PowerPoint Presentation Lecuture 7

ECW2731

Weeks 7 & 8

Weeks 7 & 8

Competition, market structures and business decisions

Examination structure

ECW2731

Weeks 7 & 8

1.

Exam duration

2.

Reading time

3.

Total number of questions 5

4.

Students must attempt all questions

5.

Use of calculators is permitted

120 minutes writing time

10 minutes

Please note, original hand written notes or computer printouts or photocopies are not permitted in the exam this year.

Examination structure

ECW2731

Weeks 7 & 8

Section 1. (Microeconomic theory from the Managerial

Perspective) – attempt

Q 1-4

Four theoretical questions. May include discussion of examples. Brief answers are expected including definitions and diagrams where approporiated and/or specifically asked for.

Section 2. (Research Question) –attempt only one question 5 or 6

5. “Discuss possible impact of the introduction of carbon emission trading scheme in Australia on the following industries:

Electricity generation

Car manufacturing and import

Tourism and hospitality

Forestry

6. Apply question 5 to any country of your choice.

ECW2731

Weeks 7 & 8

Structure

Weeks 7-8


Weeks 5 - 6

Production and Costs

Weeks 3-4

Demand analysis and estimation

Week 2

Basic economics principles: demand and supply.

Week 9

Pricing strategies and practices

Week 10

Business and Government.

Managerial

Economics

Week 11

Capital budgeting

Week. 12

Research question

Business and current economic situation.

Week1

Introduction. The nature of managerial economic decision making

ECW2731

Weeks 7 & 8


Learning objectives

What is the market Structure

How does competition affect business decisions in different market structures?

Perfect competition; monopoly; oligopoly; monopolistic competition

Competitive strategies.

Measurement of market structures

Market strategies in different market structures.

Non-price competition.

Multinational companies. Vertical and horizontal coordination.


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Reading

Hirschey, Chapters 10, 12, 13, & 14

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Table 10.1 Characteristics of Market Types

Market structure

Examples

Number of producers

Perfect competition

Parts of agriculture are reasonably close

Monopolistic competition

Retail trade

Many

Many

Oligopoly

Computers, oil, steel

Few

Type of product

Standardized

Differentiated

Standardized or differentiated

Power of firm over price

Barriers to entry

Non-price competition

None

Some

Some

Low

Low

High

None

Advertising and product differentiation

Advertising and product differentiation

Monopoly Public utilities One Very high Advertising

7


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Market structures

What is the market structure?

• The competitive environment in the market for any product is the market structure faced by the firm

– Is measured in terms of

• the number of the actual buyers and sellers plus potential entrants

• Barriers to entry and exit

• Capital requirements

• Price vs Non-price competition

• Etc

– Potential entrants pose a sufficiently credible threat of entry to affect price/output decisions of incumbents


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Weeks 7 & 8


Factors that Shape the Competitive

Environment

• Product Differentiation

– R&D, innovation, and advertising are important in many markets.

• Production Methods

– Economies of scale can preclude small-firm size.

• Entry and Exit Conditions

– Barriers to entry and exit can shelter incumbents from potential entrants.

• Buyer Power

– Powerful buyers can limit seller power.


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Weeks 7 & 8


The firm in competitive markets

Perfect competition

Non-perfect competition

Monopoly

Oligopoly

Monopolistic competition


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Weeks 7 & 8


“Perfect competition” – competitive markets

 Profit maximiser

 Identical product

 Very small share of the market

 Price-taker

 Produces a homogeneous product

 Perfect information

 No barriers to entry (legal, technological, or resource)

 No technical progress

 No investment lag - Immediate implementation of production decisions)

 Homogeneous goals of the owners and managerial staff


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• Examples of Competitive Markets

– Agricultural commodities.

– Some prominent markets for intermediate goods and services.

– Unskilled labor market.

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• Profit Maximization Imperative

– Normal profit is return necessary to attract and maintain capital investment.

