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
Features of the four market structures
Features of the four market structures
Features of the four market structures
Features of the four market structures
Features of the four 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
• 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 £
S MC AC

D = AR
Pe AR
AC = MR

D
O O Qe
Q (millions) Q (thousands)

(a) Industry (b) Firm

 Loss minimising under perfect competition

P £ AC
S MC

AC
D1 = AR1
P1 AR1
= MR1

D
O O Qe
Q (millions) Q (thousands)

(a) Industry (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 S £
MC = S
a D1 = MR1
P1
b D2 = MR2
P2
c D3 = MR3
P3
D1
D2
D3
O O
Q (millions) Q (thousands)

(a) Industry (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 £
S1
Se

LRAC
P1 AR1 D1
PL ARL DL

D
O O QL
Q (millions) Q (thousands)

(a) Industry (b) Firm

Long-run equilibrium of the firm under perfect competition
£ (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
– intimidation
 Monopoly

• The monopolist’s demand curve

– downward sloping
– MR below AR
• Equilibrium price and output
– Equilibrium output, where MC = MR
 Profit maximising under monopoly
£ 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
£ 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
£ 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
– Supernormal profit can persist in long run
 Monopoly

• Disadvantages of monopoly
– high prices / low output: short run
Equilibrium of industry under perfect competition and
monopoly: with the same MC curve
£ MC

Monopoly
P1

AR = D

MR
O Q1 Q
Equilibrium of industry under perfect competition and
monopoly: with the same MC curve
£ MC ( = supply under
perfect competition)

Comparison with
P1 Perfect competition

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
£

MCmonopoly

P1

AR = D

MR
O Q1 Q
Equilibrium of industry under perfect competition and
monopoly: with different MC curves
£ 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
– high profits encourage risk taking
 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
£ 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
£

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
£

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
£

Industry D = AR

O Q
 Profit-maximising cartel
£

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

– allocating and enforcing quotas

$ per barrel
Oil prices
Actual price
35
Iraq invades Impending
Iran OPEC’s first war
30 quotas with Iraq

Iraq invades
Revolution Kuwait
25 World-wide
in Iran recovery

20 First oil from

North Sea
World-wide
15 slowdown
Cease-fire in New OPEC
10 Iran-Iraq war quotas Recession
in Far East
Yom Kippur
5 War: Arab oil
embargo

0
70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02
$ per barrel
Oil prices Actual price
Cost in 1973 prices
35
Iraq invades Impending
Iran OPEC’s first war
30 quotas with Iraq

Iraq invades
Revolution Kuwait
25 World-wide
in Iran recovery

20 First oil from

North Sea
World-wide
15 slowdown
Cease-fire in New OPEC
10 Iran-Iraq war quotas Recession
in Far East
Yom Kippur
5 War: Arab oil
embargo

0
70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02
 Oligopoly
• Tacit collusion
– price leadership: dominant firm
Price leader aiming to maximise profits for a given market share
£
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
£

MC

l t
PL
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
£2.00 £1.80

A B
£2.00 £10m each £5m for Y
£12m for X
Y’s price
C D
£1.80 £12m for Y £8m each
£5m for X
 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
£2.00 £1.80

A B
£2.00 £10m each £5m for Y
£12m for X
Y’s price
C D
£1.80 £12m for Y £8m each
£5m for X
 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 Confess

Not
A B Nigel gets
Each gets 10 years
confess Amanda gets
1 year
Nigel's 3 months
alternatives C Nigel gets D
3 months Each gets
Confess 3 years
Amanda gets
10 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

r Boeing –£10m
(1)
ate Airbus –£10m
Airbus 00 se
5
decides
B1 400
sea
r ter Boeing +£30m (2)
a te
se

Airbus +£50m
0
50

Boeing
decides A 40
0s Boeing +£50m
ea ate
r (3)
te s e Airbus +£30m
r 5 0 0

B2 400
sea
Airbus ter
decides Boeing –£10m
Airbus –£10m
(4)
 Oligopoly
• Non-collusive oligopoly: the kinked
demand curve theory
– assumptions of the model
 Kinked demand for a firm under oligopoly
£

Current price
and quantity
give one point
on demand curve
P1

O Q1 Q
 Kinked demand for a firm under oligopoly
£

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
£

MC2

P1 MC1

a
D = AR
b

O Q1 Q
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
– difficulties in drawing general conclusions
 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

O 200 Q
 Third-degree price discrimination
P
Increased revenue
from price
discrimination
A higher discriminatory
P2 price is now introduced

P1

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 O
MRX

(a) Market X
 Profit-maximising output under
third degree price discrimination

DY
DX MRY
O O O
MRX

(a) Market X (b) Market Y

 Profit-maximising output under
third degree price discrimination

DY
DX MRY MRT
O O O
MRX

(a) Market X (b) Market Y (c) Total

(markets X + Y)
 Profit-maximising output under
third degree price discrimination

MC

DY
DX MRY MRT
O O O
MRX

(a) Market X (b) Market Y (c) Total

(markets X + Y)
 Profit-maximising output under
third degree price discrimination

MC

DY
DX MRY MRT
O O O 3000
MRX

(a) Market X (b) Market Y (c) Total

(markets X + Y)
 Profit-maximising output under
third degree price discrimination

MC

5
DY
DX MRY MRT
O O O 3000
MRX

(a) Market X (b) Market Y (c) Total

(markets X + Y)
 Profit-maximising output under
third degree price discrimination

MC

5
DY
DX MRY MRT
O 1000 O O 3000
MRX

(a) Market X (b) Market Y (c) Total

(markets X + Y)
 Profit-maximising output under
third degree price discrimination

MC

5
DY
DX MRY MRT
O 1000 O 2000 O 3000
MRX

(a) Market X (b) Market Y (c) Total

(markets X + Y)
 Profit-maximising output under
third degree price discrimination

MC

5
DY
DX MRY MRT
O 1000 O 2000 O 3000
MRX

(a) Market X (b) Market Y (c) Total

(markets X + Y)
 Profit-maximising output under
third degree price discrimination

MC

9
7
5
DY
DX MRY MRT
O 1000 O 2000 O 3000
MRX

(a) Market X (b) Market Y (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