4. Amrket structure 1 Flashcards
What is market structure?
refers to the characteristics of a market that may affect the trades
What are the characteristics considered of market structures
The characteristics we consider in this course are: (a) The number and size of sellers
(b) The barriers to entry
(c) The extent of product differentiation (d) The number and size of buyers
Such characteristics may affect the nature of trades in the market
For market structures what are markets?
markets are product markets: firms = sellers, individuals = buyers
What are the two rules for profit maximisation?
Marginal output rule
Shutdown rule
What is the marginal output rule?
Rule for profit max
What is the shutdown rule?
Rule for profit max
What are the assumptions of perfect competition?
A1, Buyers are price takers
A2, Sellers and Buyers have complete information
A3 Sellers are price takers
A4 Entry is free
Describe assumption A1, buyers are price takers
A(1): BUYERS ARE PRICE TAKERS Each buyer takes price as given
They believe that they can buy as much as they want at the going price without having an effect on that price
Reasonable assumption for most product markets, it may not hold in input markets
Describe assumption 2 of PC, sellers and buyers have complete information
A(2): SELLERS & BUYERS HAVE COMPLETE INFORMATION
Sellers are able to respond to incentives
Buyers have the greatest chance to receive what they want from the market
Describe assumption 3, Sellers are price takers
A(3): SELLERS ARE PRICE TAKERS
Each seller believes its output choice will not affect the market price
This has two parts to it:
(a) Sellers can sell as much as it wants, at a given price
(b) Sellers output choice will not trigger a reaction from rivals
Describe assumption 4 of pc , entry is free
A(4): ENTRY IS FREE
A potential seller can enter the market in the long run without incurring costs that an incumbent seller would not incur
Entry is a long-run decision: all factors of production must be able to change Effectively, assumption implies:
(a) sellers are in the market if they have capital, and they can increase their output by employing more labour
(b) a potential seller without any capital cannot produce using labour alone (they have to have capital first)
What do A1 AND A2 OF PC IMPLY?
there are many buyers, who are informed of all prices
What is the size and number of sellers? pc
Many and small, a change in seller’s output has little effect on price if it small relative to total
Describe the barriers to entry in pc
Low- firms must be able to enter the market freely
Describe the product sustainability in pc
Undifferentiated- Buyers consider all products to be identical (homogeneous) so they will buy the cheapest product
When is there an equilbrium in economic models?
economic agents will not change their behaviour from the equilibrium
When is there a short run equilibrium under perfect competition?
There is an equilibrium in a perfectly competitive market when:
(a) sellers produce as much as buyers want to purchase,
(b) buyers purchase as much as sellers choose to produce
What does the short run equilbirum of perfect compeition imply?
This implies that:
(1) The market price is determined by market supply & demand
(2) A seller’s output is determined by seller-specific supply & demand
Short-run equilibrium: first, find a seller’s supply curve
Short-run equilibrium: next, find the market supply curve
Short-run equilibrium: finally, add market demand curve
Why does the pc equilibrium change in the long run?
(1) all factors are variable which has an impact on the seller’s costs (2) other sellers can freely enter the market
What is the third condition of long run pc equilbrium and what does it imply
There is a third condition of equilibrium:
(a) sellers produce as much as buyers want to purchase (b) buyers purchase as much as sellers choose to produce (c) incumbent sellers will not leave the market
potential sellers will not enter the market
All of this implies that:
(1) Sellers make normal profit in the long-run (zero economic profit)
Long run equilbru=ium of pc
Summary notes for perfect competition
Monopoloy
When there is one large seller of a particluar good, legal monopoly = over 25% share of marekt
At its extreme, there is no competition whatsoever in a monopolised market
HWat is a pure monoply
100% share of the market
What are the assumptions for monopolies?
A1- buyers are price taakers
A2- Buyers and sellers have complete information
A3, the monopolist is a price maker
A4 entry is blocked
Describe assumption A3 for a monoply
A(3): THE MONOPOLIST IS A PRICE MAKER
A price maker can influence the price which it sells its output.
