ASPECTS OF EXTERNAL
MARKET ENVIRONMENT
• Product Demand—how price sensitive, can
demand be segmented, advertising, etc.
• Competition—how many firms, product
heterogeneity, etc.
• Entry—how easy to enter, can entry be influenced
by incumbents, can new markets be created?
• Strategy—can rivals’ behavior be influenced, is it
worth trying to?
PERFECT COMPETITION
• Most competitive market.
• Pricing—no options. Price
discrimination—no options.
• Advertising—pointless.
• Product attributes—often fixed or
standardized.
• Entry—easy and often rapid.
• Strategy—no point, too many competitors.
SO WHAT’S THERE TO DO?
• Output choice in SR: Firm Supply.
• Entry/exit in LR: LR Mkt. Supply.
• These are the only “strategic” decisions to
make, plus cut costs as much as you can.
DYNAMICS OF PERFECT
COMPETITION
• Entry occurs as long as economic profits are
positive. Exit occurs as long as economic profits
are negative.
• So, in “long run equilibrium,” economic profits
are ….. It is hard to beat zero economic profit in a
sustainable way!!
• This means firm will have long run negative
economic profits unless it has comparative
advantage: its costs are as low or lower than
competitors.
RELAX ASSUMPTIONS OF
PERFECT COMPETITION:
PRICING
• Pricing power—“market power”—can extend
from product heterogeneity (brands matter) or
from having small numbers of competitors.
• Optimal choice of single price determined by
elasticity of firm demand and marginal costs.
Fixed costs aren’t relevant!
• Price discrimination, charging different prices to
different groups of customers, is an option. This
can be done because demand elasticities differ or
because costs differ (this technically isn’t PD).
RELAX ASSUMPTIONS OF PERFECT
COMPETITION: STRATEGY
• This is feasible when you have a small number of
firms sharing most of the market. Then your
rivals’ actions can materially affect your finances.
• With “puppy dog” strategies, you are nice to
encourage passive behavior from your rival.
• With “top dog” strategies, you are aggressive to
encourage passive behavior from your rival.
• Strategies can involve capacity decisions, pricing,
output, advertising, and product characteristics.
Some are legal and some aren’t (antitrust).
RELAX ASSUMPTIONS OF PERFECT
COMPETITION: ADVERTISING
• Not useful unless price exceeds marginal
cost. When does this happen?
• Can have strategic effects (see previous
slide) or simply increase demand. It can
deter entry.
• What did it do in optometry?
• Advertising is an input. Optimal input use
requires… It is also an investment!
CREATING AND CAPTURING
VALUE
• Some of these options create value and some only
capture value (and may destroy value), and some
can do either under different circumstances.
• However, when there is a lot of competition, it is
necessary to create value in order to capture value.
We’ve talked about this!
• If time, we will discuss a practical example where
costs, production, product & labor market
environment all shape business strategy, and
discuss how the firm creates & captures value.
TAXONOMY OF MARKET
STRUCTURES
• Perfect competition. Describe characteristics and
SR & LR outcomes.
• Monopolistic competition. Describe
characteristics, strategies, and SR & LR outcomes.
• Oligopoly. Describe characteristics, strategies, and
SR & LR outcomes.
• Monopoly. Describe characteristics, strategies, and
SR & LR outcomes.
MEASURING COMPETITION
• Competitiveness in terms of number of firms can
be measured using “Herfindahl index” or
“concentration ratio.” You will use one or both of
these in your dentist assignment.
• Competitiveness in terms of product heterogeneity
can be measured informally, by measuring
“substitutability” across products, or formally,
using demand elasticity or cross-elasticity.
• Entry barriers influence long run competitiveness.
HEALTH INSURANCE
MARKET
•
•
•
•
•
Competitiveness: # of firms.
Competitiveness: product heterogeneity.
Entry barriers?
What kind of strategies?
What kind of outcomes?
HOSPITAL MARKETS
•
•
•
•
•
Competitiveness: # of firms.
Competitiveness: product heterogeneity.
Entry barriers? Exit barriers?
What kind of strategies?
What kind of outcomes?
PHARMACEUTICAL
MARKETS
• Two markets, in a way: brand name &
generic. In each, think about:
• Competitiveness: # of firms.
• Competitiveness: product heterogeneity.
• Entry barriers? Is this good?
• What kind of strategies?
• What kind of outcomes?