5,000 Total opportunity cost Rs. 50,000 Total economic cost (accounting cost + opportunity cost) Rs. 500,000
  13. 13. Normal Profit, Economic Profit, and Economic Loss Normal profit Economic profit Economic loss Revenue 500,000 550,000 480,000 Accounting cost 450,000 450,000 450,000 Opportunity cost 50,000 50,000 50,000 Profit 0 50,000 20,000 Accounting profit of Rs. 50,000 equals Accounting profit of Rs. 100,000 exceeds Accounting profit of Rs. 30,000 is less Opportunity cost of Rs. 50,000 Opportunity cost of Rs. 50,000 the opportunity cost of Rs. 50,000 than
  14. 14. Revenue Schedule Quantity Price (AR) TR MR 0 110 0 1 110 110 110 2 110 220 110 3 110 330 110 4 110 440 110 5 110 550 110 6 110 660 110 7 110 770 110 8 110 880 110 9 110 990 110 10 110 1100 110 11 110 1210 110 12 110 1320 110 14
  15. 15. Pricing and output decisions in perfect competition Perfectly elastic demand curve: consumers are willing to buy as much as the firm is willing to sell at the going market price  firm receives the same marginal revenue from the sale of each additional unit of product; equal to the price of the product  no limit to the total revenue that the firm can gain in a perfectly competitive market
  16. 16. Pricing and output decisions in perfect competition • Total revenue/Total cost approach: • compare the total revenue and total cost schedules and find the level of output that either maximizes the firm’s profits or minimizes its loss
  17. 17. Cost and Revenue schedules used to determine optimal level of output Quantity Price (AR) TR TFC TVC 0 110 0 100 0 1 110 110 100 55.70 2 110 220 100 105.60 3 110 330 100 153.90 4 110 440 100 204.80 5 110 550 100 262.50 6 110 660 100 331.20 7 110 770 100 415.10 8 110 880 100 518.40 9 110 990 100 645.30 10 110 1100 100 800 11 110 1210 100 986.70 12 110 1320 100 1209.60 TC Total Profit 100 -100 155.7 -45.7 205.6 14.4 253.9 76.1 304.8 135.2 362.5 187.5 431.2 228.8 515.1 254.9 618.4 261.6 745.3 244.7 900 200 1086.7 123.3 1309.6 10.4 17
  18. 18. Pricing and output decisions in perfect competition • Marginal revenue/Marginal cost approach • produce a level of output at which the additional revenue received from the last unit is equal to the additional cost of producing that unit (ie. MR=MC) Note: for the perfectly competitive firm, the MR=MC rule may be restated as P=MC because P=MR in perfectly competitive market
  19. 19. MC and MR cost to determine optimal level of output – case of economic profit Quantity MR =P=AR AFC AVC AC MC Marginal Profit 0 0 0 1 110 100 55.7 155.7 55.7 54.3 2 110 50 52.8 102.80 49.9 60.1 3 110 33.333 51.3 84.63 48.3 61.7 4 110 25 51.2 76.20 50.9 59.1 5 110 20 52.5 72.50 57.7 52.3 6 110 16.67 55.2 71.87 68.7 41.3 7 110 14.29 59.3 73.59 83.9 26.1 8 110 12.5 64.8 77.30 103.3 6.7 9 110 11.11 71.7 82.81 126.9 -16.9 10 110 10 80 90.00 154.7 -44.7 11 110 110 9.09 8.33 89.7 100.8 98.79 109.13 186.7 222.9 -76.7 -112.9 12 19
  20. 20. Pricing and output decisions in perfect competition Case A: economic profit The point where P=MR=MC is the optimal output (Q*)  profit = TR – TC =(P - AC) · Q*
  21. 21. Pricing and output decisions in perfect competition • Case B: economic loss The firm incurs a loss. At optimum output, price is below AC  however, since P > AVC, the firm is better off producing in the short run, because it will still incur fixed costs greater than the loss
  22. 22. Pricing and output decisions in perfect competition • Contribution margin: the amount by which total revenue exceeds total variable cost CM = TR – TVC  if CM > 0, the firm should continue to produce in the short run in order to defray some of the fixed cost
  23. 23. Pricing and output decisions in perfect competition • Shutdown point: the lowest price at which the firm would still produce At the shutdown point, the price is equal to the minimum point on the AVC If the price falls below the shutdown point, revenues fail to cover the fixed costs and the variable costs. The firm would be better off if it shut down and just paid its fixed costs
  24. 24. Pricing and output decisions in perfect competition • In the long run, the price in the competitive market will settle at the point where firms earn a normal profit • economic profit invites entry of new firms  shifts the supply curve to the right  puts downward pressure on price and reduces profits • economic loss causes exit of firms  shifts the supply curve to the left  puts upward pressure on price and increases profits