This has two parts to it:
(a) A seller sells more when its price is lower: its demand curve slopes downwards
(b) the seller’s output choice does not trigger a reaction from competitors (if there are any)
Describe assumption A4
A(4): ENTRY IS ‘BLOCKED’
A potential seller cannot enter the market. Not even in the long-run.
Barriers can be legal, structural or strategic
What do A1 and A2 imply about the market structure of a monoply?
There are many buyers, who are informed of all prices
Describe the size and numbers of sellers for the market structure of a monopoly
One, large A firm must be large enough to affect price: it is a price maker
Rivals (if any) must be small, otherwise they would respond strategically to the seller’s output choice
Describe the barriers to entry of the market structure of a monoply
high, firms must be unable to enter the market
Describe the product subsitiutiability with regards to the market structure of a monoply
Differntiated-
When the seller is the only one, its product is unique.
That is, it is differentiated so much so that it has no close rivals
What is the equilibrium of a monopoly determined by?
The equilibrium is again determined by the two rules for profit maximisation: (1) the marginal output rule and (2) the shut down rule.
How does the marginal output rule help determine the quuilbrium of a monoply
A pure monopolist’s demand curve is the market’s demand curve So, its demand curve slopes downwards
This is also the average revenue (AR) curve: D = AR = P (price)
How does this affect the marginal revenue curve? To sell another unit, the price has to fall
This has two effects on total revenue (TR):
- The good thing: another unit is sold at price P, so TR increases
- The bad thing: all other units are sold at a slightly lower price, so TR decreases
These two effects imply the marginal revenue curves lies below the demand curve
Diagram to show total revenue and marginal revenue of a monoply
What does producing an extra unit of output in a monopoly do?
- increases the amount of units sold but
- it lowers the price for which all units are sold
Diagram to show revenue curves and elasticity of demand of a monoply
What does it mean if MR is positive in a monoply?
What does it mean if MR is negative in a monoply?
Diagram to show equilbrium under a monoply
Why is a monoply worse than perfect competition?
A monopolist produces less and prices higher than a perfectly competitive market
What is total welfare?
Sum of consumer and producer surplus
What is consumer surplus?
CONSUMER SURPLUS: the sum of the difference between the amount consumers are willing to pay for the good and what they actually pay
What is producer surplus?
PRODUCER SURPLUS: the sum of the difference between the price of a good and what price producers are willing to supply it
How can we quantiyft how much better/ if perfect comeptition is better than a monoply?
If
total welfare is greater under perfect competition than under monopoly
Diagram to show consumer surplus
Diagram to show proudcer surplus
Total welfare under perfect competition
Total welfare under a monoply diagram
Sumary notes for monoploies
What condistions are necesary for profitable price discrimination
C(1): SELLERS MUST BE PRICE MAKERS
C(2): BUYERS MUST DIFFER & SELLERS MUST BE ABLE TO IDENTIFY BUYERS
C(3): CONSUMERS MUST NOT BE ABLE TO PARTICIPATE IN ARBITRAGE
Describe C1 for price discrimination, SELLERS MUST BE PRICE MAKERS
C(1): SELLERS MUST BE PRICE MAKERS
If the seller is a price taker, the market determines the price
Buyers have little choice if the seller has some market power over the buyer
Describe C2 for price discirmination
C(2): BUYERS MUST DIFFER & SELLERS MUST BE ABLE TO IDENTIFY BUYERS
If buyers are identical, then no need to price discriminate!
It may not be possible for a seller to distinguish between Miss Rich and Mr Poor Partial identification maybe possible (i.e. students, OAPs, prior purchases)
Describe C3 for price discrimination, C(3): CONSUMERS MUST NOT BE ABLE TO PARTICIPATE IN ARBITRAGE
C(3): CONSUMERS MUST NOT BE ABLE TO PARTICIPATE IN ARBITRAGE Arbitrage: when buyers, who are charged a low price, purchase the good
then sell it to a buyer who otherwise would have paid a high price For example: Mr Poor could buy 2 units at £20 and sell one to Miss Rich for £39
6
What are the assumptions for price discrimination?