– Efficient firms can earn normal profit.

– Inefficient firms suffer losses.

• Role of Marginal Analysis

– Set M π = MR – MC = 0 to maximize profits.

– MR=MC when profits are maximized.

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Profit maximization in a perfectly competitive market

• (see book)

• P = MC

• Marginal cost curve left of shutdown level (min. variable cost) is supply curve

• P = MR = MC = AC

• Firm produces at minimum of average costs! (optimal outcome for industry)

• In a constant-cost industry increase in supply will lead in the long term to constant prices (i.e. horizontal supply curve)

14

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Marginal Cost and Firm Supply

Short-run Firm Supply

– Competitive market price (P) is shown as a horizontal line because

P=MR.

– Firm’s marginal-cost curve shows the amount of output the firm would be willing to supply at any market price.

– Marginal cost curve is the short-run supply curve so long as P >

AVC .

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Long-run Firm Supply

Marginal cost curve is the long-run supply curve so long as P > ATC.

In long run, firm must cover all necessary costs of production and earn a normal profit.

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Long Run Normal Profit

Equilibrium

With a horizontal market demand curve, MR=P.

P=MR=MC=ATC.

There are no economic profits.

All firms earn a normal rate of return.


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Breakeven point

Price, cost per unit

P peak

P off peak

D

B

MC

ATC

P off peak

–

break even price off peak. At this price the firm expects

AVC to return only variable costs and can produce

P quantity Q off peak peakbreak even price at peak. This is when the firm expects to return both fixed and variable costs producing quantity Q peak

0

Q

Q off peak peak

Output per time period

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Competitive Market Supply Curve

Market Supply With a Fixed

Number of Competitors

Supply is the sum of competitor output.

Market Supply With Entry and Exit

Entry results in more firms, increased output, a rightward shift in the supply curve, and drives down prices and profits.

Exit reduces the number of firms, decreases the quantity of output, shifts the supply curve leftward, and allows prices and profits to rise for remaining competitors.


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Market price determination

• Negatively sloped demand curve

•

Positively sloped supply

Price per unit ($) curve

8

Supply

P = –$0.254 + $0.000025

6

4

2

P = $40 Q

Demand

0 50 100 150200250300350 400

Quantity per time period (millions)

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Monopoly

Basic Properties

• One firm in industry

• Profit-maximiser

• Faces market demand curve

• One product

• No close substitutes

• Price-maker

• No restrictions on resources

• Blockaded entry and/or exit

• Imperfect dissemination of information

• Opportunity for economic profits in long-run equilibrium .

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Monopoly

• Examples of Monopoly

– Electricity utilities,

– Gas

– Water

– Public Tramsport

– Telecommunications

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Monopoly graph

23



Monopoly

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Profit Maximization in Monopoly Markets

• Price/Output Decisions

• A monopoly firm is the market.

• Market and firm demand curve slopes downward.

• Monopoly demand curve is always above the marginal revenue curve,

P = AR > MR.

• Monopoly position allows above-normal profits.

P > AC in long-run equilibrium.

• Set Mπ = MR - MC = 0 to maximize profits.

• MR=MC at optimal output.

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Monopoly

Social Costs of Monopoly

•

Monopoly Underproduction

Monopolists produce too little output.

Monopolists charge prices that are too high.

•

Deadweight Loss from

Monopoly

Monopoly markets creates a loss in social welfare due to the decline in mutually beneficial trade activity.

There is also a wealth transfer problem associated with monopoly.

Under monopoly, consumer surplus is transferred to producer surplus.

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Monopoly

Social Benefits From Monopoly

• Economies of Scale

Monopoly is sometimes the natural result of vigorous competitive forces.

In natural monopoly, LRAC declines continuously and one firm is most efficient.

Some real-world monopolies are government-created or government-maintained.

• Invention and Innovation

Public policy sometimes confers explicit monopoly rights to spur productivity.

