Market
Structures
The Degree of Competition
• Classifying markets
–
–
–
–
number of firms
freedom of entry to industry
nature of product
nature of demand curve
• The four market structures
–
–
–
–
perfect competition
monopoly
monopolistic competition
oligopoly
Features of the four market structures
Type of
market
Number
of firms
Freedom of
entry
Nature of
product
Examples
Implications for
demand curve
faced by firm
Perfect
competition
Very
many
Unrestricted
Homogeneous
(undifferentiated)
Cabbages, carrots
(approximately)
Horizontal:
firm is a price taker
Monopolistic
competition
Many /
several
Unrestricted
Differentiated
Builders,
restaurants
Downward sloping,
but relatively elastic
Undifferentiated
Cement
or differentiated
cars, electrical
appliances
Downward sloping.
Relatively inelastic
(shape depends on
reactions of rivals)
Oligopoly
Monopoly
Few
One
Restricted
Restricted or
completely
blocked
Unique
Local water
company, train
operators (over
particular routes)
Downward sloping:
more inelastic than
oligopoly. Firm has
considerable
control over price
Features of the four market structures
Type of
market
Number
of firms
Freedom of
entry
Nature of
product
Examples
Implications for
demand curve
faced by firm
Perfect
competition
Very
many
Unrestricted
Homogeneous
(undifferentiated)
Cabbages, carrots
(approximately)
Horizontal:
firm is a price taker
Monopolistic
competition
Many /
several
Unrestricted
Differentiated
Builders,
restaurants
Downward sloping,
but relatively elastic
Undifferentiated
Cement
or differentiated
cars, electrical
appliances
Downward sloping.
Relatively inelastic
(shape depends on
reactions of rivals)
Oligopoly
Monopoly
Few
One
Restricted
Restricted or
completely
blocked
Unique
Local water
company, train
operators (over
particular routes)
Downward sloping:
more inelastic than
oligopoly. Firm has
considerable
control over price
Features of the four market structures
Type of
market
Number
of firms
Freedom of
entry
Nature of
product
Examples
Implications for
demand curve
faced by firm
Perfect
competition
Very
many
Unrestricted
Homogeneous
(undifferentiated)
Cabbages, carrots
(approximately)
Horizontal:
firm is a price taker
Monopolistic
competition
Many /
several
Unrestricted
Differentiated
Builders,
restaurants
Downward sloping,
but relatively elastic
Undifferentiated
Cement
or differentiated
cars, electrical
appliances
Downward sloping.
Relatively inelastic
(shape depends on
reactions of rivals)
Oligopoly
Monopoly
Few
One
Restricted
Restricted or
completely
blocked
Unique
Local water
company, train
operators (over
particular routes)
Downward sloping:
more inelastic than
oligopoly. Firm has
considerable
control over price
Features of the four market structures
Type of
market
Number
of firms
Freedom of
entry
Nature of
product
Examples
Implications for
demand curve
faced by firm
Perfect
competition
Very
many
Unrestricted
Homogeneous
(undifferentiated)
Cabbages, carrots
(approximately)
Horizontal:
firm is a price taker
Monopolistic
competition
Many /
several
Unrestricted
Differentiated
Builders,
restaurants
Downward sloping,
but relatively elastic
Undifferentiated
Cement
or differentiated
cars, electrical
appliances
Downward sloping.
Relatively inelastic
(shape depends on
reactions of rivals)
Oligopoly
Monopoly
Few
One
Restricted
Restricted or
completely
blocked
Unique
Local water
company, train
operators (over
particular routes)
Downward sloping:
more inelastic than
oligopoly. Firm has
considerable
control over price
Features of the four market structures
Type of
market
Number
of firms
Freedom of
entry
Nature of
product
Examples
Implications for
demand curve
faced by firm
Perfect
competition
Very
many
Unrestricted
Homogeneous
(undifferentiated)
Cabbages, carrots
(approximately)
Horizontal:
firm is a price taker
Monopolistic
competition
Many /
several
Unrestricted
Differentiated
Builders,
restaurants
Downward sloping,
but relatively elastic
Undifferentiated
Cement
or differentiated
cars, electrical
appliances
Downward sloping.