A1- buyers are price takers
A2- buyers have complete infomration- (seller’s information about buyers will vary across examples)
A3-A(3): THE SELLER IS A PURE MONOPOLIST
A(4): ENTRY IS BLOCKED
Describe assumption A3 for price discrimination- The seller is a pure monopolist
A(3): THE SELLER IS A PURE MONOPOLIST
Price discrimination can occur in markets with more than one seller
Focussing on monopoly allows understand the problem without unnecessary complications
Describe assumption A4, entry is blocked for price discrimination
A(4): ENTRY IS BLOCKED
A potential seller cannot enter the market. Not even in the long-run
The analysis does not change between the short- and the long-run
Total welfare under monoply diagram
What is first degree price discrimination/perfect price discrimination?
sellers charge each buyer the maximum price the buyer is willing to pay
This clearly entails charging different prices to different buyers
It may also entail charging the same buyer different prices for each unit
-is unlikely in the real world
How much is produced under first-degree price discrimination?
What does the ability to price discriminate change?
The MR curve
first degree price discrimination diagram
What is total welfare under first degree price discrimination the same as and why?
Under perfect comeptition
All buyers whose willingness to pay is above marginal cost purchase the good So, there is no deadweight loss
What does a monopolist that practices first degree price discrimination produce?
(a) produces the same output as a perfectly competitive seller
(b) produces more than what it would if it couldn’t price discriminate
What is the differnece between monopolist and pefect competiion first degree price discirmination
The difference:
● monopolist charges different prices for each unit sold
● The monopolist extracts all of the gains from trade: no consumer surplus
● a perfectly competitive seller price is equal to marginal cost for all units sold
What is third degree price discrimination
Third-degree price discrimination is where:
a seller can identify different groups of buyers and the prices charged to these groups differ
A) Buyers can be grouped in terms of their characteristics
B) Buyers can also be grouped in terms of the country they live in
What si the difference between thirs degree price discrimination and non-discriminating monoplists?
Subtle difference when marginal costs are increasing in output
Third degree price discrimination diagrams
What does a monopolist that practies third degree price discrimination produce?
A monopolist that practices third-degree price discrimination
a) produces the same output as it would if it did not price discriminate
Main difference of third degree price discrimination?
The main difference:
● Price is lower for buyers with elastic demand
● Consumer surplus is positive
● There is an associated dead weight loss: prices are above marginal cost
What does the price of of a single-price monopolist lie in
lies in between the prices charged to these two groups
Prohibiting price discrimination will benefit some buyers but not others
What is second degree price discrimination?
a seller can use a menu of “non-linear tariffs” in order to get buyers to reveal their preferences when they select their preferred tariff
When are tarrifs linear in second degree price discrimination?
Tariffs are linear when the same price is charged for every unit sold
When are tarriffs non linear in second degree price discrimination?
Tariffs are non-linear when the (average) price per unit changes
Example of linear and non linear tarriffs
Linear tariff: 25p per minute for phone calls
Non-linear tariff: £10 per month and 5p per minute
Diagram for second degree price discrimination
Summary notes for price discrimination
What are the extremes of the competition spectrum?
Perfect competition and monopolies
In reality in terms of compeition, what occurs?
In reality, most firms:
(a) face some competition (as opposed to monopoly)
(b) are not price takers (as opposed to perfect competition)
What is in the middle of th ecompetition spectrum? + examples
Imperfect competition- Examples are monopolistic competition and oligopoly
Monopolisitic competition
There are many sellers that compete with each other to sell their goods & services But each sellers can influence the price they charge for their goods and services
They have this ‘market power’ because:
their products are differentiated, so they are imperfect substitutes for each other
A firm can set a high price without losing all of its customers to low-priced rivals
Why do monopolistically competitve firms have market power?
Because their products are differentiated, so they are imperfect substitutes for each other
Whata re the assumptions for monopolisitc competition?
