Market Structure &amp Competition

ECW2731 Weeks 7 & 8
Weeks 7 & 8
Competition, market structures and business decisions
Examination structure
ECW2731 Weeks 7 & 8
1. Exam duration
120 minutes writing time
2. Reading time
3. Total number of questions 5
10 minutes
4. Students must attempt all questions 5. Use of calculators is permitted
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. (Problem solving)

Q 1-4
No questions just on definitions. All the questions are problem solving You must include the most relevant definitions as well diagrams where appropriate. Brief verbal explanation should complement you numeric solution.
Section 2. (Research Question)

"Further reforming of the Australian taxation system is back on the agenda. In particular, different approaches to the restructuring of personal tax rates are currently being debated in the media. Some advocate tax reduction targeting low to medium income earners. Others say that the top tax margin should be reduced because the gap between the corporate and personal tax rate is too high. High taxes are a reason for tax minimisation schemes." Using relevant elements of economic theory, discuss how each of the approaches may affect companies operating in Australia in the following industries: Car manufacturing; and Food
ECW2731 Weeks 7 & 8
Structure
Weeks 7-8 Competition, market structures and business decisions Week 9 Pricing strategies and practices Week 10 Business and Government.
Weeks 5 - 6 Production and Costs
Weeks 3-4 Demand analysis and estimation Week 2 Basic economics principles: demand and supply.
Week 11 Capital budgeting
Managerial Economics
Week. 12 Research question Business and current economic situation.
Week1 Introduction. The nature of managerial economic decision making
ECW2731 Weeks 7 & 8
Competition, market structures and business decisions 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.

ECW2731 Weeks 7 & 8
Reading
Mansfield, Chapters 11 & 12

ECW2731 Weeks 7 & 8
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

ECW2731 Weeks 7 & 8
Market structures
What is the market structure?

The firm in competitive markets Non-perfect competition
Perfect competition
Monopoly Oligopoly Monopolistic competition
Competition, market structures and business decisions Perfect competition Market structures ECW2731
Weeks 7 & 8
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
Weeks 7 & 8
The Firm Supply Curve

The short-run supply curve corresponds with the portion of the marginal cost curve Cost and revenue per unit ($) that lies above the average cost curve. In a perfectly competitive market, Where P<AC losses can be reduced by expanding production so long as added revenues exceed added costs
LRMC
LRAC
Weeks 7 & 8
The Industry Supply Curve

The sum of quantities that individual firms supply at each price The sum of marginal cost curves of individual firms above their average variable cost curves
Price per unit ($) 10 Supply
8
6 4 2
50 100 150 200 250 300 350 400 Quantity per time period (millions)
Weeks 7 & 8
Market price determination
Price per unit ($) 10
Supply
Negatively sloped demand curve

Positively sloped supply curve
8 6 4
P = $0.254 + $0.000025 Q
P = $40 $0.0001 Q 2 Demand 0 50 100 150 200 250 300 350 400 Quantity per time period (millions)
Weeks 7 & 8
Demand Curve for a single firm

Horizontal
Competitive firm price taker
Price per unit ($) 10 8 6
Demand
4
2 0 50 100 150 Quantity per time period (000)
Weeks 7 & 8
Optimal price/output decision in the short run
Cost and revenue per unit ($)

LRMC LRAC M P = AR = MR
P C
Q * Output per time period
Weeks 7 & 8
Optimal price/output decision in the long run Cost and revenue per unit ($) LRMC
LRAC
P = AR = MR
Q* Output per time period
Weeks 7 & 8
Breakeven point Price, cost per unit ($) MC ATC 2.00 D AVC
1.40 1.25 1.00
100 Output per time period
Competition, market structures and business decisions Monopoly Market structures ECW2731
Weeks 7 & 8
Basic Assumptions One firm in industry Profit-maximiser Faces market supply curve One product
No close substitutes
Price-maker No restrictions on resources
Weeks 7 & 8
Price-makers demand curve

Price per unit ($)
12 10 8 6 4 2 0 50 100 150 Quantity per time period 200 Demand
Weeks 7 & 8
P, Cost
MC
Produces the quantity maximising profit (P>AC) revenue Makes economic profit Restricts information Imposes barriers to entry (controlling markets, inputs and/or lobbing the government)
AC Operates at a price above marginal
MR
Competition, market structures and business decisions In the real life Market structures ECW2731
Weeks 7 & 8
A real competitive firm (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
Competition, market structures and business decisions ligopoly Market structures ECW2731
Weeks 7 & 8
Element of the theory relevant to this subject An oligopolistic industry is composed of a few firms selling identical or similar products in the same market Each firm carefully watches decisions of competitors and often plans anti-strategies; they either ignore each other
or form cartels
or a price leader appears, causing monopolistic price formation Elements of non-profit maximisation appear. A salesrevenue producers more than a profit maximiser and charges a lower price.

