Competition and Market
Structure
Frederick
University
2013
Industry
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Industry (market) – a collection of
firms, each of which is supplying products
that have some degree of substitutability,
to the same potential buyers
Common buyers for sellers
Common sellers for buyers
Relatively homogeneous product
SCP Paradigm
Basic Conditions
Market Structure
Conduct
Performance
BASIC CONDITIONS
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SUPPLY
raw material
technology
product durability
value/weight
business attitudes
unionization
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DEMAND
price elasticity
rate of growth
substitutes
marketing type
purchase method
cyclical and seasonal
character
Market Structure
Market Structure – those characteristics of
the market that significantly affect the
behavior and interaction of buyers and sellers
MARKET STRUCTURE

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number and size of sellers and buyers
type of the product
conditions of entry and exit
transparency of information
Perfect Competition - structure
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Many and small sellers, so that no one
can affect the market
Homogeneous product
Free entry to and exit from the industry
Transparent and free information
Pure Monopoly- market
structure
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Only one producer in the industry
The product does not have close
substitutes
Blocked entry
Monopolistic competition structure
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Many and small sellers
Differentiated product
Free entry and exit
Transparent and free information
Oligopoly – market structure
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A) Tight oligopoly – a few big firms in the
industry with comparable market shares/
B) Dominant firm oligopoly – one of the big
firms in the industry is recognized as the
price leader
Homogeneous / Heterogeneous oligopoly
Significant barriers to entry to and exit from
the industry
Significant barriers to information
Entry
Entry into an industry or to a segment of an industry can
occur because there is
•de novo entry.
•takeover from outside the industry
•the development of technologically similar firms who
develop their product range.
•the transference of brand names across sectors
•an increase in import penetration. Again, the scale of the
firm involved is important here.
Barriers to Entry
Structural barriers

High capital cost

Economies of scale

Product differentiation and brand loyalty

High switching cost

Ownership/control of key factors or outlets
Strategic barriers

Limit pricing

Excess capacity
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Vertical integration
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Sleeping patents
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Predatory pricing

Tying sales
Institutional barriers

Patents

Regulations
Alternative Market Structures

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
Pure
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
Very
Many
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
Pure
Monopoly
Few
One
Restricted
Restricted or
completely
blocked
Unique
Local water
company
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
Very
Many
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
Pure
Monopoly
Few
One
Restricted
Restricted or
completely
blocked
Unique
Local water
company
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
Very
Many
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
Pure
Monopoly
Few
One
Restricted
Restricted or
completely
blocked
Unique
Local water
company
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
Very
Many
Unrestricted
Differentiated
Builders,
convenience
stores
Downward sloping,
but relatively
elastic
Undifferentiated
Cement
or differentiated
cars, electrical
appliances
Downward sloping.
Relatively inelastic
(shape depends on
reactions of rivals)
Oligopoly
Pure
Monopoly
Few
One
Restricted
Restricted or
completely
blocked
Unique
Local water
company
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
Very
Many
Unrestricted
Differentiated
Builders,
convenience
stores
Downward sloping,
but relatively
elastic
Undifferentiated
Cement
or differentiated
cars, electrical
appliances
Downward sloping.
Relatively inelastic
(shape depends on
reactions of rivals)
Oligopoly
Pure
Monopoly
Few
One
Restricted
Restricted or
completely
blocked
Unique
Local water
company
Downward sloping:
more inelastic than
oligopoly. Firm has
considerable
control over price
Market Conduct
Market Conduct – a firm’s policies toward its
market and toward the moves made by its
rivals in that market
CONDUCT
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pricing behavior
product strategy
research and innovation
advertising
legal tactics
Perfect competition - conduct
Industry’s market
P
D
S
Firm’s market
P
5
5
5
q
0
10
P 20
TR
0
50
100
d
MR
Pe
Qe
Q
0
MR
5
5
10
Q 20
Perfect competition – short
run “conduct”
p
MC
AC
dd = MR
Economic profit = (P-AC) q
P = MR
MC = MR
P>AC
q
Q
Perfect Competition – long run
“conduct”
Industry’s equilibrium
P
D
S
If P>AC, new firms start
entering the industry and
the equilibrium price falls.
If Р < АС, the firms will
start leaving the industry
and the equilibrium price
will increase.
Pe
P’
Qe
Q
The industry is in a long run
equilibrium when P = AC
In the long run the firms make
normal profit
Perfect Competition - Deriving the
short-run supply curve
P
S
MC = S
a
P1
P2
b
c
P3
d1 = MR1
d2 = MR2
d3 = MR3
D1
D3
D2
Q (thousands)
Q (millions)
The firm’s short run supply curve is determined by its MC curve above AVC
(a) Industry
fig
(b) Firm
Long-run equilibrium of the firm
(SR)MC
under perfect competition
(SR)AC
LRAC
DL
AR = MR
LRAC = (SR)AC = (SR)MC = MR = AR
Q
Pure Monopoly - conduct
P
MC
D
P
10
9
8
Q
1
2
3
P
TR
10
18
24
MR
10
8
6
P>MR
Economic
AC
Profit
Qm
MC=MR
Q
MR
Pure Monopoly and Perfect competition
P
N
R
Consumer surplus = ∑ (P –MWP)
Under perfect competition = KLNMC
Under pure monopoly = NRT
Producer surplus =
∑ (P-MC)
AC
Under pure monopoly the producer
surplus rises by KGTR at the expen
of the consumer surplus
T
Pm
Pp.c.K
G
L
J
MR
Qm
Qp.c.
GTL – the
portion of the
consumer
surplus,
which is a
deadweight loss
ARthe=society
D
for
JGL – the portion
of the producer
surplus, which is
a deadweight
loss for the
Q
society
Monopolistic competition – conduct in
P>MR
the short run
P
MC
MC = MR
AC
Ps
ACs
AR = D
MR
Qs
Q
Monopolistic competition – conduct in
the long run
If P>AC new firms will enter
P
the industry and the firm’s
market segment will shrink
- its individual demand curve
shifts leftwards
LRMC
LRAC
PL
ARL = DL
MRL
Q
The long run equilibrium
QL is achieved at P = AC, however, АС is not minimized
– there is excess capacity
Long run equilibrium under perfect competition and under
monopolistic competition
P
LRAC
P1
P2
DL under perfect
competition
DL under
monopolistic
competition
Q1
fig
Q2
Q
Tight oligopoly - conduct
P
NFD
FD
Q
P
The kinked demand curve under
the tight oligopoly
NFD
P1
FD
Q
Q1
fig
P
The kinked demand curve
P1
MRnf
a
D = AR
b
Q
Q1
MRf
P
Rigid prices under the tight
oligopoly
MC2
MC1
P1
а
D = AR
b
Q
Q1
MR
Price leadership of the dominant firm
P
Sothers
Dleader
Dindustry
Q
Price
leadership
of
the
dominant
firm
P
MCleader
PL
l
f
Sother firms
t
Dindustry
Dleader
MRleader
QL
QF
QT
Q
Market Performance
Market Performance – how well does an
industry do what society might reasonably
expect it to do
PERFORMANCE