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Monopoly

Monopoly Regulation

• Dilemma of Natural Monopoly

Monopoly has the potential for efficiency.

Unregulated monopoly can lead to economic profits and underproduction.

ECW3830 COMPETITION AND REGULATION

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Monopolists produce less, price higher than firms in competitive equilibrium

MR = P(1 + 1/ h )

• Situation is inefficient, insofar as the sum of consumer and producer surplus is concerned

– What is producer and consumer surplus?

• Monopolist has to take demand conditions explicitly into account

• Why is no other firm entering the market???

28

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Other aspects of monopoly

• “Natural monopoly” if minimum of average cost occurs only at very high output level (minimum efficient scale) ==> there is only place for one firm in the market!

• Measure of monopoly power (markup of price over cost):

markup



MC

29

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Sources of monopoly power

• Natural monopoly (public utilities best example, railway tracks), economies of scale,

• Capital requirements on production or big sunk costs on entry

• Patents (17 years), trade secrets (Coke)

• Exclusive or unique assets (minerals, talent)

• Locational advantage (popcorn shop in cinema – but in general you pay rent for these advantages)

• Regulation (TV, taxi, telephone in the past)

• Collusion by competitors

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In the “real life”

A “real” firm in a market place

(compare to the “ideal” one):

• A typical firm, if it is not a small one, is not owner-managed

• Separation of ownership, long-term strategic and short-run current control (shareholders, board of directors, brunch managers) implies the segregation of objectives;

• Natural, economic and legal barriers

• Diversification (non-homogenous product, more than one kind of activity)

• Technical progress

• Different criteria for different time horizons (short-run operation vs long-run planning.

• Price-making

• Price/marketing strategies

• Imperfect information

• Investment lag

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Sources of monopoly power

• Natural monopoly (public utilities best example, railway tracks), economies of scale,

• Capital requirements on production or big sunk costs on entry

• Patents (17 years), trade secrets (Coke)

• Exclusive or unique assets (minerals, talent)

• Locational advantage (popcorn shop in cinema – but in general you pay rent for these advantages)

• Regulation (TV, taxi, telephone in the past)

• Collusion by competitors

34

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What can a monopolist do?

Erect strategic entry barriers

• Excessive patenting and copyright

• Limit pricing (set price below monopoly price)

• Extensive advertising to create brand name to raise cost of entry

• Create intentionally excess capacity as a warning for a price war

35

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Franchising „McFood“

• A Franchiser (mother company) gets a fixed percentage of sales,

• The franchisee is the residual claimant

• What are the incentives for the two partners?

• Other problems like number of shops in a region…

• Other examples??

36

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37


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Oligopoly and Monopolistic Competition

Contrast Between Monopolistic Competition and Oligopoly

• Monopolistic Competition

• Large number of sellers that offer differentiated products.

• Normal profit opportunity in long-run equilibrium.

• Oligopoly

• Few sellers.

• Economic profits are possible in long-run equilibrium.

• Dynamic Nature of Competition

• Timely market structure information is required for managerial investment decisions


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Market structures Мonopolistic competition

• The market consists of n mono-product firms;

• The products are viewed by the buyers as close though not perfect substitutes for one another;

• Therefore, each of the sellers is a monopolist of its particular product variant with a limited degree of monopoly power.

• Such a monopolist is enjoying a monopoly power and making economic profit during only a short period of time

• from the introduction of an unique product or technology

• until such a technology becomes available to rivals, or

• until a new “more innovative” product is introduced by a rival.


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Price

Costs MC

AC

P mc

Q mc

MR

Q

Demand

Quantity

Short-run Monopoly Equilibrium

Monopolistically competitive firms take full advantage of short-run monopoly.