  25. 25. Pricing and output decisions in perfect competition • Observations in perfectly competitive markets: • the earlier the firm enters a market, the better its chances of earning above-normal profit • as new firms enter the market, firms must find ways to produce at the lowest possible cost, or at least at cost levels below those of their competitors • firms that find themselves unable to compete on the basis of cost might want to try competing on the basis of product differentiation instead
  26. 26. PERFECT COMPETITION • Advantages of perfect competition: • High degree of competition helps allocate resources to most efficient use • Price = marginal costs • Competition encourages efficiency • Firms operate at maximum efficiency • Consumers benefit: consumers charged a lower price • Responsive to consumer wishes: Change in demand, leads extra supply
  27. 27. PERFECT COMPETITION • Disadvantage of perfect competition: • • • • • • The conditions for perfect competition are very strict, there are few perfectly competitive markets Insufficient profits for investment Lack of product variety Lack of competition over product design and specification Unequal distribution of goods & income Externalities e.g. Pollution
  28. 28. MONOPOLY Definition ( economics) • a market in which there are many buyers but only one seller
  29. 29. MONOPOLY’S CHARACTERISTICS • A single firm selling all output in a market : it is a direct contrast to perfect competition. • Unique product: • Barriers to Entry and Exit. • • • • • Government license or franchise Resource ownership Patent and copyrights High start- up cost Decreasing average total cost • Specialized information
  30. 30. MONOPOLY • Average Revenue and Marginal Revenue Figure 10.1 Average and Marginal Revenue
  31. 31. Using MR & MC to determine Optimal Price and Output Quantity Price TR 0 180 0 1 170 170 2 160 3 MR TC AC MC Total Profit 100 0 170 155.7 155.7 55.7 14.3 320 150 205.6 102.8 49.9 114.4 150 450 130 253.9 84.6 48.3 196.1 4 140 560 110 304.8 76.2 50.9 255.2 5 130 650 90 362.5 72.5 57.7 287.5 6 120 720 70 431.2 71.9 68.7 288.8 7 110 770 50 515.1 73.6 83.9 254.9 8 100 800 30 618.4 77.3 103.3 181.6 9 90 810 10 745.3 82.8 126.9 64.7 10 80 800 -10 900 90.0 154.7 -100 11 70 770 -30 1086.7 98.8 186.7 -316.7 12 60 720 -50 1309.6 109.1 222.9 -589.6 -100
  32. 32. Pricing and output decisions in monopoly markets Demand is the same as before, as is MR MC is upward sloping, which shows diminishing returns  set output where MR=MC
  33. 33. Implications of perfect competition and monopoly for decision making • Perfectly competitive market • most important lesson is that it is extremely difficult to make money • must be as cost efficient as possible • it might pay for a firm to move into a market before others start to enter
  34. 34. Implications of perfect competition and monopoly for decision making • Monopoly market • most important lesson is not to be arrogant and assume their ability to earn economic profit can never be diminished • changes in economics of a business eventually break down a dominating company’s monopolistic power
  35. 35. ADVANTAGES OF MONOPOLY • Import the products and compete with foreign companies • Complete freedom in selecting prices or quantity • No guarantee of profitability........ there is only one firm
  36. 36. DISADVANTAGES OF MONOPOLY • • • • The prices charged even increase prices Reduce the quality of the products Reduce the satisfaction of the customers Cause many disadvantages for the employees of the company
  37. 37. Problems • • • • • Qd = 100-5P TC = 150 + 0.2Q Mc = 0.2 P = 20- 0.2Q What is the profit maximizing price? 37
  38. 38. • The demand function of a monopolist is given as follows: P = 500 – 8Q. If the marginal cost of the firm is MC = 9Q, the profit maximizing price of the firm is (in Rs.) • a) 320 b) 340 c) 360 d) 350 e) 355 38
  39. 39. • The total cost function is TC = 25Q. What is profit maximizing output and profit at that level of output respectively? • (a)20 units and Rs.400 (b) 25 units and Rs.625 (c)30 units and Rs.625 • (d)25 units and Rs.400 (e) 30 units and Rs.400. 39
  40. 40. • The demand function for a firm is P = 30 – 3Q. If the average cost (AC) is Rs.6, what is the output at which the firm earns normal profits? (a)12 units (b) 10 units (c) 14 units (d) 11 units (e) 8 units. 40