ECW2731 Weeks 7 & 8
Market structures
onopolistic competition
Neoclassical view
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.

ECW2731 Weeks 7 & 8
Market structures
Price Costs
MC
AC
Pmc
MR
Demand
Qmc
Quantity
Short-run quantity, price and economic profit

ECW2731 Weeks 7 & 8
Market structures
Price Costs
MC
AC
Price Costs
MC
AC
Pmc
D2
MR2 MR1
D1 MR
D Qmc Quantity
Quantity
Entry of new firms offering product substitutes shifts the demand and MR curves)
Long-run equilibrium same costs, lower demand and excess capacity low output high price decision

ECW2731 Weeks 7 & 8
Market structures
Price Costs
MC
AC
Price Costs
MC
AC
Pm Pacc
D2
MR2 MR1
D1
MR Qmc Qac
D
Quantity
Quantity
Long-run equilibrium high output low price decision (corresponds to perfect Competition)

ECW2731 Weeks 7 & 8
Market structures
onopolistic competition contemporary view
Neoclassical monopolistic competition
versus
Monopolistic competition in High-Tech product markets
Cost functions are identical across firms Non-zero marginal costs Perfect availability of the technology used in the production of all product variants
the firms are characterised by different cost functions Relatively low marginal costs Each portion of cuttingedge technological information does not spill over immediately

ECW2731 Weeks 7 & 8
Market structures
Cutting-edge technology does not spill over immediately For the time, each firm possesses some unique productattributable elements of otherwise common technology
These unique elements make the product variants different

The differences are viewed by the buyers as differences in quality characteristics
We assume the simplest case:

all the quality characteristics of each product can be aggregated into a scalar quality characteristic
Increase quality generates increase in consumer demand. Increase in quality can be achieved by a firm only through increase in the cost of the first copy Each firm is characterised by its cost elasticity of quality

ECW2731 Weeks 7 & 8
Market structures
Consumer
Aiming at increase in profit, High Tech firm struggles for consumer demand investing in the quality of its product. Increase in quality is associated with increase in costs.
IT firm IT firm
IT firm
IT firm
High Tech Firm
The firm sets the price to cover the costs and earn profit, depending on anticipated demand Increase in quality causes increase in quantity demanded
Increase in price causes decrease in quantity demanded

ECW2731 Weeks 7 & 8
Market structures
To ensure economic profit, relative increase in demand, associated with increase in quality per unit of relative increase in cost should not be offset by relative decrease in demand per unit of relative increase in price; and
Otherwise, the firm is not competitive.

ECW2731 Weeks 7 & 8
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.

ECW2731 Weeks 7 & 8
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

ECW2731 Weeks 7 & 8
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 A university bookshop The rice market in Japan etc
Access to a unique market


ECW2731 Weeks 7 & 8
Non-price competition. 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

ECW2731 Weeks 7 & 8
Non-price competition. Product differentiation
A simple model of the reason for product differentiation Price

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
P*
Quantity

ECW2731 Weeks 7 & 8
Non-price competition. Barriers to entry
Price
Absolute cost advantages: Ability of established firms to produce any given level of output at lower unit costs than potential entrants
P* P
LAC*
LAC
Q* Q
Quantity

ECW2731 Weeks 7 & 8
Economies of scale:
Price LAC
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
P D
Q*
Quantity

ECW2731 Weeks 7 & 8
Product differentiation advantages:
Price LAC
Variety of demand curves and common LAC.

Some firms have advantage of technology or specialisation and are facing demand curves to the right of the critical one.
P*
D1
D2
D2 Q* Quantity

ECW2731 Weeks 7 & 8
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 managers remuneration * Banks and retailers would prefer to deal with firms increasing the volume of sales

ECW2731 Weeks 7 & 8
P, Cost
MC
AC
MR
D Q
Profit maximising decision

ECW2731 Weeks 7 & 8
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

ECW2731 Weeks 7 & 8
P, Cost
MC
AC
MR
D Q

ECW2731 Weeks 7 & 8
P, Cost
MC
Old sales maximising decision is a profit maximising decision at a new level of average cost
AC
MR
D Q
Old profit maximising decision
New profit maximising decision

ECW2731 Weeks 7 & 8
Measurement of market structures 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

ECW2731 Weeks 7 & 8
The Australian Bureau of Statistics
8140.0.55.001 Industry Concentration Statistics

