Managerial Economics- Market Structures

8/14/2019 Managerial Economics- Market Structures

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Market Structures by Prof. Tarun Das 1

Market StructuresProf. Tarun Das,

IILM, New Delhi


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1.1 Different marketstructures

A market is an arrangement through which

buyers and sellers exchange their goods andservices, anything of value.

Market structure is a set of characteristics thatdetermine business environment under whichfirms operate.

Market structure is determined by:

a) Number of sellers and buyers,

b) Degree of product differentiation,

c) Procedures for entry and exit of firms,

d) Degree of contestability and rivalry of firms.


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1.2 Different marketstructures

Markets Number of

sellers

Number of

buyers

Perfectcompetition

Many Many

Monopoly Mono (single) Poly (many)

Duopoly Duo (two) Poly (many)

Oligopoly Oligo (a few) Poly (many)Monopolisticcompetition

A few A few


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2.1 Perfect Competition-Basic characteristics

Many sellers and many buyers.

Perfectly competitive firms are price-takers.They sell homogeneous/standardized product Perfect knowledge of buyers and sellers

about the market.

No restrictions on entry and exit of firms Price is determined by free market forces of

supply and demand. Despite the term competitive, firms do not

contest others and donot act as rivals.

Perfect competition is an utopia- real marketis neither perfect nor competitive.


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2.2 Perfect Competition-Equilibrium Conditions

1. Objective Function- Maximize Profits

= Total Revenue Total Cost= TR TC= PQ TC(Q)

2. First order condition,d /dQ= 0 P-MC=0 P=AR=MR=MC

3.The second order and sufficient condition: 2nd derivative should be negative i.e.

d2 /dQ2 < 0, -d(MC)/dQ 0, i.e. MC must be rising, MC>ATC

4. Break even point:P=MR=ATC= AVC+AFC5. Shut down point: P=MR=AVC


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2.3 Perfect Competition-equilibrium

0

50

100

150

200

1 3 5 7 911

13

15

17

OUTPUT (Q)

COST(Rupees

AVC ATC MC


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2.4 Perfect Competition- assignment-11. A firm with AVC = 10 - 0.03Q + 0.00005Q and

fixed cost Rs.600 operates in a perfectlycompetitive market, and faces a market price ofRs.10 per unit.

(a) Find out the profit-maximizing output and thelevel of profit.

(b) At what market price, will the firm breakeven? And At what market price, will it shutdown? What are levels of loss at these points?

Source: Ch-11, Q-11, p.465, Thomas and Morris.

Answer: pp.726-727, Thomas and Morris.


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2.5 Perfect Competition- assignment-22. A firm with MC = 80 - 0.1Q + 0.0001Q operates

in a perfectly competitive market, and faces amarket price of Rs.75 per unit.

(a) Find out the profit-maximizing output,average cost and the level of profit.

(b) At what other level of output, does MC equalmarket price? Is this output level optimal? Ifnot, why?

Source:Ch-11,Q-12, p.465, Thomas and Morris.

Answer: p.727, Thomas and Morris.


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3.1 Monopoly and MonopolisticCompetition

1. Monopoly- Single Firm but many buyers.

Unlike in the perfect competition, priceis variable and is determined by themonopolist. Entry is restricted.

Equilibrium condition MR = MC

2. Monopolistic Competition- existence oflarge number of small firms supplyingdifferentiated products to manyconsumers. Entry and exit of firms, as inthe case of perfect competition, is free-

only difference is the productdifferentiation.Equilibrium condition MR=MC for all


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3.2 Monopoly and MonopolisticCompetition- Assignment

1. A Monopoly Firm faces the following demand

and average cost functions:Q = 2600 100P + 0.2 Y 500 Pr

AVC = 20 0.07 Q + 0.0001QWhere Q=output, P=Price of the product,

Y=consumers income=Rs.20,000

Pr=Price of related good=Rs.2AVC= Average variable cost.(a) Derive MR and MC functions.(b) Find out optimal level of production, price

and profits.Source:Ch-12, Q-15 and Q-18,pp.512-513,Thomas and Maurice. Answer: pp.729


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4.1 Market power and Lerner Index

1. Market power is the ability of the price-

setting firm to raise their prices withoutloosing their market share.