  41. 41. • The demand and supply functions of a good are given as follows: Qd = 19,000 – 300P, Qs = 17,000 – 100P, What is the equilibrium price of the good? (a) Rs.10 (b) Rs.20 (c) Rs.30 (d) Rs.40 (e) Rs.50. 41
  42. 42. • Soft Shoes Ltd. has enjoyed rapid growth in sales and high operating profits on its innovative extendedwear soft shoes. The cost function of Soft Shoes Ltd. is given as TC = 150 + 100 Q –10 Q2 + Q3. The price at which Soft Shoes Ltd. shuts down its operations is? • (a) Rs.75 (b) Rs.100 (c) Rs.125 (d) Rs.150 (e) Rs.175. 42
  43. 43. • For a perfectly competitive market supply and demand functions are Qs = 1,000P + 500, Qd = 5,000 – 500P, If variable cost function of a firm is VC = 103Q – 0.5Q2, profit maximizing output for the firm is (a) 2,500 units (b) 500 units (c) 4,000 units (d) 1,000 units (e) 100 units. 43
  44. 44. • Beta, a shoe manufacturer, is operating in a perfectly competitive industry. The total cost function of Beta is estimated to be TC = 200 + 300Q – 40Q2 + Q3 Industry supply function for shoes is Qs = 100 + 2P. If profit maximizing output for Beta is 50 units, equilibrium output for the industry is • (a) 2,667 Units (b) 3,800 Units (c) 7,700 Units (d) 8,100 Units (e) 2,800 Units. 44
  45. 45. • The total cost function for Lignite Ltd. is given as 200 + 4Q + 2Q2. The firm is a perfectly competitive firm and is selling the product at Rs.24. If the output produced and sold by the firm is 5 units, the profit (loss) earned by the firm is (a) Profit of Rs.100 (b) Loss of Rs.100 (c) Profit of Rs.150 (d) Loss of Rs.150(e) Profit of Rs.200. 45
  46. 46. MONOPOLISTIC COMPETITION What is Monopolistic Competition? Monopolistic Competition, also called competitive market, where there are a large number of independent firms which have a very small proportion of the market share
  47. 47. MONOPOLISTIC COMPETITION Characteristics of Monopolistic Competition • There are many buyers and sellers. • Products differentiated.
  48. 48. MONOPOLISTIC COMPETITION • There are few barriers to entry and exit. • Each firms may have a tiny ―monopoly‖. • Firm has some control over price.
  49. 49. MONOPOLISTIC COMPETITION • The Makings of Monopolistic Competition A monopolistically competitive market has two key characteristics: 1. Firms compete by selling differentiated products that are highly substitutable for one another but not perfect substitutes. In other words, the cross-price elasticities of demand are large but not infinite. 2. There is free entry and exit: it is relatively easy for new firms to enter the market with their own brands and for existing firms to leave if their products become unprofitable.
  50. 50. MONOPOLISTIC COMPETITION Monopolistic Competition Examples: books, restaurants, grocery stores, shoes, clothing, coffee, chocolate…
  56. 56. MONOPOLISTIC COMPETITION Monopolistic Competition and Perfect Competition. • Monopolistic competitive firms produce products that are not perfect substitutes or are at least perceived to be different to all other brands products. • Unlike in perfect competition, the monopolistic competitive firm does not produce at the lowest possible average total cost • Perfect competition is an economic model that describes a hypothetical market form in which no producer or consumer has the market power to influence prices. While monopolistic competition is inefficient, perfect competition is the most efficient, with supply meeting demand and production therefore matching this, so stock is not sat in storage for prolonged periods or going to waste
  57. 57. OLIGOPOLY • A market/industry dominated by a small number of sellers (oligopolists) • Decisions of one firm --influence-- decisions of other firms
  58. 58. OLIGOPOLY • The Makings of Monopolistic Competition In oligopolistic markets, the products may or may not be differentiated. What matters is that only a few firms account for most or all of total production. In some oligopolistic markets, some or all firms earn substantial profits over the long run because barriers to entry make it difficult or impossible for new firms to enter. Oligopoly is a prevalent form of market structure. Examples of oligopolistic industries include automobiles, steel, aluminum, petrochemicals, electrical equipment, and computers.
