Transcript MarketStructurex

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Perfect Competition
Market Structure – A classification system for the key traits of a
market, including
• the number of firms,
• the similarity of the products they sell, and
• the ease of entry and exit
Perfect Competition
many small firms (no firm, not even the largest, can impact
market price)
homogeneous (identical) product (goods cannot be
distinguished from one another; corn, wheat etc…)
very easy entry and exit
Firms operating in perfect competition are price takers ( sellers
with no control over the price of the product they sell)
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Revenue
Total Revenue – price times quantity
TR  P  Q
Average Revenue – total revenue
divided by the quantity
TR
AR 
Q
Marginal revenue – the change in total
revenue from an additional unit sold
MR 
TR TR1  TR0

Q
Q1  Q0
In Perfect Competition both AR and MR are equal to Price
Firms don’t have to discount to sell more output
Firms may sell large amounts of output or little
output at the market price
A firm’s participation in the market will not impact price
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Revenue
One Firm’s Demand Curve
TR  PQ
Q
P
TR
MR
0
$10
$0
----
1
$10
$10
$10
2
$10
$20
$10
3
$10
$30
$10
4
$10
$40
$10
$20
5
$10
$50
$10
$15
6
$10
$60
$10
7
$10
$70
$10
8
$10
$80
$10
9
$10
$90
$10
TR TR1  TR0
MR 

Q
Q1  Q0
$25
Perfectly Elastic Demand
$10
P = MR = D
$5
$0
0
1
2
3
4
5
6
7
8
9 10
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Short-run Decisions
Business Objective: Maximize Profit
Total Profit = Total Revenue – Total Cost
Achieve Profit Maximization
Marginal Revenue = Marginal Cost
MR  MC
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Short-run Decisions
Q
P
TR
MR
TFC
TVC
TC
MC
AFC
AVC
ATC
Profit
0
$10
$0
----
$10
$0
$10
----
$10
$0
$10.00
-$10
1
$10
$10
$10
$10
$4
$14
$4
$10
$4.00
$14.00
-$4
2
$10
$20
$10
$10
$7
$17
$3
$5
$3.50
$8.50
$3
3
$10
$30
$10
$10
$11
$21
$4
$3.33 $3.67
$7.00
$9
4
$10
$40
$10
$10
$18
$28
$7
$2.50 $4.50
$7.00
$12
5
$10
$50
$10
$10
$28
$38
$10
$2.00 $5.60
$7.60
$12
6
$10
$60
$10
$10
$47
$57
$19
$1.67 $7.83
$9.50
$3
7
$10
$70
$10
$10
$74
$84
$27
$1.43 $10.57
$12.00
-$14
8
$10
$80
$10
$10
$112
$122
$38
$1.25 $14.00
$15.25
-$42
9
$10
$90
$10
$10
$162
$172
$50
$1.11 $18.00
$19.11
-$82
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Short-run Decisions
Economic
Loss
Single Firm
$25
MC
Profit
Maximization
MR = MC
$20
ATC
AVC
$15
P = MR = D
$10
$7.60
$5
$0
0
1
2
3
4
5
6
7
8
9
10
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Short-run Decisions
Economic
Loss
Single Firm
$25
MC
ATC
$20
AVC
$15
$10
$7.60
P = MR = D
$5
$0
0
1
2
3
4
5
6
7
8
9
10
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Short-run Decisions
Single Firm
$
MC
ATC
AVC
P0
D0 (Economic Profit)
Economic
Profit
P2
AFC
Lost
AVC
D2 (Economic Loss – will produce)
Recovering some AFC
P4
D4 (Economic Loss – will shut down)
Q
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Long-run Decisions
Long Run:
All inputs are variable (no fixed cost)
Firms are free to change scale
Firms may enter the market
Firms may exit the market
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Long-run Equilibrium
Average Firm
Market
P
$
MC
S0
LRAC
S1
P0
D0 (Economic Profit)
P1
D1 (Normal Profit)
P2
D2 (Economic Loss)
S2
D0
Q
Q
Long Run Economic Profit – When firms make more than a normal profit, firms enter the
industry, as supply increases, a downward pressure is put on prices
Long Run Economic Loss – When firms make less than a normal profit, firms leave the
industry, as supply decreases, an upward pressure is put on prices
Long Run Equilibrium – At the market price that enables firms to make a normal profit
Normal Profit – The minimum profit necessary to keep a firm in operation
Long Run Perfectly Competitive Equilibrium – (P = MR = SRMC = SRATC = LRAC)
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Monopoly
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Monopoly