Relatively inelastic
(shape depends on
reactions of rivals)
Oligopoly
Monopoly
Few
One
Restricted
Restricted or
completely
blocked
Unique
Local water
company, train
operators (over
particular routes)
Downward sloping:
more inelastic than
oligopoly. Firm has
considerable
control over price
Features of the four market structures
Type of
market
Number
of firms
Freedom of
entry
Nature of
product
Examples
Implications for
demand curve
faced by firm
Perfect
competition
Very
many
Unrestricted
Homogeneous
(undifferentiated)
Cabbages, carrots
(approximately)
Horizontal:
firm is a price taker
Monopolistic
competition
Many /
several
Unrestricted
Differentiated
Builders,
restaurants
Downward sloping,
but relatively elastic
Undifferentiated
Cement
or differentiated
cars, electrical
appliances
Downward sloping.
Relatively inelastic
(shape depends on
reactions of rivals)
Oligopoly
Monopoly
Few
One
Restricted
Restricted or
completely
blocked
Unique
Local water
company, train
operators (over
particular routes)
Downward sloping:
more inelastic than
oligopoly. Firm has
considerable
control over price
The Degree of Competition
• Classifying markets
–
–
–
–
number of firms
freedom of entry to industry
nature of product
nature of demand curve
• The four market structures
–
–
–
–
perfect competition
monopoly
monopolistic competition
oligopoly
• Structure  conduct  performance
Perfect Competition
• Assumptions
– firms are price takers
– freedom of entry
– identical products
– perfect knowledge
• Short-run equilibrium of the firm
– price, output and profit
Short-run equilibrium of industry and firm under perfect
competition
P
R
MC
S
Pe
D = AR
= MR
AR
AC
D
O
O
Q (millions)
(a) Industry
AC
Qe
Q (thousands)
(b) Firm
Loss minimising under perfect competition
P
R
AC
P1
AC
MC
S
D1 = AR1
AR1
= MR1
D
O
O
Q (millions)
(a) Industry
Qe
Q (thousands)
(b) Firm
Perfect Competition
• Assumptions
– firms are price takers
– freedom of entry
– identical products
– perfect knowledge
• Short-run equilibrium of the firm
– price, output and profit
• The short-run supply curve of the firm
Deriving the short-run supply curve
P
R
S
MC = S
a
P1
P2
b
c
P3
D1 = MR1
D2 = MR2
D3 = MR3
D1
D3
O
D2
O
Q (millions)
(a) Industry
Q (thousands)
(b) Firm
Perfect Competition
• Long-run equilibrium of the firm
– all supernormal profits competed away
– LRAC = AC = MC = MR = AR
Long-run equilibrium under perfect
competition
Profits
return
Supernormal
New firms enter
to normalprofits
P
R
S1
Se
LRAC
P1
AR1
D1
PL
ARL
DL
D
O
O
Q (millions)
(a) Industry
QL
Q (thousands)
(b) Firm
Long-run equilibrium of the firm under perfect competition
R
(SR)MC
(SR)AC
LRAC
DL
AR = MR
LRAC = (SR)AC = (SR)MC = MR = AR
O
Q
Perfect Competition
• Incompatibility of economies of scale with
perfect competition
• Benefits of perfect competition
– price equals marginal cost
– prices kept low
– firms must be efficient to survive
Monopoly
• Defining monopoly
• Barriers to entry
– economies of scale
– economies of scope
– product differentiation and brand loyalty
– lower costs for an established firm
– ownership/control of key factors
– ownership/control over outlets
– legal protection
– mergers and takeovers
– aggressive tactics
Monopoly
• The monopolist’s demand curve
– downward sloping
– MR below AR
• Equilibrium price and output
– Equilibrium output, where MC = MR
Profit maximising under monopoly
R
MC
MR
O
Qm
Q
Monopoly
• The monopolist’s demand curve
– downward sloping
– MR below AR
• Equilibrium price and output
– Equilibrium output, where MC = MR
– Equilibrium price, found from demand curve
Profit maximising under monopoly
R
MC
AC
AR
AC
AR
MR
O
Qm
Q
Monopoly
• The monopolist’s demand curve
– downward sloping
– MR below AR
• Equilibrium price and output
– Equilibrium output, where MC = MR
– Equilibrium price, found from demand curve
• Profit
– Measuring profit
Profit maximising under monopoly
R
MC
Total profit
AC
AR
AC
AR
MR
O
Qm
Q
Monopoly
• The monopolist’s demand curve
– downward sloping
– MR below AR
• Equilibrium price and output
– Equilibrium output, where MC = MR
– Equilibrium price, found from demand curve