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Price

Costs

MC

AC

Price

Costs

MC

AC

P mc

D2

D1

D

MR2

MR1

Entry of new firms offering product substitutes shifts the demand and MR curves)

Quantity

Q mc

MR

Quantity

Long-run equilibrium same costs, lower demand and excess capacity – low output high price decision With differentiated products, P=AC at a point above minimum LRAC.

P > MR = MC.

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Weeks 7 & 8



Price

Costs

MC

AC

Price

Costs

MC

AC

D2

D1

MR2

MR1 Quantity

Long-run equilibrium same costs, lower demand and excess capacity – low output high price decision

With differentiated products, P=AC at a point above minimum LRAC.

P > MR = MC.

P m

P ac c

D

MR

Q mc

Q ac

Quantity

Long-run equilibrium– high output low price decision (corresponds to perfect

Competition)

With homogenous products, P=AC at minimum

LRAC.

This is a competitive market equilibrium with homogeneous production.

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Market structures Oligipoly

• Oligopoly Market Characteristics

• Few sellers.

• Homogenous or unique products.

• Blockaded entry and exit.

• Imperfect dissemination of information.

• Opportunity for above-normal (economic) profits in long-run equilibrium.

• Examples of Oligopoly

• National markets for aluminum, cigarettes, electrical equipment, filmed entertainment, ready-to-eat cereals, etc.

• Local retail markets for gasoline, food, specialized services, etc.

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Cartels and Collusion

• Overt and Covert Agreements

• Cartels operate under formal agreements.

• Powerful cartels function as a monopoly.

• Collusion exists when firms reach secret, covert agreements.

• Enforcement Problem

• Cartels are typically rather short-lived because coordination problems often lead to cheating.

• Cartel subversion can be extremely profitable.

• Detecting the source of secret price concessions can be extremely difficult.

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Cartels and Collusion

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Oligopoly Output-Setting Models

• Cournot Oligopoly

• Cournot equilibrium output is found by simultaneously solving output-reaction curves for both competitors.

• Cournot equilibrium output exceeds monopoly output but is less than competitive output.

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Stackelberg Oligopoly

• Stackelberg model posits a first-mover advantage.

• Price wars severely undermine profitability for both leading and following firms.

• Price signaling can reduce uncertainty in oligopoly markets.

• Price leadership occurs when firms follow the industry leader’s pricing policy.

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Stackelberg Oligopoly

• Price leader sets the price at P

2

• Profit is maximised at Q

1

.

• The follower(s) will supply the combined output of

Q

4

-Q

1

• At P

3

- Follows will supply everything

At P

1

– the leader will supply everything at no economic profit

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Oligopoly Price-Setting Models

• Bertrand

Oligopoly: Identical

Products

– The Bertrand model focuses upon the price reactions.

– The Bertrand model predicts a competitive market price/output solution in oligopoly markets with identical products.

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Weeks 7 & 8



Oligopoly Price-Setting Models

• Bertrand

Oligopoly: Identical

Products

– The Bertrand model focuses upon the price reactions.

– The Bertrand model predicts a competitive market price/output solution in oligopoly markets with identical products.

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Market structures Game Theory Basics

• Types of Games

– Zero-sum game: offsetting gains/losses.

– Positive sum game: potential for mutual gain.

– Negative-sum game: potential for mutual loss.

– Cooperative games: joint action is favored.

• Role of Interdependence

– Sequential games: moves in succession.

– Simultaneous-move game: coincident moves.

• Strategic Considerations



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Prisoner’s Dilemma

• Classic Riddle

– Rational behavior can give suboptimal result.

– Rationality can hamper beneficial cooperation.

• Business Application

– Dominant strategy gives best result regardless of moves by other players.

– Secure strategy gives best result assuming the worst possible scenario.

• Broad Implications

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Nash Equilibrium

• Nash Equilibrium Concept

– Neither player can improve their payoff through a unilateral change in strategy.

– Nash equilibrium concept is broader than the concept of a dominant strategy equilibrium.

