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Alternative Market Structures: - Classifying Markets (By Degree of Competition)
Alternative Market Structures: - Classifying Markets (By Degree of Competition)
– nature of product
• homogeneous or differentiated?
– monopoly
– monopolistic competition
– oligopoly
Features of the four market structures
Alternative Market Structures
• The four market structures
– perfect competition
– monopoly
– monopolistic competition
– oligopoly
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
• 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
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
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
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
• possibility of cross-subsidisation
Pricing in Practice
• Pricing and the product life cycle
• launch
• growth
• maturity
• decline
O Time
The stages in a product’s life cycle
Product not
becoming
obsolete
Sales per period
Product
becoming
obsolete