  59. 59. OLIGOPOLY • Equilibrium in an Oligopolistic Market When a market is in equilibrium, firms are doing the best they can and have no reason to change their price or output. Nash Equilibrium: Equilibrium in oligopoly markets means that each firm will want to do the best it can given what its competitors are doing, and these competitors will do the best they can given what that firm is doing. ● Nash equilibrium Set of strategies or actions in which each firm does the best it can given its competitors’ actions. ● duopoly Market in which two firms compete with each other.
  60. 60. CARTEL • A formal(explicit) agreement among firms • A formal organization of producers who agree to coordinate prices and production.
  61. 61. CARTEL MEMBERS AGREE ON • • • • • • • Price fixing Total industry output Market shares Allocation of customers Allocation of territories Bid rigging Division of profits
  62. 62. Increase individual member’s profit by reducing competition Firm B normal Firm B advertising aggressive advertising Firm A normal advertising earns $50 profit A: $0 profit Firm B: $80 profit Firm A aggressive advertising A: $80 profit earns $15 profit Firm B: $0 profit
  63. 63. 6 movie studios receive 90% of American film revenues U.S./Canada market share(2008) 12.4% 18.4% 13.2% 10.5% 16.4% 12.7%
  64. 64. Television industry 1950s  1970s Today
  65. 65. 3 leading food processing companies
  66. 66. In Vietnam
  67. 67. OLIGOPSONY • Few buyers & many sellers • A form of imperfect competition
  68. 68. OLIGOPSONY • Ex: cocoa • Ex: tobacco
  69. 69. MONOPSONY • Single buyer faces many sellers • A form of imperfect competition • Monopolist becomes monopsonist • Sells products with higher price • Buys material with lower price
  70. 70. OLIGOPSONY & MONOPSONY • Play off one supplier against another => lower cost • Dictate exact specifications to suppliers • Don’t have risks
  71. 71. CONCLUSION • Market structure can be described with reference to different characteristics of a market, including its size and value, the number of providers and their market share, consumer and business purchasing behavior, and growth forecasts
  72. 72. CONCLUSION Market Structure Seller Seller Buyer Buyer Entry Number Entry Number Barriers Barriers Perfect Competition No Many No Many Monopolistic competition No Many No Many Oligopoly Yes Few No Many Oligopsony No Many Yes Few Monopoly Yes One No Many Monopsony No Many Yes One
  73. 73. Game Theory
  74. 74. GAMING AND STRATEGIC DECISIONS ● game Situation in which players (participants) make strategic decisions that take into account each other’s actions and responses. ● payoff Value associated with a possible outcome. ● strategy Rule or plan of action for playing a game. ● optimal strategy Strategy that maximizes a player’s expected payoff. If I believe that my competitors are rational and act to maximize their own payoffs, how should I take their behavior into account when making my decisions?
  75. 75. GAMING AND STRATEGIC DECISIONS • Noncooperative versus Cooperative Games ● cooperative game Game in which participants can negotiate binding contracts that allow them to plan joint strategies. ● noncooperative game Game in which negotiation and enforcement of binding contracts are not possible. It is essential to understand your opponent’s point of view and to deduce his or her likely responses to your actions.
  76. 76. GAMING AND STRATEGIC DECISIONS • Noncooperative versus Cooperative Games How to Buy a Dollar Bill A dollar bill is auctioned, but in an unusual way. The highest bidder receives the dollar in return for the amount bid. However, the second-highest bidder must also hand over the amount that he or she bid—and get nothing in return. If you were playing this game, how much would you bid for the dollar bill?
