Alternative Market Structures

• Classifying markets (by degree of competition)

– number of firms
– freedom of entry to industry
• free, restricted or blocked?

– nature of product
• homogeneous or differentiated?

– nature of demand curve

• degree of control the firm has over price
 Alternative Market Structures
• The four market structures
– perfect competition

– monopoly

– monopolistic competition

– oligopoly
Features of the four market structures
 Alternative Market Structures
• The four market structures
– perfect competition

– monopoly

– monopolistic competition

– oligopoly

• Structure → conduct → performance

 Monopoly
• Defining monopoly
– importance of market power
• 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 or outlets
– legal protection
– mergers and takeovers
 Monopoly
• The monopolist's demand curve
– downward sloping
• the greater the market power, the less elastic the
demand curve
– MR below AR
 8 AR and MR curves for a monopoly
Q P
(units) =AR
6 1 (£)
8
2 7
4 3 6
4 5
2
5 4
AR, MR (£)

6 3
7 2
0
1 2 3 4 5 6 7

-2 AR

-4

Quantity
 8 AR and MR curves for a monopoly
Q P TR MR
(units) =AR (£) (£)
6 1 (£)
8 8
6
2 7 14
4
4 3 6 18
2
4 5 20
0
5 4 20
2 -2
AR, MR (£)

6 3 18
-4
7 2 14
0
1 2 3 4 5 6 7

-2 AR

-4

Quantity

MR
 Monopoly
• The monopolist's demand curve
– downward sloping
• the greater the market power, the less elastic the
demand curve
– MR below AR
• Equilibrium price and output
– Equilibrium output, where MC = MR
£ Profit maximisingMCunder monopoly

MR
O Qm Q
 Monopoly
• The monopolist's demand curve
– downward sloping
• the greater the market power, the less elastic the
demand curve
– MR below AR
• Equilibrium price and output
– Equilibrium output, where MC = MR
– Equilibrium price, found from D curve
 Profit maximising under monopoly
£ MC

MR
O Qm Q
£ Profit maximisingMCunder monopoly
AC

AR

AC

AR
MR
O Qm Q
 Monopoly
• The monopolist's demand curve
– downward sloping
• the greater the market power, the less elastic the
demand curve
– MR below AR
• Equilibrium price and output
– Equilibrium output, where MC = MR
– Equilibrium price, found from D curve
• Profit
– Measuring profit
£ Profit maximisingMCunder monopoly
Total profit
AC

AR

AC

AR
MR
O Qm Q
 Monopoly
• The monopolist's demand curve
– downward sloping
• the greater the market power, the less elastic the
demand curve
– MR below AR
• Equilibrium price and output
– Equilibrium output, where MC = MR
– Equilibrium price, found from D curve
• Profit
– Measuring profit
– Supernormal profit can persist in long run
 Monopoly
• Monopoly versus perfect competition
– lower short-run output at a higher price
– supernormal profit not competed away
– costs under monopoly
• lack of competition to drive down costs
• BUT possibility of substantial economies of scale
– innovation and new products
• less incentive to innovate
• BUT greater possibility of innovation through
investing ploughed-back profit
– competition for corporate control
 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
• Monopoly versus perfect competition
– lower short-run output at a higher price
– supernormal profit not competed away
 Monopoly
• Monopoly versus perfect competition
– lower short-run output at a higher price
– supernormal profit not competed away
– costs under monopoly
• lack of competition to drive down costs
• BUT possibility of substantial economies of scale
 Monopoly
• Monopoly versus perfect competition
– lower short-run output at a higher price
– supernormal profit not competed away
– costs under monopoly
• lack of competition to drive down costs
• BUT possibility of substantial economies of scale
– innovation and new products
• less incentive to innovate
• BUT greater possibility of innovation through
investing ploughed-back profit
 Monopoly
• Monopoly versus perfect competition
– lower short-run output at a higher price
– supernormal profit not competed away
– costs under monopoly
• lack of competition to drive down costs
• BUT possibility of substantial economies of scale
– innovation and new products
• less incentive to innovate
• BUT greater possibility of innovation through
investing ploughed-back profit
– competition for corporate control
 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
 Oligopoly
• Collusive oligopoly (cont.)
– tacit collusion
• price leadership
• rules of thumb
– factors favouring collusion
• few firms which are open with each other
• similar cost structures
• similar products
• there is a dominant firm
• significant barriers to entry
• stable market conditions
• no government measures to curb collusion
 Oligopoly
• The breakdown of collusion
• Non-collusive oligopoly: game theory
– alternative strategies
• optimistic or cautious approach?
– 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
• optimistic or cautious approach?
– 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
• Non-collusive oligopoly: game theory
– alternative strategies
• optimistic or cautious approach?
– simple dominant strategy games
• Nash equilibrium
• the prisoners’ dilemma
 Oligopoly
• Non-collusive oligopoly: game theory
– alternative strategies
• optimistic or cautious approach?
– simple dominant strategy games
• Nash equilibrium
• the prisoners’ dilemma
– more complex non-dominant strategy games
 Oligopoly
• Non-collusive oligopoly: game theory
– alternative strategies
• optimistic or cautious approach?
– simple dominant strategy games
• Nash equilibrium
• the prisoners’ dilemma
– more complex non-dominant strategy games
– the importance of threats and promises
 Oligopoly
• Non-collusive oligopoly: game theory
– alternative strategies
• optimistic or cautious approach?
– simple dominant strategy games
• Nash equilibrium
• the prisoners’ dilemma
– more complex non-dominant strategy games
– the importance of threats and promises
• are threats seen by rivals as credible?
 Oligopoly
• Non-collusive oligopoly: game theory
– alternative strategies
• optimistic or cautious approach?
– simple dominant strategy games
• Nash equilibrium
• the prisoners’ dilemma
– more complex non-dominant strategy games
– the importance of threats and promises
• are threats seen by rivals as credible?
– the importance of timing
 Oligopoly
• Non-collusive oligopoly: game theory
– alternative strategies
• optimistic or cautious approach?
– simple dominant strategy games
• Nash equilibrium
• the prisoners’ dilemma
– more complex non-dominant strategy games
– the importance of threats and promises
• are threats seen by rivals as credible?
– the importance of timing
• decision trees
 A decision tree