A1- Buyers are price takes
A2- buyers and sellers have complete information
A(3): SELLERS ARE PRICE MAKERS
A(4): ENTRY IS FREE
Describe the assumption A3, Sellers are price makers for monopolisitc competition
A(3): SELLERS ARE PRICE MAKERS
A price maker can influence the price which it sells its output
This has two parts:
(a) A seller sells more when its price is lower
(b) the seller’s output choice does not trigger a reaction its rivals
Describe the assumption A4- entrey is free, for monopolistic compeition
A(4): ENTRY IS FREE
A potential seller can enter the market in the long run without incurring costs that an incumbent seller would not incur
Entry is a long-run decision: all factors of production must be able to change Notice that we made A(3) for monopoly and A(4) for perfect competition
What do A1 and A2 iply about the market structure?
There are many buyers who are informed of all prices
What is the size and the number of sellers in the monopolistic market strcuture?
Many, small
Sellers will not respond to each others output choices if there are lots in the market (This does not lead to price taking behaviour on its own)
What are the barriers to entry of the monopolistic market structure?
Low- firms must be able to enter the market
What is the product substitutability of the monopolistic compeition market structure?
Undifferentiated-
Buyers may prefer one differentiated product to another
(1) horizontal – same quality, different tastes e.g. Mercedes v Audi (2) vertical – better quality, same tastes e.g. Mercedes v Ford
A seller can raise the price of its product and not lose all of its sales
Its demand curve slopes downward, even when there are many firms in the market
What does sellers being symmetric mean for costs and demand in monopolisitc competition? (short run equilibrium)
For costs: this means their cost curves are the same shape
For demand: it is less realistic but it simplifies things considerably
Why is the demand curve of th eshort run equilbrium under monopolistic competition downards sloping?
Since a seller is a price maker, its demand curve is downward sloping
But its demand curve of is affected by the number of sellers there are in the market Why? The more sellers, the fewer buyers there are to go around
Example of monopolisitc competition
EXAMPLE: Suppose there are 4000 people who regularly frequent 40 pubs
At the market price, each pub would have 100 people (= 4000 people/40 pubs)
Now suppose the number of pubs increased by 10 and the price does not change Each pub would have 80 regulars (i.e. 4000 people/50 pubs)
Incumbents would lose 20 people to entrants, who each attract 80 people
Short run equilbrium under monopolsitic competition diagram
Diagram to show the effect of more sellers under monopilsitc competition
the effect of more sellers under monopilsitc competition
When there are more sellers, there are less buyers to go around, so the seller’s demand curve shifts to the left
What do we need to consider in the long run equilbrium under monopolistic competition?
Long run equilibrium and its effect on the cost curves?
Long run equilibrium and the effect on entry
What are the two main differences between monopolistic competition and perfect comeptition?
Price margin cost and excess capacity
Describe the price - cost margin -difference between monopolisirc and perfect competition
(i) price-cost margin
Monopolistic competition: price is above marginal cost, even in the long run Perfect competition: price equals marginal cost
How is this consistent with the free entry condition?
The zero profit condition requires that price is equal to average total cost
Sellers produce on the downward portion of their average total cost curve, so marginal cost must be below average total costs
Thus, for price equal to average total costs, price must be above marginal cost
Describe the excess capacity -difference between monopolisirc and perfect competition
(ii) excess capacity
A seller’s output is smaller than the level that minimises average total costs This point is called the efficient scale of the firm
At any level of output below the efficient scale, a firm can increase its output and lower its average cost of production
In the long run:
perfectly competitive sellers produce at the efficient scale, monopolistically competitive sellers do not
Thus, firms have excess capacity: they can produce more & lower ATC
Comparision table between perfect comeptition, monopolistic competition and monopolies
Summary of monopolosistc competition
What is game theory used by economists for?
Game theory is used by economists to highlight strategies for maximizing gains/minimising losses within prescribed constraints
It helps us make predictions about how economic agents will behave in certain situations
Game theory models strategic interaction:
“GAME”
In any game, there are decision makers:
“PLAYERS”
Players can make certain choices:
“STRATEGIES”
The best strategy will depend on what they know
“INFORMATION”
And when they can make the decision:
“TIMING”
Strategies determine how well players do:
“PAYOFFS”
Wht are the two convient ways to represent a game?
Extensive form and normal form