– Every dominant strategy equilibrium is also a Nash equilibrium.

– Nash equilibrium can exist where there is no dominant strategy equilibrium.

• Nash Bargaining



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Infinitely Repeated Games

• Role of Reputation

– Infinitely repeated games occur over and over again without boundary or limit.

– Firms receive sequential payoffs that shape current and future strategies.

– Reputations for high quality give consumers confidence for repeat transactions.

• Product Quality Games

– In a one-shot game, poor quality can fool customers.

– In an infinitely repeated game, poor quality is shunned by customers.

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Finitely Repeated Games

• Uncertain Final Period

– Finitely repeated games have limited duration.

– With end point uncertainty, a finitely repeated game mirrors an infinitely repeated game.

• End-of-game Problem

– Enforcing end-of-game performance is difficult.

– Solution: simply extend the game!

• First-mover Advantages

– Benefits earned by the player able to make the initial move in a sequential move or multistage game.


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Competitive strategies in Imperfectly competitive markets







Not all industries offer the same potential for sustained profitability;

Not all firms are equally capable of exploring the profit potential that is available.

An effective competitive strategy in imperfectly competitive markets must be founded on the firms competitive advantage.


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



A competitive advantage is a unique or rare ability to create, distribute or service valued by customers.

It is a business-world analogue to what economists call comparative advantage or when one nation or region of the country is better suited to the production of one product than to the production of some other product

Above-normal rate of return require a competitive advantage that cannot easily be copied

In production;

In distribution; or

In marketing


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

Reasons for competitive advantage:



Access to a unique resource



(Exclusive) Access to a mineral deposit



(

Exclusive) Access to a material



Efficient energy source



Unique climatic condition



Unique technology



Unique (specially qualified or very talented) labour force; or



Access to a unique market



A university bookshop



The rice market in Japan

 etc


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Product differentiation

Product differentiation refers to the increase in time of the number of product categories suppled and the number of items in each category



Historically, a step from oligopolistic to monopolistic competition


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Product differentiation

Price

P*

P

A simple model of the reason for product differentiation

• Considers constant quantity as well as nonchanging AC and MC corresponding to this quantity

• Producing a little bit different product a firm might hope to charge a higher price

Q Quantity


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Price

P*

P

LAC*

LAC

Absolute cost advantages:

Ability of established firms to produce any given level of output at lower unit costs than potential entrants

Q* Q

Quantity


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Price

P

LAC

D

Economies of scale:

Ability of established firms

* To produce any given level of output greater than a certain level Q* at lower unit costs and

* To restrict potential entrants who are not able to invest in that level of production

Q* Quantity


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Price

P*

LAC

Product differentiation advantages:

Variety of demand curves and common LAC.

D1

Some firms have advantage of technology or specialisation and are facing demand curves to the right of the critical one.

D2

D2

Q* Quantity


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Non-profit-maximising competition.

Appear as the result of

• Ability to affect prices and

• Separation of ownership and managerial control

*

Managers’ aim at stability and increase in salaries

*

Stability may be achieved through the increase in the scale of operations

*

Increase in sales (not in profit) affects manager’s remuneration

*

Banks and retailers would prefer to deal with firms increasing the volume of sales


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P, Cost

Profit maximising decision

MC

AC

MR

D

Q


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P, Cost

• Increasing sales, the firm is moving to the right and downward the demand curve and, therefore, decreases price,

• The limitation is AC curve.

