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  1. 1. Market structures<br />Prepared by:<br />Abayan, Axiel Chris<br /> Dansalan, Gladys Joyce<br />dela Torre, Childeen Nova<br /> Ngo, Sarah Mae<br /> Palacio, Dorie Jane<br /> Plana, Debby Gilsyl<br /> Yap, Jennifer Joyce<br />BSA-2D<br />ECON 222 | TTH | J205 | 4:10 - 5:40<br />
  2. 2. MONOPOLY<br />
  3. 3. Pure Monopoly An industry with a single firm that produces a product for which there are no close substitutes and in which significant barriers to entry prevent other firms from entering the industry to compete for profits.<br />
  4. 4. Natural MonopolyAn industry that realizes such large economies of scale in producing its product that single-firm production of that good or service is most efficient.<br />
  5. 5. Characteristics of a Monopoly<br /><ul><li>Single seller
  6. 6. The firm is the industry.
  7. 7. Unique good with no close substitutes
  8. 8. Price maker
  9. 9. The firm can change the price by changing the quantity it produces.
  10. 10. High barriers to entry
  11. 11. New firms cannot enter the market
  12. 12. No immediate competitors
  13. 13. Some “non-price” competition</li></li></ul><li>Drawing Monopolies<br />
  14. 14. MR is below Demand<br />P<br />$100<br />80<br />60<br />40<br />D<br />Q<br />
  15. 15. Why is MR less than demand?<br />
  16. 16. MR is less than price<br />$10<br />$9<br />$9<br />$8<br />$8<br />$8<br />$7<br />$7<br />$7<br />$7<br />$6<br />$6<br />$6<br />$6<br />$6<br />$5<br />$5<br />$5<br />$5<br />$5<br />$5<br />$4<br />$4<br />$4<br />$4<br />$4<br />$4<br />$4<br />
  17. 17. Monopolies and Efficiency<br />Monopolies are inefficient because they…<br /><ul><li>Charge a higher price
  18. 18. Under produce
  19. 19. Not allocate efficient
  20. 20. Produce at higher costs
  21. 21. No productive efficiency
  22. 22. Have little incentive to innovate</li></li></ul><li>INEFFICIENCY OF PURE MONOPOLY<br />P<br />S = MC<br />At MR=MC<br />A monopolist will sell less units at a higher price than in competition<br />Pm<br />Pc<br />D<br />MR<br />Q<br />Qc<br />Qm<br />
  23. 23. Are Monopolies Productively Efficient?<br />200<br />175<br />150<br />125<br />100<br />75<br /> 50<br />25<br />Price, costs, and revenue<br />Q<br />0 1 2 3 4 5 6 7 8 9 10<br />Does Price = Min ATC?<br />No. They are not producing at the lowest cost (min ATC)<br />MC<br />ATC<br />D<br />MR<br />
  24. 24. Do Monopolies Have Allocative Efficiency?<br />200<br />175<br />150<br />125<br />100<br />75<br /> 50<br />25<br />Price, costs, and revenue<br />Q<br />0 1 2 3 4 5 6 7 8 9 10<br />Does Price = MC?<br />No. Price is greater. The monopoly is under producing.<br />MC<br />ATC<br />D<br />MR<br />
  25. 25. Price DiscriminationCharging different prices to different buyers.<br />
  26. 26. Conditions for Price Discrimination<br /><ul><li>Firm must have monopoly power
  27. 27. Firm must be able to segregate the market
  28. 28. Consumers must not be able to resell product</li></li></ul><li>Types of Price Discrimination<br /><ul><li>Personal Discrimination
  29. 29. Separate price is charged from each buyer according to the intensity of his desire or according to the size of his pocket.
  30. 30. Trade Discrimination
  31. 31. It may take place when a monopolist charges different prices according to the uses to which the commodity is put.
  32. 32. Place Discrimination
  33. 33. It occurs when a monopolist charges different prices for the same commodity at different places.</li></li></ul><li>Degree of Price Discrimination<br /><ul><li>First Degree Price Discrimination
  34. 34. This involves charging consumers the maximum price that they are willing to pay.
  35. 35. Second Degree Price Discrimination
  36. 36. This involves charging different prices depending upon the quantity consumed.