2. Lerner Index =(P-MC)/P = (P-MR)/P

= [P-P(1+1/Ep)]/P = 1- (1+1/Ep)/P= -1/ Ep

3. Market power varies inversely with priceelasticity of demand, and equals zero

under perfect competition.


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4.2 Determinants of Market power

1. Strong barriers to entry due to

government licensing, investmentand franchise policies.

2. Existence of very large firms witheconomies of scale.

3. Input barriers4. Loyalties to brand names/ trade

marks

5. Consumers lock-in due to largeswitching cost caused by installationand other costs.

6. Network externalities


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5.1 Strategy-Conduct-Performance(SCP) Analysis - Market strategy

of different markets

MarketType

No. offirms

Entry Product

Perfect

competition

Very

large

Free Standard-

ized

Monopoly One Blocked Differen-tiated

Oligopoly Few Impeded Both

Monopolisti

ccom etition

Many Easy Differen-

tiated


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5.2 Strategy-Conduct-Performance(SCP) Analysis Conduct


MarketType

Pricestrategy

Productstrategy

R&D andadvertising

Perfectcompetition

None Independent

None

Monopoly Indepen

dent

Indepen

dent

Light

Oligopoly Independent

Independent

Heavy

Monopolistic

Independent

Independent

Heavy


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5.3 Strategy-Conduct-Performance(SCP) Analysis Performance


MarketType

Profit Technicalefficiency

Progre-ssiveness

Perfectcompetition

Normal Good Good

Monopoly Excessive Poor Poor

Oligopoly Excessive Poor Poor

Mono olisti Fair Good Fair


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5.4 Strategy-Conduct-Performance(SCP) Analysis Performanceand Equilibrium Conditions

MarketType

Equity andemploymen

t

Equilibriumconditions

Perfectcompetition

Good MC=MR=P=AR

Monopoly Poor MC=MR=P(1-1/Ep)

Oligopoly Poor MC=MR for all

Monopolistic

competition

Fair MC=MR=P(1-1/Ep)


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5.5 Critique of SCP Approach

1. The structure-conduct-performance (SCP) approach

argues that behavior and therefore the performance offirms is determined by the industrial structure in whichfirms operate. But, SCP approach has been criticized bymany economists:

(a) Complex Relations- The causality from structure toconduct to performance is not uni-directional and ismuch more complex.

(b) Contestable Markets- SCP emphasizes the role of pricesetting for making profits. But Baumol argues that profitsactually depend on the degree of contestability i.e. theease with which the firms can enter and exit.


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5.5 Critique of SCP Approach

Chicago school (Milton Friedman)- There is no

significant degree of monopoly power. In thelong run, markets will bring competition in theabsence of government intervention.

(d) The Austrian school - Like Chicago school, itcriticizes government intervention as it leads

to non-optimal and inefficient allocation ofresources. But it concludes that monopolypower is a reality and not a bad thing as itencourages cost-effectiveness and innovationsand promotes growth. It says that SCP analysis

is too static.


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5.6 Market Power and SCPApproach- Assignments

1. What is meant by market power? What are thefactors influencing market power? Explain LernerIndex to measure market power. What is the value ofLerner Index for the perfectly competitive market?

2. Provide a structure-conduct-performance (SCP)analysis, in a tabular form, for perfect competition,

monopoly, oligopoly and monopolistic competition.What are the criticisms by Baumol, Chicago schooland Austrian school against the SCP analysis? Do youagree with their views?


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Thank youHave a Good Day

Managerial Economics- Market Structures

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