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profitability
allocative efficiency
static production efficiency
dynamic efficiency - progress
full employment
equity
Perfect Competition Performance
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P = MR
MC = MR
P = MC
P = AC
AC = MC
AC minimum
Perfect Competition Performance
Static Efficiency
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
Efficiency in allocation
Efficiency in motivation
Efficiency in distribution
MC = P
AC = MC
AC = P
The Perfect Competition achieves static
efficiency
Dynamic Efficiency
There is NO potential and motivation for innovations and technological progress
The Perfect Competition does not achieve
dynamic efficiency
Pure Monopoly - performance
Static efficiency

Efficiency in allocation
Efficiency in motivation

Efficiency in distribution

MC < P
excess capacity
AC < P
The pure monopoly does not achieve static efficiency
Dynamic efficiency
There is a potential and motivation for innovations and technological progress
The pure monopoly is motivated to achieve dynamic efficiency at
the presence of potential competition
Monopolistic competition performance
Static Efficiency
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Efficiency in allocation
MC < P
Efficiency in motivation excess capacity
Efficiency in distribution
AC = P
Contestable Markets
Key characteristics:
 Firms’ behaviour influenced by the threat of
new entrants to the industry – if even the
industry is concentrated, the incumbent firms
behave as if they are perfect competitors
 Firms’ performance depends on the potential
competition
Contestable markets

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Ultra easy entry
Ultra easy exit
Zero sunk cost
“Hit and run”
strategy”
Contestable market
Oligopoly – non-collusive
behavior
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
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Game theory – the study of multi-person
decision problems (the reactions of a few
interdependent decision makers)
Game - any situation that involves welldefined rules and outcomes, where outcomes
are dependent on players’ strategic decisions
Strategy – a complete plan, specifying the
game under any possible circumstances
The Prisoners’ dilemma
Two suspects, V and G, are arrested by the police. The police
have insufficient evidence for a conviction, and, having
separated both prisoners, visit each of them to offer the
same deal: if one testifies for the prosecution against the
other and the other remains silent, the betrayer gets 3
months and the silent accomplice receives the full 10-year
sentence. If both stay silent, both prisoners are sentenced to
only 1 year in jail for a minor charge. If each betrays the
other, each receives a three-year sentence. Each prisoner
must make the choice of whether to betray the other or to
remain silent. However, neither prisoner knows for sure
what choice the other prisoner will make. So this dilemma
poses the question: How should the prisoners act?
The Prisoners’ dilemma
V’s alternatives
Does not confess
Does not confess
G’s
alterantives
Confesses
Everyone gets
1 year
G3 months
V- 10 years
fig
Confesses
G10 years
V3 months
Everyone gets
3 years
The Prisoners’ dilemma
The Prisoners’ dilemma is the duopoly’s
dilemma. Prisoners cannot coordinate their
confessions. Even though they both would
get less if they do not confess, they betray
the other player, because of the greater
payoff.
No matter what the other player does, one
player will always gain a greater payoff by
playing defect. Since in any situation playing
defect is more beneficial than cooperating, all
rational players will play defect.
Payoffs for firms A и B under different
pricing policies
A’s Price
2.00
2.00
1.80
10mil. for each
5 for В
12 for А
12 for В
5 for А
8 for each
B’s Price
1.80
fig
Collusive behavior


How could the firms overcome the
prisoners’ dilemma?
Collusive behavior will set higher
prices for the buyers!