  37. 37. Third Degree Price Discrimination
  38. 38. This involves charging different prices to different groups of people.</li></li></ul><li>Examples of Price Discrimination<br /><ul><li>Retail price discrimination
  39. 39. Travel industry
  40. 40. Coupons
  41. 41. Premium pricing
  42. 42. Segmentation by age group
  43. 43. Discounts
  44. 44. Incentives for buyers
  45. 45. Financial aid in education
  46. 46. Haggling
  47. 47. International price discrimination
  48. 48. Academic pricing
  49. 49. Dual pricing
  50. 50. Wage discrimination</li></li></ul><li>The purpose of price discrimination is generally to capture the market's consumer surplus.<br />
  52. 52. Monopolistic CompetitionA common form of market structure characterized by a large number of firms, none of which can influence market price by virtue of size alone. Some degree of market power is achieved by firms producing differentiated products. New firms can enter and established firms can exit such an industry with ease.<br />
  53. 53. Characteristics of Monopolistic Competition<br /><ul><li>Relatively large number of seller
  54. 54. Differentiated products
  55. 55. Some control over price
  56. 56. Easy entry and exit
  57. 57. Non-price competition (advertising)</li></li></ul><li>Monopolistic Competition and Efficiency<br /><ul><li>No Productive Efficiency
  58. 58.  Minimum ATC
  59. 59. No allocative efficiency
  60. 60. Price  MC
  61. 61. Firm has excess capacity</li></li></ul><li>Role of advertising<br />Firms produce differentiated products<br />Face downward sloping demand curves<br />Build up brand loyalty<br />Gives them some influence over price<br />Engage in heavy advertising to maintain brand loyalty<br />
  62. 62. Concentration ratios are measures of the total output that is produced in an industry by a given number of firms in the industry. Concentration ratios are usually used to show the extent of market control of the largest firms in the industry and to illustrate the degree to which an industry is oligopolistic.<br />
  63. 63. Low concentration ratios<br />No concentration: 0% means perfect competition or at the very least monopolistic competition. If for example CR4=0 %, the 4 largest firm in the industry would not have any significant market share.<br />Total concentration: 100% means an extremely concentrated oligopoly. If for example CR1= 100%, we talk of a monopoly.<br />Low concentration: 0% to 50%. This category ranges from perfect competition to oligopoly.<br />Medium concentration: 50% to 80%. An industry in this range is likely an oligopoly.<br />High concentration: 80% to 100%. This category ranges from oligopolyto monopoly.<br />
  64. 64. Under MC concentration ratio tends to be low so many firms operating in the market. A price change by one will have negligibleeffects on the demand for rival products<br />
  65. 65. Drawing Monopolistic Competition<br />
  66. 66. PRICE AND OUTPUT IN<br />MONOPOLISTIC COMPETITION<br />MC<br />What Happens?<br />ATC<br />$4<br />$2<br />Price and Costs<br />Short-Run<br />Economic<br />Profits<br />D<br />MR<br />Q1<br />Quantity<br />
  67. 67. PRICE AND OUTPUT IN<br />MONOPOLISTIC COMPETITION<br />MC<br />New Firms Enter<br />ATC<br />$4<br />$2<br />Price and Costs<br />Short-Run<br />Economic<br />Profits<br />D<br />MR<br />Q1<br />Quantity<br />
  68. 68. LONG- RUN EQUILIBRIUM<br />MC<br />ATC<br />Normal Profit<br />$4<br />$2<br />Price and Costs<br /> $1<br />D<br />MR<br />Q1<br />Quantity<br />
  69. 69. PRICE AND OUTPUT IN<br />MONOPOLISTIC COMPETITION<br />MC<br />What happens?<br />ATC<br />$7<br />Price and Costs<br /> $1<br />Short-Run<br />Economic<br />Loss<br />D<br />MR<br />Q1<br />Quantity<br />
  70. 70. PRICE AND OUTPUT IN<br />MONOPOLISTIC COMPETITION<br />MC<br />Long-Run Equilibrium<br />Normal<br />Profit<br />Only<br />ATC<br />$7<br />Price and Costs<br />D<br />MR<br />Q3<br />Quantity<br />
  71. 71. OLIGOPOLY<br />
  72. 72. OligopolyA form of market structure characterized by a few dominant firms. Products may be homogenous or differentiated. The behavior of any one firm in an oligopoly depends to a great extent on the behavior of others.<br />
  73. 73. Characteristics of Oligopoly<br /><ul><li>A few large producers
  74. 74. Identical or differentiated products
  75. 75. Mutual interdependence
  76. 76. Firms use strategic pricing
  77. 77. High entry barriers</li></li></ul><li>Colluding Oligopoly<br />
  78. 78. Cartel (Collusion Model) A group of firms that gets together and makes joint price and output decisions to maximize joint profits.<br />
  79. 79. Cournot ModelA model of duopoly in which a series of output adjustment decisions leads to a final level of output between the output that would prevail if the market were organized competitively and the output that would be set by a monopoly.<br />
  80. 80. CARTELS AND COLLUSION<br />Cartel = Colluding Oligopoly<br />A cartel is a group of producers that create a formal agreement to fix prices high. <br />Cartels set price and output at an agreed upon price <br />Firms require identical or highly similar demand and costs <br />Cartel must have a way to punish cheaters<br />Together they act as a monopoly<br />
  81. 81. CARTELS AND OTHER COLLUSION<br />Economic<br />Profit<br />MC<br />P0<br />Price and costs<br />ATC<br />A0<br />D<br />MR = MC<br />MR<br />Q0<br />Colluding Oligopolists Will<br />Split the Monopoly Profits.<br />
  82. 82. Assumptions of CournotModel<br /><ul><li>There are just two firms in the industry- a duopoly.