• Profit
– Measuring profit
Monopoly
• Disadvantages of monopoly
– high prices / low output: short run
Equilibrium of industry under perfect competition and monopoly: with
the same MC curve
R
MC
Monopoly
P1
AR = D
MR
O
Q1
Q
Equilibrium of industry under perfect competition and monopoly: with
the same MC curve
R
MC ( = supply under
perfect competition)
Comparison with
Perfect competition
P1
P2
AR = D
MR
O
Q1
Q2
Q
Monopoly
• Disadvantages of monopoly
– high prices / low output: short run
– high prices / low output: long run
Monopoly
• Disadvantages of monopoly
– high prices / low output: short run
– high prices / low output: long run
– lack of incentive to innovate
Monopoly
• Disadvantages of monopoly
– high prices / low output: short run
– high prices / low output: long run
– lack of incentive to innovate
– X-inefficiency
Monopoly
• Disadvantages of monopoly
– high prices / low output: short run
– high prices / low output: long run
– lack of incentive to innovate
– X-inefficiency
• Advantages of monopoly
Monopoly
• Disadvantages of monopoly
– high prices / low output: short run
– high prices / low output: long run
– lack of incentive to innovate
– X-inefficiency
• Advantages of monopoly
– economies of scale
Equilibrium of industry under perfect competition and monopoly: with
different MC curves
R
MCmonopoly
P1
AR = D
MR
O
Q1
Q
Equilibrium of industry under perfect competition and monopoly: with
different MC curves
R
MC ( = supply)perfect competition
MCmonopoly
P2
P1
x
P3
AR = D
MR
O
Q2
Q1
Q3
Q
Monopoly
• Disadvantages of monopoly
– high prices / low output: short run
– high prices / low output: long run
– lack of incentive to innovate
– X-inefficiency
• Advantages of monopoly
– economies of scale
– profits can be used for investment
Monopoly
• Disadvantages of monopoly
– high prices / low output: short run
– high prices / low output: long run
– lack of incentive to innovate
– X-inefficiency
• Advantages of monopoly
– economies of scale
– profits can be used for investment
Monopoly
• Contestable markets
– importance of potential competition
– a perfectly contestable market
– contestable markets and natural monopolies
– importance of costless exit
• Contestable markets and the public interest
Monopolistic Competition
• Assumptions of monopolistic competition
• Equilibrium of the firm
– short run
Short-run equilibrium of the firm
under monopolistic competition
R
MC
AC
Ps
ACs
AR = D
MR
O
Qs
Q
Monopolistic Competition
• Assumptions of monopolistic competition
• Equilibrium of the firm
– short run
– long run
Long-run equilibrium of the firm
under monopolistic competition
R
LRMC
LRAC
PL
ARL = DL
MRL
O
QL
Q
Monopolistic Competition
• Assumptions of monopolistic competition
• Equilibrium of the firm
– short run
– long run
– underutilisation of capacity in the long run
Long run equilibrium of the firm under perfect and
monopolistic competition
R
LRAC
P1
P2
DL under perfect
competition
DL under monopolistic
competition
O
Q1
Q2
Q
Monopolistic Competition
• Assumptions of monopolistic competition
• Equilibrium of the firm
– short run
– long run
– underutilisation of capacity in the long run
• Non-price competition
Monopolistic Competition
• Assumptions of monopolistic competition
• Equilibrium of the firm
– short run
– long run
– underutilisation of capacity in the long run
• Non-price competition
• The public interest
Monopolistic Competition
• Assumptions of monopolistic competition
• Equilibrium of the firm
– short run
– long run
– underutilisation of capacity in the long run
• Non-price competition
• The public interest
– comparison with perfect competition
Monopolistic Competition
• Assumptions of monopolistic competition
• Equilibrium of the firm
– short run
– long run
– underutilisation of capacity in the long run
• Non-price competition
• The public interest
– comparison with perfect competition
– comparison with monopoly
Oligopoly
• Key features of oligopoly
– barriers to entry
– interdependence of firms
• Competition versus collusion
• Collusive oligopoly: cartels
– equilibrium of the industry
Profit-maximising cartel
R
Industry D = AR
