Transcript of "Market Structure Conduct and Performance"
Market Structure Conductand PerformanceRevising for A2 Economics Questions on Markets
What is market structure?• Organisational characteristics of a market• We usually focus on those characteristics of amarket which affect the degree of competitionbetween firms + their pricing decisions• Traditionally we emphasise:1. The number and size distribution of buyers and sellers2. The existence or absence of barriers to entry and exit
Structural characteristics of a market• Ownership structure (e.g. state or private sector)• Market share of largest businesses (concentration ratio)• Nature of costs in the short & long run• Degree of vertical integration along the supply chain• Extent of product differentiation / product branding• Price (Ped) and cross (Xed) price elasticity of demand• Number and size of buyers of the industry’s product• Turnover of customers from one seller to another (called“market churn”) – affected by brand loyalty and advertisingand marketing
Q3Q2Q1Cost & PriceOutput (Q)Costs and contestability in different industriesLow MES, limited scaleeconomies, contestable marketLRACQ1 Output (Q)High MES, falling LRAC, barriers tocontestabilityExtensive internaleconomies of scaleleading to lower LRACExtensive internaleconomies of scaleleading to lower LRACLRACMinimumefficientscale (MES)Minimumefficientscale (MES)Q4
AverageCost perUnit (£)Quantity of output (Q)Long Run Average Cost for a Natural MonopolyAverage cost falls acrossa large range of output –due to increasing returnsto scaleAverage cost falls acrossa large range of output –due to increasing returnsto scaleLong run marginal cost ofproduction is often lowand stable as outputchangesLong run marginal cost ofproduction is often lowand stable as outputchangesLRACLRMCAC1AC2AC3Q1 Q2 Q3
Importance of defining the market• Market and the industry often used inter-changeably• But……………………………– If we define a market in a narrow sense, it is likely that therewill be fewer producers• E.g. the market for air travel to Aberdeen– A broader definition of the market often gives us more choice• E.g. the air transport industry (low cost airlines)• The market for sportswear– Defining the market is important when we measure theconcentration ratio and the extent to which a market isdominated by one or a few large producers
Market Share and Market PowerMarket share is notthe same as marketpower!First-Mover Advantages for Apple?
The Nature of Costs in an Industry• Entry costs into a market– Capital costs will vary from industry to industry– E.g. a natural monopoly such as energy and power networks• Sunk costs / exit costs– These are costs that are not recoverable if a business leaves• E.g. advertising and marketing• Depreciation of capital equipment– High sunk costs makes a market less contestable• Natural cost advantages– Location advantages e.g. close to ports, access to cheaper labour– Ownership of important raw materials– Control of the supply chain through vertical integration
Product differentiation• Homogeneous goods– Essentially the same physical characteristics– Associated with perfect competition– Different grades e.g. steel, cement, coal, fresh fruit• Non-homogeneous goods– Products differentiated from their competitors– Branding, packaging and marketing are key here• Strong product differentiation and brand loyalty allows firms tocharge higher premium prices– Demand become less price elastic– Reduction in the cross-price elasticity of demand– Higher profit margins for a given unit cost
Conduct / Behaviour of Firms• How does market structure affect pricing, output and other decisions ofbusinesses within the market• Are there dominant firms?• Is there evidence of anti-competitive behaviour?– Collusive pricing agreements– Control over the supply chain?• How important is non-price competition in the market?• Is there interdependence between firms?• Do businesses behave strategically to retain profits by deterring theentry of new competitors in the long run?• Be aware that the market structure will affect the behaviour of firms
Some Key Performance Indicators• Trends in real price levels for consumers over time• Size of business profits – evidence of excess (monopoly) profits?• How much spending on research and development and innovation• Trend changes in labour productivity (output per worker employed)• Environmental indicators e.g. Progress in reducing carbon intensity• Does the conduct of firms give rise to efficient outcomes?1. Allocative efficiency (prices relative to marginal cost)2. Productive efficiency (unit costs in short and long run)3. Dynamic efficiency (pace of innovation, quality of product)4. Social efficiency (accounting for externalities)
Cost & PriceOutput (Q)Allocative Efficiency – Competition / Pure MonopolyCost & PriceOutput (Q)Perfectly Competitive Market Pure Monopoly MarketS1D1P1P2Entry ofnew firmsdrivespricelowerEntry ofnew firmsdrivespricelowerACMCACMCMonopolydemand(AR)MRP1 P1Q1 Q2P2C2Monopoly ProfitP>MCLoss of allocativeefficiencyMonopoly ProfitP>MCLoss of allocativeefficiencyS2
The usual causal viewMarketstructureMarketstructureConduct ofFirmsConduct ofFirmsPerformancePerformance
Conduct and market structureThe conduct of firms in a marketcan affect market structure – e.g.merger and takeover activityMarketstructureMarketstructureConduct ofFirmsConduct ofFirmsPerformancePerformance
Performance and changing marketsThe actual performance of firms in the market affects market structure –e.g. rising dominance of best performing businesses – examples:pharmaceuticals, food retailingMarketstructureMarketstructureConduct ofFirmsConduct ofFirmsPerformancePerformance
Performance can affect market structure• Performance can affect structure– Top performing firms will gain market share at expense of rivals– This gives them more market power– Fine line between market dominance and economic efficiency• Market conduct affects structure– E.g. decisions about research and development and marketing• Strategic behaviour of firms especially in oligopoly makes itdifficult to rely on the structure conduct performance model• The theory of contestable markets stresses the dynamicnature of competition especially when a market is open
Market power isoften self-reinforcingInnovativebusinesses candisrupt dominance
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