Lecture 10 Markets with market power. Four idealized types of market structure Perfect competition:...
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Transcript of Lecture 10 Markets with market power. Four idealized types of market structure Perfect competition:...
Lecture 10
Markets with market power
Four idealized types of market structure
• Perfect competition: many sellers; they are selling an identical product
• Pure monopoly: only one seller
• Monopolistic competition: many sellers, selling slightly different goods/services
• Oligopoly: only a few sellers; each needs to watch what the others are doing
Pure monopoly
• Conditions:– There is only one seller– The good has no close substitutes– Barriers to entry prevent other firms from starting to
produce the good
• Barriers to entry: economic, legal, or deliberate obstacles that keep new sellers from entering a market
Pure monopoly: Barriers to entry
• Economic barriers: related with the production technology (high fixed costs, economies of scale, network externalities. Ex: natural monopoly)
• Legal barriers: copy rights, franchises, patents, trademarks
• Deliberate barriers: physical, financial, and political intimidation of potential competitors. Many are illegal (Ex: predatory pricing, dumping, exclusionary practices)
Pure monopoly: Profit maximization
DemandA
BC
-10
-20
0
10
2012
2830
40
50
MC
MR
987654321
Quantity
Co
st a
nd
Pri
ce (
$)
Pure monopoly: Profit maximization
Demand
ATC
Economic Profit
Total Cost
Quantity of Hair Dryers
-10
-20
0
10
20
30
40
50
MC
MR
987654321Co
st a
nd
Pric
e (
$)
Pure monopoly and inefficiency
Quantity
Demand
MC
ConsumerSurplus
Transfer
ProducerSurplus
QEQM
DeadweightLoss
PM
Pri
ce
PE C
B
Can monopoly be efficient?
In some cases, the efficiency cost of monopoly may not be as bad as the previous analysis suggests:
•Natural monopoly: A single big firm may sometimes be socially preferable compared to many small ones.•Intellectual property: Firms may need a period of exclusive, high profits in order to cover the costs of research and development•When there is some pressure to appear competitive, monopolies may tend to reduce the price and increase the quantity that it produces•Perfect price discrimination: A monopolist able to charge different prices to its customers based on their willingness to pay would be efficient.
Can monopoly be efficient?
Quantity
Demand
Qall buyersQA
PA
PB
PC
Pric
e
P
Price discrimination: A seller charging different prices to different buyers, depending on their ability and willingness to pay
Quantity
Demand
MC
ProducerSurplus
QE
Pri
ce
PE
Perfectly price discriminating monopolist: an extreme form of price discrimination
Monopolistic competition
• Conditions:– Many sellers and buyers– The sellers produce slightly different products
(product differentiation)– Sellers can freely enter and exit– Buyers have perfect information
Monopolistic competition: Profit maximization
MC
D2
D1
MR1
MR2
Quantity
Pri
c
Monopolistic competition: Long-run efficiency
MC
ATC
DemandMR
Quantity
Total Cost =Total Revenue
A
B
Co
st a
nd
Pri
ce (
$)
Oligopoly
• Conditions:– Only a few sellers control the market– Entry is difficult
• Concentration ratio: The share of total production, sales, or revenues attributable to
the largest firms in an industry (usually the share of the largest four firms)
Examples (from year 2002):
Car and light-truck manufacturing in the US: 88.1%
Breakfast cereal manufacturing: 78.4%
Credit card issuing financial firms: 75.8%
Oligopoly: Behavior of firms
• The behavior of oligopolistic firms is interdependent; marginal thinking that we used so far not applicable anymore
• Therefore, game theory needed to analyze the behavior of oligopolistic firms (due to strategic interaction between firms)
Oligopoly: An example with a DuopolyF
irm 1
’s O
ptio
ns
Low Price High Price
Firm 2’s Options
low profit
low profit
moderate profit
moderate profit
loss
loss
high profit
high profit
High Price
Low Price
Assume that the firms are non-cooperative: They are rivals and do not communicate or cooperate with each other
This payoff matrix shows possible outcomes for each of the two players, depending on the strategy each one chooses
Oligopoly: Collusion, cartels, etc.
• Collusion: Cooperation among potential rivals to gain market power as a group
• Cartel: explicit collusion (Example: OPEC)
• Tacit collusion: collusion that takes place without creation of a cartel (without a formal organization)
• Price leadership: a form of collusion in which many sellers follow the price changes instituted by one particular seller
Oligopoly: Efficiency?
• Inefficient like pure monopoly
• Maybe even worse sometimes:
Because no possibility of reaping advantages of economies of scale
Summary: 4 types of idealized market structures