Market Structure – A classification system for the key traits of a
market, including
• the number of firms,
• the similarity of the products they sell, and
• the ease of entry and exit
Monopoly
one firm with market power
unique product (no close substitutes)
impossible entry and exit
firm demand curve is downward sloping (must
discount to sale more)
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Monopoly
Barriers to Entry and Exit
Legal barriers
– Licenses
– Patents and copyrights
– Public franchises
Ownership of Vital Resource
Economies of Scale or Natural Monopoly
– Infinite economics of scale leading to a single company having lowest cost
Cost
per
unit
LRAC
Water service
Sewer service
Power service
Q
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TR  PQ
TR TR1  TR0
MR 

Q
Q1  Q0
Q
P
TR
MR
0
$21
$0
----
1
$19
$19
$19
2
$17
$34
$15
3
$15
$45
$11
$20
4
$13
$52
$7
$15
5
$11
$55
$3
$10
6
$9
$54
- $1
7
$7
$49
- $5
8
$5
$40
- $9
9
$3
$27
- $13
MR  P
$25
$5
D
$0
-$5
-$10
0
1
2
3
4
5
6
7
8
9 10
MR
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Short-run Equilibrium
Q
P
TR
MR
TFC
TVC
TC
MC
AFC
AVC
ATC
Profit
0
$21
$0
----
$10
$0
$10
----
$10
$0
$10.00
-$10
1
$19
$19
$19
$10
$4
$14
$4
$10
$4.00
$14.00
$5
2
$17
$34
$15
$10
$7
$17
$3
$5
$3.50
$8.50
$17
3
$15
$45
$11
$10
$11
$21
$4
$3.33 $3.67
$7.00
$24
4
$13
$52
$7
$10
$18
$28
$7
$2.50 $4.50
$7.00
$24
5
$11
$55
$3
$10
$28
$38
$10
$2.00 $5.60
$7.60
$17
6
$9
$54
- $1
$10
$47
$57
$19
$1.67 $7.83
$9.50
-$3
7
$7
$49
- $5
$10
$74
$84
$27
$1.43 $10.57
$12.00
-$35
8
$5
$40
- $9
$10
$112
$122
$38
$1.25 $14.00
$15.25
-$82
9
$3
$27
- $13
$10
$162
$172
$50
$1.11 $18.00
$19.11
-$145
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$
Short-run Equilibrium
Profit Max: MR = MC
MC
ATC
AVC
$13.00 P
$7.00 ATC
D
$4.50 AVC
MR
4
Q
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Long Run View
Monopoly allocates resources inefficiently
$
AC
MC
Pm
Ppc
Dperfect competition
Dmonopoly
MR
Qm Qpc
Q
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Inefficiency of monopoly
Monopoly produces quantity where MC = MR
– which produces less than the socially efficient
quantity of output
– charges a Price > Marginal Cost
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Price Discrimination
Price Discrimination – selling the a product or service at
different prices to different customers
• Price Discrimination is a rational strategy:
– Charge each customer a price closer to his or her willingness to pay
– Producers earn higher profit
– Sell more output
• Requires the ability to separate customers according to their
willingness to pay (market segmentation)
Certain market forces can prevent firms from price discriminating such
as arbitrage (buying a good in one market then selling it in other
market at a higher price)
• Perfect price discrimination charges each customer a
different price exactly equal to his or her willingness to pay
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Price Discrimination
Monopolist with Price Discrimination
Price
Examples of price discrimination
– Movie tickets
•
•
•
Children
Middle Aged
Seniors
– Airline prices
•
•
Pl
Pm
Pv
Lecture
Business
– Discount coupons
– Financial aid
– Quantity discounts
Revenue
Demand
0
Ql Qm Qv
Quantity
Outlets to purchase a sweater
l = Lord and Taylor
m = Macy’s
v = Venture
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Monopolistic Competition
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Monopolistic Competition
Market Structure – A classification system for the key traits of a
market, including
• the number of firms,
• the similarity of the products they sell, and
• the ease of entry and exit
Monopolistic Competition
– Many sellers
– Product differentiation
• Not price takers
• Downward sloping demand curve
– Free entry and exit
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Monopolistic Competition
Firms operating in “Monopolistic Competition”
need product differentiation to offer different
prices and face a downward sloping firm
demand curve.
