a presentation on market structure group members

8/7/2019 A presentation on market structure GROUP MEMBERS

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GROUP MEMBERSMOHSIN RAFIQUE MB-S1-09-41

ABDUL JABBAR MB-S1-09-83

MUHAMMAD IMRAN MB-S1-09-119


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Market structure identifies how a marketis made up in terms of:

The number of firms in the industry

The nature of the product producedThe degree of monopoly power each firm has

The degree to which the firm can influence price

Profit levels

Firms behaviour pricing strategies, non-price competition,output levels

The extent of barriers to entry

The impact on efficiency


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More competitive (fewer imperfections)

PerfectCompetition

PureMonopoly


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Market Structure

Less competitive (greater degreeof imperfection)

PerfectCompetition

PureMonopoly


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Market StructurePerfect

Competition

PureMonopoly

Monopolistic Competition Oligopoly Duopoly Monopoly

The further right on the scale, the greater the degreeof monopoly power exercised by the firm.


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` Importance:

` Degree of competition affects

the consumer will it benefit

the consumer or not?` Impacts on the performance

and behaviour of the company/companies

involved


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` One extreme of the market structure spectrum` Characteristics:

Large number of firms Products are homogenous (identical) consumer

has no reason to express a preference for any firm

Freedom of entry and exit into and outof the industry

Firms are price takers have no controlover the price they charge for their product

Each producer supplies a very small proportionof total industry output

Consumers and producers have perfect knowledge about themarket


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Diagrammatic representation

Cost/Revenue

Output/Sales

The industry price isdetermined by the demandand supply of the industryas a whole. The firm is avery small supplier withinthe industry and has nocontrol over price. They will

sell each extra unit for thesame price. Price therefore= MR and AR

P = MR = AR

MC

The MC is the cost ofproducing additional(marginal) units of output. Itfalls at first (due to the law ofdiminishing returns) then risesas output rises.

AC

The average cost curve is thestandard U shaped curve.MC cuts the AC curve at itslowest point because of themathematical relationshipbetween marginal and averagevalues.

Q1

Given the assumption of profitmaximisation, the firm producesat an output where MC = MR(Q1). This output level is afraction of the total industrysupply.

At this output the firm

is making normal profit.

This is a long run

equilibrium position.


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` Where the conditions of perfect competition

do not hold, imperfect competition will exist` Varying degrees of imperfection give rise to

varying market structures

` Monopolistic competition is one of these

not to be confused with monopoly!


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` Characteristics: Large number of firms in the industry

May have some element of control over price due tothe fact that they are able to differentiate their product

in some way from their rivals products are thereforeclose, but not perfect, substitutes

Entry and exit from the industry is relatively easy fewbarriers to entry and exit

Consumer and producer knowledge imperfect


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Implications for the diagram:

Cost/Revenue

Output / Sales

MC

AC

Marginal Cost andAverage Cost will be thesame shape. However,because the products

are differentiated insome way, the firm willonly be able to sell extraoutput by lowering

price.

D (AR)

The demand curve facingthe firm will be downward

sloping and represents theAR earned from sales.

MR

Since the additionalrevenue received from

each unit sold falls, theMR curve lies under the

AR curve.

We assume that the firmproduces where MR = MC(profit maximising output).At this output level, AR>AC

and the firm makesabnormal profit (the greyshaded area).

Q1

1.00

0.60

Abnormal Profit

If the firm produces Q1 andsells each unit for 1.00 on

average with the cost (onaverage) for each unit being

60p, the firm will make 40p xQ1 in abnormal profit.

This is a short run equilibriumposition for a firm in a

monopolistic marketstructure.


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Monopolistic or ImperfectCompetitionImplications for the diagram:

Cost/Revenue

Output / Sales

MC

AC

D (AR)MR

Q1

Because there is relativefreedom of entry and exitinto the market, newfirms will enter

encouraged by theexistence of abnormalprofits. New entrants willincrease supply causing

price to fall. As price falls,the AR and MR curvesshift inwards as revenuefrom each sale is nowless.

AR1MR1


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Cost/Revenue

Output / Sales

MC

AC

D (AR)MR

Q1

AR1MR1

Notice that the existenceof more substitutes makesthe new AR (D) curvemore price elastic. The

firm reduces output to apoint where MC = MR(Q2). At this output AR =AC and the firm will make

normal profit.

Q2

AR = AC


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Cost/Revenue

Output / Sales

MC

AC

AR1MR1

This is the long runequilibrium positionof a firm in monopolisticcompetition.

Q2

AR = AC


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` Some important points about monopolistic

competition: May reflect a wide range of markets

Not just one point on a scale reflects many degreesof imperfection

Examples?


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` Restaurants

` Plumbers/electricians/local builders

` Solicitors

` Private schools

` Plant hire firms` Insurance brokers

` Health clubs

` Hairdressers

` Funeral directors

` Estate agents

` Damp proofing control firms


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` In each case there are many firmsin the industry

` Each can try to differentiate its productin some way

` Entry and exit to the industry is relatively free` Consumers and producers do not have perfect

knowledge of the market the market may indeed berelatively localised. Can you imagine trying to search outthe details, prices, reliability, quality of service, etc for

every plumber in the UK in the event of an emergency??