  83. 83. Each firm takes the output of the other as given.
  84. 84. Both firms maximize profits.</li></li></ul><li>Non Colluding Oligopoly<br />
  85. 85. Kinked Demand Curve ModelA model of oligopoly in which the demand curve facing each individual firm has a “kink” in it. The kink results from the assumption that competitor firms will follow if a single firm cuts price but will not follow if a single firm raises price.<br />
  86. 86. Kinked Demand Curve Model<br />Noncollusive firms are likely to react to competitor’s pricing in two ways:<br />1. Match price- If one firm cuts it’s prices, then the other firms follow suit causing inelastic demand <br />2. Ignore change- If one firm raises prices, others maintain same price causing elastic demand <br />
  87. 87. KINKED DEMAND THEORY:<br />The demand and MR curves if other firms match lower pricing <br />If this firm lowers its price and others follow, Qd will increase mildly<br />Price<br />D1<br />MR1<br />Quantity<br />
  88. 88. KINKED DEMAND THEORY:<br />The demand and MR curves if other firms ignore higher pricing <br />If this firm increases its price and others ignore it, Qd for this firm will decrease significantly <br />Price<br />D2<br />MR2<br />Quantity<br />
  89. 89. Two sets of curves based on the pricing decisions of other firms<br />The firm’s demand and<br />marginal revenue curves<br />Price<br />D2<br />MR2<br />D1<br />MR1<br />Quantity<br />
  90. 90. Two sets of curves based on the pricing decisions of other firms<br />Rivals tend to<br />follow a price cut<br />Price<br />D2<br />MR2<br />D1<br />MR1<br />Quantity<br />
  91. 91. Two sets of curves based on the pricing decisions of other firms<br />Rivals tend to<br />follow a price cut<br />or ignore a<br />price increase<br />Price<br />D2<br />MR2<br />D1<br />MR1<br />Quantity<br />
  92. 92. Two sets of curves based on the pricing decisions of other firms<br />Effectively creating<br />a kinked demand curve<br />Price<br />D2<br />MR2<br />D1<br />MR1<br />Quantity<br />
  93. 93. Two sets of curves based on the pricing decisions of other firms<br />Effectively creating<br />a kinked demand curve<br />Price<br />D<br />Quantity<br />
  94. 94. Two sets of curves based on the pricing decisions of other firms<br />What about MR?<br />Price<br />D2<br />MR2<br />D1<br />MR1<br />Quantity<br />
  95. 95. Two sets of curves based on the pricing decisions of other firms<br />Since we use sections of both MR curves, the MR has a vertical gap. <br />MR2<br />Price<br />D<br />MR1<br />Quantity<br />
  96. 96. KINKED DEMAND THEORY:<br />NONCOLLUSIVE OLIGOPOLY<br />Profit maximization<br />MR = MC occurs<br />at the kink.<br />MR2<br />Price<br />D<br />MR1<br />Quantity<br />
  97. 97. Kinked Demand Curve Assumption<br /> The elasticity of demand in response to an increase in price is different from the elasticity of demand in response to a price cut.<br />
  98. 98. Price Leadership Model A form of oligopoly in which one dominant firm sets prices and all the smaller firms in the industry follow its pricing policy.<br />
  99. 99. Assumptions of Price Leadership Model<br /><ul><li>The industry is made up of one large firm and a number of smaller competitive firms.
  100. 100. The dominant firm maximizes profit subject to the constraint of market demand and subject to the behavior of the smaller and competitive firm.