O
Q
Profit-maximising cartel
R
Industry MC
P1
Industry D = AR
Industry MR
O
Q1
Q
Oligopoly
• Key features of oligopoly
– barriers to entry
– interdependence of firms
• Competition versus collusion
• Collusive oligopoly: cartels
– equilibrium of the industry
Oil prices
$ per barrel
Actual price
35
Iraq invades
Iran
OPEC’s first
quotas
30
Iraq invades
Kuwait
Revolution
in Iran
25
20
Impending
war
with Iraq
World-wide
recovery
First oil from
North Sea
World-wide
slowdown
15
10
Cease-fire in
Iran-Iraq war
New OPEC
quotas
86
92
Recession
in Far East
Yom Kippur
War: Arab oil
embargo
5
0
70
72 74
76
78
80 82
84
88 90
94 96
98
00
02
Oil prices
$ per barrel
Actual price
Cost in 1973 prices
35
Iraq invades
Iran
OPEC’s first
quotas
30
Iraq invades
Kuwait
Revolution
in Iran
25
20
Impending
war
with Iraq
World-wide
recovery
First oil from
North Sea
World-wide
slowdown
15
10
Cease-fire in
Iran-Iraq war
New OPEC
quotas
86
92
Recession
in Far East
Yom Kippur
War: Arab oil
embargo
5
0
70
72 74
76
78
80 82
84
88 90
94 96
98
00
02
Oligopoly
• Tacit collusion
– price leadership: dominant firm
Price leader aiming to maximise profits for a given market share
R
Assume constant
market share
for leader
AR = D market
AR = D leader
MR leader
O
Q
Price leader aiming to maximise profits for a given market share
R
MC
PL
l
t
AR = D market
AR = D leader
MR leader
O
QL
QT
Q
Oligopoly
• Tacit collusion
– price leadership: dominant firm
– price leadership: barometric
Oligopoly
• Tacit collusion
– price leadership: dominant firm
– price leadership: barometric
– rules of thumb
Oligopoly
• Factors favouring collusion
– Few firms
– Open with each other
– Similar production methods and average costs
– Similar products
– Dominant firm
– Significant entry barriers
– Stable market
– No government measures to curb collusion
Oligopoly
• The breakdown of collusion
• Non-collusive oligopoly: game theory
– alternative strategies
• maximax and maximin
– simple dominant strategy games
Profits for firms A and B at different prices
X’s price
R2.00
B
A
R2.00
Y’s price
R1.80
R1.80
R5m for Y
R12m for X
R10m each
D
C
R12m for Y
R5m for X
R8m each
Oligopoly
• The breakdown of collusion
• Non-collusive oligopoly: game theory
– alternative strategies
• maximax and maximin
– simple dominant strategy games
• Nash equilibrium
Profits for firms A and B at different prices
X’s price
R2.00
B
A
R2.00
Y’s price
R1.80
R1.80
R5m for Y
R12m for X
R10m each
D
C
R12m for Y
R5m for X
R8m each
Oligopoly
• The breakdown of collusion
• Non-collusive oligopoly: game theory
– alternative strategies
• maximax and maximin
– simple dominant strategy games
• Nash equilibrium
• the prisoners’ dilemma
The prisoners' dilemma
Amanda's alternatives
Not confess
Not
confess
B
A
Each gets
1 year
Nigel's
alternatives C Nigel gets
Confess
Confess
3 months
Amanda gets
10 years
Nigel gets
10 years
Amanda gets
3 months
D
Each gets
3 years
Oligopoly
• The breakdown of collusion
• Non-collusive oligopoly: game theory
– alternative strategies
• maximax and maximin
– simple dominant strategy games
• the prisoners’ dilemma
• Nash equilibrium
– more complex non-dominant strategy games
Oligopoly
• The breakdown of collusion
• Non-collusive oligopoly: game theory
– alternative strategies
• maximax and maximin
– simple dominant strategy games
• the prisoners’ dilemma
• Nash equilibrium
– more complex non-dominant strategy games
– the importance of threats and promises
Oligopoly
• The breakdown of collusion
• Non-collusive oligopoly: game theory
– alternative strategies
• maximax and maximin
– simple dominant strategy games
• the prisoners’ dilemma
• Nash equilibrium
– more complex non-dominant strategy games
– the importance of threats and promises
– the importance of timing of decisions
Oligopoly
• The breakdown of collusion
• Non-collusive oligopoly: game theory
– alternative strategies
• maximax and maximin
– simple dominant strategy games
• the prisoners’ dilemma
• Nash equilibrium
– more complex non-dominant strategy games
– the importance of threats and promises
– the importance of timing of decisions
• decision trees
