Lecture 2 - SCP Paradigm and Market Concentration Flashcards
What is the SCP paradigm
An analytical framework for the analysis of a given industry
- Emphasises The links between market structure and business conduct in determining market performance
- J.S. Bain (1950’s - 1960’s) with Mason we’re among the first to model this relationship
- Harvard school of thought
What consists of market structure part of the SCP paradigm
- Number and size of firms
- Market shares/concentration
- Vertical integration
- Entry and exit conditions
What consists of conduct of firms as part of SCP paradigm
- Pricing strategies
- Production strategies
- Product choice
- Collusion
- R&D
- Advertising
What consists of performance as part of the SCP paradigm
- Market power
- Profit rates
- Growth
- Technological progress
- Static efficiency
- Dynamic efficiency
What does causal relationship between SCP mean
Structure affects conduct and conduct affects performance
- E.g. small number of firms in the market (structure), more incentives for collusion (conduct), high market power and low efficiency (performance)
What’s market power and what is wrong with it
The firms ability to price profitably above marginal cost
- For the firm it makes higher profits so there’s nothing wrong however wealth transfers from consumers to firms, Inefficiencies (allocative and productive inefficiency)
What’s the key indicator of market power in SCP
Structure, its embodied in the size distribution of firms
Critiques of SCP model
- Too concerned with static short run equilibrium; more like a snapshot - evolution of the structural variables?
- Hard to decide which variables belong to structure, conduct and performance
- Difficulty measuring the variables, e.g. Barriers to entry
- What exactly do we mean by performance? Can we have a set of performance indicators?
Is there a positive relationship between market power and market concentration
Yes, if a firm has market power there is high market concentration
Positives of SCP paradigm
- Widely used to study the conduct and performance of firms and industries
- Allows breakdown of complex industry-level data into meaningful categories
- Grounded within the neoclassical theory of the firm, which assumes direct links between market structure, firm conduct and performance
- By defining an acceptable standard of performance, its useful for policy analysis
What should SCP paradigm be thought of as
Complex and interconnected rather than seen as a set sequence
What’s market concentration
The degree to which production is concentrated within a few large firms in a particular market or industry
- Most used indicator of market structure and level of competition or monopoly power present within a market
- Used to reflect Number of firms and their size distribution for competition in the industry
Empirical measure of market concentration
A concentration curve
- Plots cumulative percentage of output against the cumulative number of firms in an industry
Determined by:
- Size of the largest firms relative to the rest
- Number of firms in the industry
The more concave the contraction curve means what?
A number of firms significantly larger than the rest
How to work out the concentration ratio
Sum of the market shares of the firms, in order, the largest firm is first
What’s the Herfindahl-Hirschman Index
Better measure of market concentration but more difficult to compute
- It requires knowledge of the market share of all firms in the industry
- You square each market share when adding them together
What’s the Hannah and Kay’s index
Allows greater weight to be given to large firms, by varying the power to which the market share is put
- The Higher the power, the greater the weight placed on the largest firms
- If power is 2 then it’s the same as the HHI index
- If power less than 2, attaches more weight to smaller firms and less weight to larger firms
Critiques of concentration measures
- Choice of appropriate industry
- Defining The boundaries of the market - Local, national or international market?
- Treatment if imports and exports and multi-product operations - Should imports be taken into account?
- Multi-product operations - Firms May serve separate markets
Factors that affect seller concentration
- Economies of scale
- Entry and exit barriers
- Regulation
- Scope of discretionary sunk cost expenditure on items such as R&D and advertising
- The industry life cycle
What does each measure of seller concentration aim to reflect
The number of firms and their size distribution for competition in the industry concerned