Example: The bar soap industry is differentiated with easy
entry.
Characteristics
•
•
•
•
•
•
•
Color
Scent
Size
Packaging
Texture
Antibacterial
Allergenic
Brands
•
•
•
•
•
•
•
Irish Spring
Dove
Dial
Zest
Lava
Coast
Unbranded
Sales Outlets
•
•
•
•
•
•
•
Grocery Stores
Big Box Stores
Convenience Stores
Specialty Stores
Department Stores
On-line
Flea Markets
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Monopolistic Competition
Example: Fast food hamburger
Sales Outlets
•
•
•
•
•
•
•
•
McDonalds
Burger King
Dairy Queen
Only represents
White Castle
half the market
Hardees
Rally’s
Wendy’s
Mom and Pops make
up the other half
Are hamburgers differentiated?
Again, in Monopolistic Competition
product differentiation is critical
otherwise firms have no control over
price
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Short Run
Firm makes profit
Firm makes losses
Price
Price
MC
ATC
Price
MC
ATC
ATC
Price
ATC
Profit
Demand
Loss
Demand
MR
MR
0
Q*
Quantity
0
Q*
Quantity
Monopolistic competitors maximize profit by producing the quantity at which marginal revenue equals
marginal cost.
• The firm to the left makes a profit because, at this quantity, price is above average total cost.
• The firm to the right makes losses because, at this quantity, price is less than average total cost.
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Short Run
Monopolistically competitive firms in short run
maximizes profit at quantity consistent with
MR = MC
– Price on the demand curve
– If P > ATC: profit
– If P < ATC: loss
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Long Run Equilibrium
• When firms are earning an economic profit
– New firms enter the market
– Increase number of products
– Reduces demand faced by each firm
• Each firm’s demand curve shifts left
– Each firm’s profit declines until zero economic profit
• When firms experiencing economic lose
– Firms have incentive to exit the market
– Decrease number of products
– Increases demand faced by each firm
• Each firm’s demand curve shifts right
– Each firm’s loss declines until zero economic profit
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Long Run Equilibrium
A Single Firm
Price
ATC
MC
Price = ATC
MR
0
Q*
Demand
Quantity
• In the long run if firms are making profit, new firms enter, and the demand curves for the incumbent
firms shift to the left.
• If firms are making losses, old firms exit, and the demand curves of the remaining firms shift to the
right.
• Because of these shifts in demand, a monopolistically competitive firm eventually finds itself in the
long-run equilibrium where price equals average total cost, and the firm earns zero economic profit.
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Long Run Equilibrium
• Zero economic profit
• Demand curve is tangent to average total cost
curve
– At quantity where marginal revenue = marginal cost
– Price = average total cost
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Inefficiencies
Perfectly Competitive Firm
Monopolistically Competitive Firm
Price
Price
MC
MC
ATC
ATC
Price
P=MC
Markup
Demand
MC
Demand
MR
0
Quantity produced
at efficient scale
Quantity
0
Quantity
produced
Efficient
scale
Quantity
Excess capacity
The right graph shows the long-run equilibrium in a perfectly competitive market while the left graph shows the long-run
equilibrium in a monopolistically competitive market.