Some profit should be earned anyway

MR

D

Q


Sales maximising decision


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P, Cost

MC

AC

MR

D

Q



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P, Cost

MC

AC

Old profit maximising decision

MR

D

Q

New profit maximising decision

Old sales maximising decision is a profit maximising decision at a new level of average cost


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Seller concentration

Seller concentration refers to the degree to which production for a particular market or or in a particular industry is concentrated in the hand of few large firms

Measurement of concentration

• number of firms in the market

• size distribution of firms in the market


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The

Australian

Bureau of

Statistics

8140.0.55.001 Industry

Concentration Statistics


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C2542 - Paint Manufacturing in Australia

KEY COMPETITORS ( www.ibisworld.com.au/static/iwabout/SamIndPart.asp

)

MAJOR PLAYERS

Table: Market Share

Major Player

Orica Limited

Wattyl Limited

Market Share Range

22.00% - 25.00% (2004)

17.00% - 19.00% (2004)

Barloworld Australia Pty Limited 9.00% - 11.00% (2004)

Akzo Nobel Industries Limited 7.00% - 9.00% (2003)


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Measurement of concentration

The firms in the industry are sorted according to the size of their output.

X i

- the output of the firm

X - the output of industry

X i

X - the share of the firm in the industry output

The ratio of r lagest firms in the industry output

C r

 r  i 1

X i

X



X

1

X



X

2

X

X r

X

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Census Measures of Market Concentration

• Concentration Ratios

– Group market share data are called concentration ratios.

– CRi = ∑ Xi, where Xi is market share of the ith leading firm.

– CRi = 100 for monopoly.

– CRi ≈ 0 for a perfectly competitive industry.

• Herfindahl-Hirschmann Index

– Calculated in percentage terms, the HHI is the sum of squared market shares for all competitors.

– HHI = ∑ Xi2, where Xi2 is squared market share of the ith firm.

–

HHI = 10,000 for monopoly.

– HHI ≈ 0 for a perfectly competitive industry.

• Limitations of Census Information

– Slow reports hinder usefulness.

– National statistics obscure local markets.


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Measurement of concentration

Diagrammatic approach

100%

The curve of real (not equal distribution

The curve of equal distribution of shares of the market among firms

N

This distance measures concentration

No of firms cumulated from the largest


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Diversification

Vertical coordination

Multinational company


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Diversification

Invest in production facilities to produce a product D

A firm X producing a good A

Buys shares of a firm Y producing a good B

Invents a new product C


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Invest in production facilities or buys shares of or coordinate activities with a firm producing an input D


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Invest in facilities or buys shares of or coordinate activities with a firm providing professional training for employees


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Invest in production facilities or buys shares of or coordinate activities with a firm using

A as an input





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Invest in production facilities or buys shares of or coordinate activities with a firm using

A as an input


Invest in or buys shares of or coordinate activities with a firm specialising in the selling of product A




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Multinational company

Undertake vertical coordination measures abroad

Conduct diversification practices abroad

A firm producing a good A in a home country

Establishes branches in other countries

Buys share of analogous firms in other countries

PowerPoint Presentation Lecuture 7

Weeks 7 & 8

Competition, market structures and business decisions

Structure

Table 10.1 Characteristics of Market Types

What is the market structure?

Factors that Shape the Competitive

Environment

Profit maximization in a perfectly competitive market

Marginal Cost and Firm Supply

Long-run Firm Supply

–

Competitive Market Supply Curve

Monopoly graph

Monopolists produce less, price higher than firms in competitive equilibrium

Other aspects of monopoly

markup

MC

Sources of monopoly power

Sources of monopoly power

What can a monopolist do?

Erect strategic entry barriers

Franchising „McFood“

Related documents

Products

Support

PowerPoint Presentation Lecuture 7

Weeks 7 & 8

Competition, market structures and business decisions

Structure

Table 10.1 Characteristics of Market Types

What is the market structure?

Factors that Shape the Competitive

Environment

Profit maximization in a perfectly competitive market

Marginal Cost and Firm Supply

Long-run Firm Supply

–

Competitive Market Supply Curve

Monopoly graph

Monopolists produce less, price higher than firms in competitive equilibrium

Other aspects of monopoly

markup

MC

Sources of monopoly power

Sources of monopoly power

What can a monopolist do?

Erect strategic entry barriers

Franchising „McFood“

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