Lecture 2 - SCP Paradigm and Market Concentration

Question 1

What is the SCP paradigm

Answer 1

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

Question 2

What consists of market structure part of the SCP paradigm

Answer 2

• Number and size of firms
• Market shares/concentration
• Vertical integration
• Entry and exit conditions

Question 3

What consists of conduct of firms as part of SCP paradigm

Answer 3

• Pricing strategies
• Production strategies
• Product choice
• Collusion
• R&D
• Advertising

Question 4

What consists of performance as part of the SCP paradigm

Answer 4

• Market power
• Profit rates
• Growth
• Technological progress
• Static efficiency
• Dynamic efficiency

Question 5

What does causal relationship between SCP mean

Answer 5

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)

Question 6

What’s market power and what is wrong with it

Answer 6

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)

Question 7

What’s the key indicator of market power in SCP

Answer 7

Structure, its embodied in the size distribution of firms

Question 8

Critiques of SCP model

Answer 8

• 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?

Question 9

Is there a positive relationship between market power and market concentration

Answer 9

Yes, if a firm has market power there is high market concentration

Question 10

Positives of SCP paradigm

Answer 10

• 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

Question 11

What should SCP paradigm be thought of as

Answer 11

Complex and interconnected rather than seen as a set sequence

Question 12

What’s market concentration

Answer 12

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

Question 13

Empirical measure of market concentration

Answer 13

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

Question 14

The more concave the contraction curve means what?

Answer 14

A number of firms significantly larger than the rest

Question 15

How to work out the concentration ratio

Answer 15

Sum of the market shares of the firms, in order, the largest firm is first

Question 16

What’s the Herfindahl-Hirschman Index

Answer 16

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

Question 17

What’s the Hannah and Kay’s index

Answer 17

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

Question 18

Critiques of concentration measures

Answer 18

• 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

Question 19

Factors that affect seller concentration

Answer 19

• 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

Question 20

What does each measure of seller concentration aim to reflect

Answer 20

The number of firms and their size distribution for competition in the industry concerned