• Note the perfectly competitive firm produces at the efficient scale, where average total cost is minimized while the
monopolistically competitive firm produces at less than the efficient scale.
• Also price equals marginal cost under perfect competition, but price is above marginal cost under monopolistic
competition.
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Oligopoly
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Oligopoly
Market Structure – A classification system for the key traits of a
market, including
• the number of firms,
• the similarity of the products they sell, and
• the ease of entry and exit
Oligopoly
only a few firms (firms have market power, can change price)
offer identical (homogeneous) or similar (differentiated)
products
difficult to enter or exit the industry
Interdependent unlike participants in perfect competition where firms
don’t need to consider actions of other producers in the short run, in
oligopoly actions of each firm will impact other firms in the market
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Oligopoly Definition
• Homogeneous Oligopoly
– Steel (U.S. Steel, Arcelor Mittal, Nuco)
– Copper (Phelps Dodge, Arasco, Freeport-McMoRan, Southwire)
GE or GM both needing Steel and Copper will write specification and no
matter which producer wins the business GE and GM will get an identical
product.
• Differentiated Oligopoly
– ½ Ton Truck Market (Ford, GM, Chrysler, Toyota)
– Commercial Airline Market (America, United, Southwest,
Delta, _________, ___________
Even if you don’t know a thing about ½ ton trucks you can identify every
truck producer. How? Trucks are different and each one has the brand
name on the vehicle.
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Oligopoly Theory
Non-price completion
– Unique product features (iPhone, iPad)
– Increase transaction cost of switching
• Contracts (Wireless phones, insurance, etc…)
• Lock-in ([email protected])
Price Leadership – a dominant firm sets the price for an
industry and other firms follow
Cartel – a group of firms that formally agree to reduce
competition by coordinating the price and output of a product
Game Theory – a model of the strategic moves and
countermoves of rivals
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Non-collusive
The prisoners’ dilemma
– Particular “game” between two captured prisoners
– Illustrates why cooperation is difficult to maintain
even when it is mutually beneficial
Dominant strategy
– A strategy that is best for a player in a game
regardless of the strategies chosen by the other
players
Pay-off Table quantifies the value of each outcome in
game theory based on participant choices
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Prisoners’ dilemma
Bonnie’s decision
Confess
Bonnie gets 8 years
Remain silent
Bonnie gets 20 years
Confess
Clyde gets 8 years
Clyde’s
Decision
Bonnie goes free
Clyde goes free
Bonnie gets 1 year
Remain
silent
Clyde gets 20 years
Clyde gets 1 year
In this game between two criminals suspected of committing a crime, the dominate strategy for each
is to confess.
Why? No matter what the other does, confession is the best choice.
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Prisoners’ dilemma
Oligopolies as a prisoners’ dilemma
– In trying to reach the monopoly outcome
– Firms have self-interest
• and do not cooperate even though cooperation would
increase profits
• each firm has incentive to cheat to maximize profit
Example Ford and GM (1/2 ton pick-up trucks)
– Differentiated oligopoly
– Ford discounting vs. GM free features
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Prisoners’ dilemma
GM Decision
Free Options
No Free Options
GM earns $4
million profit
Rebate
GM earns $3
million profit
Ford gets $6
million profit
Ford gets $4
million profit
Ford
Decision
GM earns $6
million profit
No
Rebate
Ford gets $3
million profit
GM earns $5
million profit
Ford gets $5
million profit
In the ½ ton truck market, using the above payoff table, Ford will choice to Rebate and GM to
offer free options. While each could earn more by cooperating, cooperation is not a
sustainable equilibrium in the ½ ton truck market.
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