ECW2731 Weeks 7 & 8
C2542 - Paint Manufacturing in Australia

KEY COMPETITORS (www.ibisworld.com.au/static/iwabout/SamIndPart.asp)
MAJOR PLAYERS
Table: Market Share Major Player
Market Share Range
Orica Limited 22.00% - 25.00% (2004) Wattyl Limited 17.00% - 19.00% (2004) Barloworld Australia Pty Limited 9.00% - 11.00% (2004)
Akzo Nobel Industries Limited
7.00% - 9.00% (2003)

ECW2731 Weeks 7 & 8
T e firm in th in u try a s rte h s e d s re o d a c rd g to th s e o th ir o tp t. c o in e iz f e u u X i - th o tp t o th firm e u u f e X

X i X
th o tp t o in u try e u u f d s
- th s a o th firmin th in u try e h re f e e d s o tp t u u T e ra h tio o r la e t firm in th in u try f g s s e d s o tp t u u

X X X X C i 1 2 r ... r X X X i 1 X
r

ECW2731 Weeks 7 & 8
Diagrammatic approach 100%

Cumulative % of output The curve of real (not equal distribution The curve of equal distribution of shares of the market among firms This distance measures concentration
No of firms cumulated from the largest

ECW2731 Weeks 7 & 8
Multinational companies. Vertical and horizontal coordination.
Diversification
Vertical coordination
Multinational company

ECW2731 Weeks 7 & 8
Multinational companies. Vertical and horizontal coordination. 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

ECW2731 Weeks 7 & 8
Multinational companies. Vertical and horizontal coordination. Vertical coordination

ECW2731 Weeks 7 & 8
Invest in production facilities or buys shares of or coordinate activities with a firm producing an input D

ECW2731 Weeks 7 & 8
Invest in facilities or buys shares of or coordinate activities with a firm providing professional training for employees

ECW2731 Weeks 7 & 8
Invest in production facilities or buys shares of or coordinate activities with a firm using A as an input A firm X producing a good A

ECW2731 Weeks 7 & 8
Invest in production facilities or buys shares of or coordinate activities with a firm using A as an input A firm X producing a good A
Invest in or buys shares of or coordinate activities with a firm specialising in the selling of product A

ECW2731 Weeks 7 & 8
Multinational companies. Vertical and horizontal coordination. Multinational company
Undertake vertical coordination measures abroad

A firm producing a good A in a home country Conduct diversification practices abroad
Establishes branches in other countries
Buys share of analogous firms in other countries

Market Structure &amp Competition

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ECW2731 Weeks 7 & 8

Competition, market structures and business decisions

120 minutes writing time

4. Students must attempt all questions 5. Use of calculators is permitted

Section 1. (Problem solving)

Section 2. (Research Question)

ECW2731 Weeks 7 & 8

Weeks 5 - 6 Production and Costs

Week 11 Capital budgeting

Week1 Introduction. The nature of managerial economic decision making

ECW2731 Weeks 7 & 8

Competition, market structures and business decisions Learning objectives

Competition, market structures and business decisions

Mansfield, Chapters 11 & 12

Competition, market structures and business decisions

What is the market structure?

Competition, market structures and business decisions

What is the market structure?

Monopoly Oligopoly Monopolistic competition

The Firm Supply Curve

The Industry Supply Curve

Price per unit ($) 10 Supply

Market price determination

Price per unit ($) 10

Negatively sloped demand curve

Demand Curve for a single firm

Competitive firm price taker

Price per unit ($) 10 8 6

Optimal price/output decision in the short run

Cost and revenue per unit ($)

Q * Output per time period

Q* Output per time period

1.40 1.25 1.00

100 Output per time period

Price-makers demand curve

12 10 8 6 4 2 0 50 100 150 Quantity per time period 200 Demand

AC Operates at a price above marginal

A real competitive firm (compare to the ideal one):

Competition, market structures and business decisions

Competition, market structures and business decisions

Short-run quantity, price and economic profit

Competition, market structures and business decisions

Competition, market structures and business decisions

Competition, market structures and business decisions

onopolistic competition contemporary view

Neoclassical monopolistic competition

Monopolistic competition in High-Tech product markets

Competition, market structures and business decisions

onopolistic competition contemporary view

These unique elements make the product variants different

We assume the simplest case:

Competition, market structures and business decisions

onopolistic competition contemporary view

High Tech Firm

Competition, market structures and business decisions

onopolistic competition contemporary view

Otherwise, the firm is not competitive.

Competition, market structures and business decisions

Competitive strategies in Imperfectly competitive markets

Competition, market structures and business decisions

Competitive strategies in Imperfectly competitive markets

Competition, market structures and business decisions