A decision tree
Airbus
decides
Boeing –R10m
(1)
Airbus –R10m
B1
Boeing +R30m (2)
Airbus +R50m
Boeing
decides A
Boeing +R50m
(3)
Airbus +R30m
B2
Airbus
decides
Boeing –R10m
(4)
Airbus –R10m
Oligopoly
• Non-collusive oligopoly: the kinked demand
curve theory
– assumptions of the model
Kinked demand for a firm under oligopoly
R
Current price
and quantity
give one point
on demand curve
P1
O
Q1
Q
Kinked demand for a firm under oligopoly
R
D
P1
D
O
Q1
Q
Oligopoly
• Non-collusive oligopoly: the kinked demand
curve theory
– assumptions of the model
– stable prices
Stable price under conditions of a kinked demand curve
R
MC2
MC1
P1
a
D = AR
b
O
Q
Q1
MR
Oligopoly
• Non-collusive oligopoly: the kinked demand
curve theory
– assumptions of the model
– stable prices
– limitations of the model
Oligopoly
• Non-collusive oligopoly: the kinked demand
curve theory
– assumptions of the model
– stable prices
– limitations of the model
• Oligopoly and the public interest
Oligopoly
• Non-collusive oligopoly: the kinked demand
curve theory
– assumptions of the model
– stable prices
– limitations of the model
• Oligopoly and the public interest
– advantages
Oligopoly
• Non-collusive oligopoly: the kinked demand
curve theory
– assumptions of the model
– stable prices
– limitations of the model
• Oligopoly and the public interest
– advantages
– disadvantages
Oligopoly
• Non-collusive oligopoly: the kinked demand
curve theory
– assumptions of the model
– stable prices
– limitations of the model
• Oligopoly and the public interest
– advantages
– disadvantages
Price Discrimination
• Meaning of price discrimination
– First degree
– Second degree
– Third degree (the most common form)
Third-degree price discrimination
P
Revenue from
a single price
P1
D
O
200
Q
Third-degree price discrimination
P
Increased revenue
from price
discrimination
A higher
discriminatory
price is now introduced
P2
P1
D
O
150
200
Q
Price Discrimination
• Meaning of price discrimination
– First degree
– Second degree
– Third degree (the most common form)
• Conditions necessary for price discrimination
Price Discrimination
• Meaning of price discrimination
– First degree
– Second degree
– Third degree (the most common form)
• Conditions necessary for price discrimination
• Advantages to the firm
Price Discrimination
• Profit maximising prices and output under
price discrimination
Profit-maximising output under
third degree price discrimination
DX
O
O
MRX
(a) Market X
O
Profit-maximising output under
third degree price discrimination
DY
DX
O
MRY
O
O
MRX
(a) Market X
(b) Market Y
Profit-maximising output under
third degree price discrimination
DY
DX
O
MRY
O
MRT
O
MRX
(a) Market X
(b) Market Y
(c) Total
(markets X + Y)
Profit-maximising output under
third degree price discrimination
MC
DY
DX
O
MRY
O
MRT
O
MRX
(a) Market X
(b) Market Y
(c) Total
(markets X + Y)
Profit-maximising output under
third degree price discrimination
MC
DY
DX
O
MRY
O
O
MRX
(a) Market X
MRT
(b) Market Y
3000
(c) Total
(markets X + Y)
Profit-maximising output under
third degree price discrimination
MC
5
DY
DX
O
MRY
O
O
MRX
(a) Market X
MRT
(b) Market Y
3000
(c) Total
(markets X + Y)
Profit-maximising output under
third degree price discrimination
MC
5
DY
DX
O 1000
MRY
O
O
MRX
(a) Market X
MRT
(b) Market Y
3000
(c) Total
(markets X + Y)
Profit-maximising output under
third degree price discrimination
MC
5
DY
DX
O 1000
MRY
O
MRX
(a) Market X
2000
(b) Market Y
MRT
O
3000
(c) Total
(markets X + Y)
Profit-maximising output under
third degree price discrimination
MC
9
5
DY
DX
O 1000
MRY
O
MRX
(a) Market X
2000
(b) Market Y
MRT
O
3000
(c) Total
(markets X + Y)
Profit-maximising output under
third degree price discrimination
MC
9
7
5
DY
DX
O 1000
MRY
O
MRX
(a) Market X
2000
(b) Market Y
MRT
O
3000
(c) Total
(markets X + Y)
Price Discrimination
• Profit maximising prices and output under
price discrimination
• Price discrimination and the public interest
– competition
Price Discrimination
• Profit maximising prices and output under
price discrimination
• Price discrimination and the public interest
– competition
– profits