  101. 101. The dominant firm allows allow the smaller firms to sell all they want at the price the leader has set.</li></li></ul><li>Perfectly Contestable Market A market in which entry and exit are costless.<br />
  102. 102. Assumptions of Perfectly Contestable Market Model<br />The freedom of entry eliminates any excess economic profits.<br />Inefficient enterprises cannot survive in a perfectly contestable industry because cost inefficiencies invite replacement of the existing firms by entrants that can provide the same outputs at lower cost and lower prices.<br />
  103. 103. Game Theory Analyzes oligopolistic behavior as a complex series of strategic moves and reactive countermoves among rival firms. In game theory, firms are assumed to anticipate rival reactions.<br />
  104. 104. Key Elements of a game<br />Players: Who is interacting?<br />Strategies: What are their options?<br />Payoffs: What are their incentives?<br />Information: What do they know?<br />Rationality: How do they think?<br />
  105. 105. Nash Equilibrium In game theory, the result of all players’ playing their best strategy given what their competitors are doing.<br />
  106. 106. i.e.<br />Each firm has the knowledge about other firm’s strategy<br />Their actions are dependent on each other. (like in oligopoly)<br />
  107. 107. Nash Equilibrium<br />Here, no price changes is an equilibrium because neither firm can benefit by increasing its price if other firm does not.<br />
  108. 108. Maximin Strategy In game theory, a strategy chosen to maximize the minimum gain that can be earned.<br />
  109. 109. This strategy is based on the fact that sometimes it is more prudent to maximize the minimum gains achievable in a gaming situation.<br />
  110. 110. Maximin Strategy<br /> In this example, Businessman M loves selling Meat, and Businessman P loves selling potatoes. As a consequence, let's assume they have the following payoff matrix (the number before the comma is the payoff in dollars for Businessman M and the number after the comma is the payoff in dollars for Businessman P):<br />
  111. 111. As you can see, businessman M has a dominant strategy of selling meat. Why? Because irrespective of what P sells, M comes out ahead by selling meat. If M sells potatoes, he can mor $110,000. Both these amounts are less than $150,000 (and $200,000) which M can make by selling M. However, P does not have a dominant strategy; his fortunes are tied to what M does.<br />
  112. 112. Let's first consider the Nash Equilibrium for this game. If P assumes that M is rational and will maximize his profits by pursuing the dominant strategy of selling meat, P will respond by selling potatoes. <br />So the top right-hand quadrant is the Nash Equilibrium here; both M and P maximize their profits. M can make $200,000 and P can make $120,000. <br />
  113. 113. The whole concept of Nash Equilibrium is based on the fact that both M and P behave rationally. However, can P always count on M being rational? Suppose M starts following a Guru, who convinces M that he should not only give up eating meat, but he should stop selling it as well. Even though not rational, if M starts selling potatoes; if P has the strategy of selling potatoes, it can be extremely costly for P. Why? Because M will make $110,000; where as P will make only $20,000. <br />
  114. 114. Let's further assume that P lives in a nice home and makes a mortgage payment of $3000 per month. With $20,000 yearly profit, P can't pay that mortgage, and will be foreclosed. So, CAN P TAKE THE RISK OF SELLING POTATOES, IF HE IS CONSERVATIVE AND AFRAID THAT M MAY NOT BEHAVE RATIONALLY? No.<br />So, what does P do?<br />
  115. 115. So, what does P do?<br />P will sell meat, for he is assured of making at least $80,000.  In this scenario, P is pursuing a Maximin Strategy of maximizing the minimum gains that can be earned. <br /> Please note that even though it is not a profit-maximizing strategy, the Maximin strategy ensures that P will not be on the streets!<br />
  116. 116. Prisoners’ Dilemma A game in which the players are prevented from cooperating and in which each has a dominant strategy that leaves them both worse off than if they could cooperate.<br />
  117. 117. Prisoner’s Dilemma<br />
  118. 118. Situation<br />There are two prisoners whose aim is to minimize the years of imprisonment. They have committed a crime jointly.<br />Each prisoner is interviewed separately and there are not any contacts whatsoever between them.<br />They decide individually to confess or deny the crime taking into account possible decisions of the other prisoner (strategic game).<br />
  119. 119. Each prisoner chooses his dominant strategy, that is the behavior giving the best result regardless of the decision of the other prisoner.<br />Two prisoners are interrogated separately, they have no idea whether the other prisoner will confess or not.<br />
  120. 120. Dominant Strategy In game theory, a strategy that is best no matter what the opposition does.<br /> One firm will be in dominant position in terms of changes in strategy.<br />
  121. 121. Dominant Strategy<br /> If student 1 goes first and chooses to study, student 2 will also choose to study. This gives student 2 an A rather than the D they would have received if they did not study. <br /> If student 1 chooses to not study, student 2 will choose to study so they get a B instead of an F. Student 2 obviously has a dominant strategy - to study. <br />
  122. 122. If this game is played again with student 2 leading, student 1 would also have the dominant strategy of studying. <br /> This dominant strategy also marks this game's Nash equilibrium, or the "set of strategies in which no player can improve her payoff by unilaterally changing her own strategy, given the other players' strategies" (Baye, 357).<br />
  123. 123.<br /><br /><br /><br />