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

Airbus +£50m
0
50

Boeing
decides A 40
0s Boeing +£50m
ea a ter (3)
te s e Airbus +£30m
r 50 0
B2 400
sea
Airbus t er
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 consumer

 Oligopoly
• Non-collusive oligopoly: the kinked
demand curve theory
– assumptions of the model
– stable prices
– limitations of the model

• Oligopoly and the consumer

– advantages
 Oligopoly
• Non-collusive oligopoly: the kinked demand
curve theory
– assumptions of the model
– stable prices
– limitations of the model

• Oligopoly and the consumer

– advantages
– disadvantages
 Oligopoly
• Non-collusive oligopoly: the kinked demand curve
theory
– assumptions of the model
– stable prices
– limitations of the model
• Oligopoly and the consumer
– advantages
– disadvantages
– difficulties in drawing general conclusions
 Alternative Aims to Profit
Maximisation
• Alternative aims
– separation of ownership and control
– the principal–agent problem
– managerial utility maximisation
– profit satisficing
• Sales revenue maximisation (short run)
– equilibrium output and price
• comparisons with short-run profit maximising
• implications for advertising
 Sales revenue maximising price and
£
output
MC

Profit-maximising
price and output
P1

AR

O Q1 Q
MR
 Sales revenue maximising price and
£
output
MC

Sales revenue
maximising
P1 price and output

P2

AR

O Q1 Q2 Q
MR
 Alternative Aims to Profit
Maximisation
• Alternative aims
– separation of ownership and control
– the principal–agent problem
– managerial utility maximisation
– profit satisficing
• Sales revenue maximisation (short run)
– equilibrium output and price
• comparisons with short-run profit maximising
• implications for advertising
– implications for the consumer
 Alternative Aims to Profit
Maximisation
• Growth maximisation
– measuring ‘growth’
– equilibrium for growth maximising firm?
• Multiple aims
– satisficing and the setting of targets
• different stakeholders with different aims
• various possible targets
• potential conflicts between targets
– organisational slack
• a way of reconciling conflicting aims?
• cutting slack with 'just-in-time' methods
 Pricing in Practice
• Do firms know their costs and revenues?
– difficulties in identifying the profit-maximising
price and output
– difficulties in predicting rivals’ behaviour
• Cost-based pricing
– the use of a profit mark-up on AC
• choosing the level of output
• choosing the mark-up
Choosing
£ the output and profit mark-up

P1
f

AC
P2 h
g
j

O Q1 Q2 Q
 Pricing in Practice
• Do firms know their costs and revenues?
– difficulties in identifying the profit-maximising price and
output
– difficulties in predicting rivals’ behaviour
• Cost-based pricing
– the use of a profit mark-up on AC
• choosing the level of output
• choosing the mark-up
• equilibrium price and output?
 Pricing in Practice
• Do firms know their costs and revenues?
– difficulties in identifying the profit-maximising price
and output
– difficulties in predicting rivals’ behaviour
• Cost-based pricing
– the use of a profit mark-up on AC
• choosing the level of output
• choosing the mark-up
• equilibrium price and output?
– variations in the mark-up
 Pricing in Practice
• Price discrimination
– meaning of price discrimination
• charging different prices to different consumers for
reasons unrelated to costs

• the prices depend on price elasticity of demand

 P Price discrimination

P1

O 200 Q
 P Price discrimination

P2

P1

O 150 200 Q
 Pricing in Practice
• Price discrimination (cont.)
– conditions for price discrimination
• firm must be able to set its price

• markets must be separate

• demand elasticity must differ between markets

– advantages to the firm

• higher profits

• possibility of cross-subsidisation
 Pricing in Practice
• Pricing and the product life cycle

– the four stages

• launch

• growth

• maturity

• decline

– competition and pricing in each stage

 The stages in a product’s life cycle
Sales per period

O Time
 The stages in a product’s life cycle
Product not
becoming
obsolete
Sales per period

Product
becoming
obsolete

O (1) (4) Time

(2) (3)
Launch Growth Maturity Decline