  77. 77. GAMING AND STRATEGIC DECISIONS You represent Company A, which is considering acquiring Company T. You plan to offer cash for all of Company T’s shares, but you are unsure what price to offer. The value of Company T depends on the outcome of a major oil exploration project. If the project succeeds, Company T’s value under current management could be as high as $100/share. Company T will be worth 50 percent more under the management of Company A. If the project fails, Company T is worth $0/share under either management. This offer must be made now—before the outcome of the exploration project is known. You (Company A) will not know the results of the exploration project when submitting your price offer, but Company T will know the results when deciding whether to accept your offer. Also, Company T will accept any offer by Company A that is greater than the (per share) value of the company under current management. You are considering price offers in the range $0/share (i.e., making no offer at all) to $150/share. What price per share should you offer for Company T’s stock? The typical response—to offer between $50 and $75 per share—is wrong. The correct answer to this problem appears at the end of this chapter.
  78. 78. DOMINANT STRATEGIES ● dominant strategy Strategy that is optimal no matter what an opponent does. Suppose Firms A and B sell competing products and are deciding whether to undertake advertising campaigns. Each firm will be affected by its competitor’s decision.
  79. 79. DOMINANT STRATEGIES ● equilibrium in dominant strategies Outcome of a game in which each firm is doing the best it can regardless of what its competitors are doing. Unfortunately, not every game has a dominant strategy for each player. To see this, let’s change our advertising example slightly.
  80. 80. THE NASH EQUILIBRIUM REVISITED Dominant Strategies: I’m doing the best I can no matter what you do. You’re doing the best you can no matter what I do. Nash Equilibrium: I’m doing the best I can given what you are doing. You’re doing the best you can given what I am doing. The Product Choice Problem Two breakfast cereal companies face a market in which two new variations of cereal can be successfully introduced.
  81. 81. THE NASH EQUILIBRIUM REVISITED The Beach Location Game Figure 13.1 Beach Location Game You (Y) and a competitor (C) plan to sell soft drinks on a beach. If sunbathers are spread evenly across the beach and will walk to the closest vendor, the two of you will locate next to each other at the center of the beach. This is the only Nash equilibrium. If your competitor located at point A, you would want to move until you were just to the left, where you could capture three-fourths of all sales. But your competitor would then want to move back to the center, and you would do the same.
  82. 82. THE NASH EQUILIBRIUM REVISITED • Maximin Strategies The concept of a Nash equilibrium relies heavily on individual rationality. Each player’s choice of strategy depends not only on its own rationality, but also on the rationality of its opponent. This can be a limitation. ● maximin strategy Strategy that maximizes the minimum gain that can be earned.
  83. 83. THE NASH EQUILIBRIUM REVISITED • Maximin Strategies Maximizing the Expected Payoff If Firm 1 is unsure about what Firm 2 will do but can assign probabilities to each feasible action for Firm 2, it could instead use a strategy that maximizes its expected payoff. The Prisoners’ Dilemma What is the Nash equilibrium for the prisoners’ dilemma?
  84. 84. REPEATED GAMES Almost all the water meters sold in the United States have been produced by four American companies. Rockwell International has had about a 35-percent share of the market, and the other three firms have together had about a 50- to 55-percent share. Most buyers of water meters are municipal water utilities, who install the meters in order to measure water consumption and bill consumers accordingly. Utilities are concerned mainly that the meters be accurate and reliable. Price is not a primary issue, and demand is very inelastic. Because any new entrant will find it difficult to lure customers from existing firms, this creates a barrier to entry. Substantial economies of scale create a second barrier to entry. The firms thus face a prisoners’ dilemma. Can cooperation prevail? It can and has prevailed. There is rarely an attempt to undercut price, and each firm appears satisfied with its share of the market.
  85. 85. ENTRY DETERRENCE The disposable diaper industry in the United States has been dominated by two firms: Procter & Gamble, with an approximately 50-percent market share, and KimberlyClark, with another 30–40 percent. The disposable diaper industry in the United States has been dominated by two firms: Procter & Gamble, with an approximately 50-percent market share, and Kimberly-Clark, with another 30–40 percent. How do these firms compete? And why haven’t other firms been able to enter and take a significant share of this $5-billion-per-year market? The competition occurs mostly in the form of cost-reducing innovation. As a result, both firms are forced to spend heavily on research and development in a race to reduce cost.