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` Competition between the few May be a large number of firms in the industry but the

industry is dominatedby a small number of very large producers

` Concentration Ratio the proportion of totalmarket sales (share) held by the top 3,4,5, etcfirms: A 4 firm concentration ratio of 75% means the top 4

firms account for 75% of allthe sales in the industry


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` Example:

` Music sales The music industry hasa 5-firm concentrationratio of 75%.Independents make up

25% of the market butthere could be manythousands of firms thatmake up this

independents group.An oligopolistic marketstructure thereforemay have many firmsin the industry but it isdominated by a fewlarge sellers.

Market Share of the Music Industry 2002. Source IFPI: http://www.ifpi.org/site-content/press/20030909.html


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` Features of an oligopolistic market structure: Price may be relatively stable across the industry

kinked demand curve?

Potential for collusion

Behaviour of firms affected by what they believe their rivalsmight do interdependence of firms

Goods could be homogenous or highly differentiated

Branding and brand loyalty may be a potent source of competitive advantage

Non-price competition may be prevalent

Game theory can be used to explain some behaviour

AC curve may be saucer shaped minimum efficient scale

could occur over large range of output High barriers to entry


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The kinked demand curve - an explanation for price stability?Price

Quantity

D = elastic

D = Inelastic

5

100

Kinked D Curve

The principle of the kinked demandcurve rests on the principlethat:

a. If a firm raises its price, its

rivals will not follow suitb. If a firm lowers its price, its

rivals will all do the same

Assume the firm is charging a price of5 and producing an output of 100.

If it chose to raise price above 5, itsrivals would not follow suit and the firm

effectively faces an elastic demandcurve for its product (consumers would

buy from the cheaper rivals). The %change in demand would be greaterthan the % change in price and TRwould fall.

Total Revenue A

Total

Revenue B

If the firm seeks to lower its price togain a competitive advantage, its rivalswill follow suit. Any gains it makes will

quickly be lost and the % change indemand will be smaller than the %reduction in price total revenuewould again fall as the firm now facesa relatively inelastic demand curve.

Total Revenue B

Total Revenue A

The firm therefore, effectively facesa kinked demand curve forcing it tomaintain a stable or rigid pricing

structure. Oligopolistic firms mayovercome this by engaging in non-price competition.


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` Pure monopoly where onlyone producer exists in the industry

` In reality, rarely exists always

some form of substitute available!` Monopoly exists, therefore,

where one firm dominates the market` Firms may be investigated for examples of

monopoly power when market share exceeds

25%` Use term monopoly power with care!


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` Monopoly power refers to cases where firms

influence the market in some way through their

behaviour determined by the degree

of concentration in the industry Influencing prices

Influencing output

Erecting barriers to entry

Pricing strategies to prevent or stifle competition

May not pursue profit maximisation encourages unwantedentrants to the market

Sometimes seen as a case of market failure


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` Origins of monopoly: Through growth of the firm

Through amalgamation, merger

or takeover

Through acquiring patent or license

Through legal means Royal charter, nationalisation,

wholly owned plc


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` Summary of characteristics of firms exercising

monopoly power: Price could be deemed too high, may be set to

destroy competition (destroyer or predatory pricing),price discrimination possible.

Efficiency could be inefficient due to lack of

competition (X- inefficiency) or

x could be higher due to availability of high profits


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Costs / Revenue

Output / Sales

AC

MC

ARMR

AR (D) curve for a monopolistlikely to be relatively priceinelastic. Output assumed tobe at profit maximising output(note caution here not allmonopolists may aimfor profit maximisation!)

Q1

7.00

3.00

MonopolyProfit

Given the barriers to entry,the monopolist will be able toexploit abnormal profits in thelong run as entry to themarket is restricted.

This is both the short run andlong run equilibrium positionfor a monopoly


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MonopolyCosts / Revenue

Output / Sales

AC

MC

ARMR

Welfareimplications ofmonopolies

A look back at the diagram forperfect competition will revealthat in equilibrium, price will be

equal to the MC of production.

We can look therefore at acomparison of the differencesbetween price and output in acompetitive situation comparedto a monopoly.

Q1

3

The price in a competitivemarket would be 3 withoutput levels at Q1.

Q2

7The monopoly price would be7 per unit with output levelslower at Q2.

On the face of it, consumersface higher prices and less

choice in monopoly conditionscompared to more competitiveenvironments.

Loss of consumersurplus

The higher price and loweroutput means that consumersurplus is reduced, indicated by

the grey shaded area.


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MonopolyCosts / Revenue

Output / Sales

AC

MC

ARMR

Welfareimplications ofmonopolies

Q1

3

Q2

7The monopolist will beaffected by a loss of producersurplus shown by the grey

triangle but..

The monopolist will benefitfrom additional producersurplus equal to the grey

shaded rectangle.Gain in producersurplus


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` Final reminders:` Models can be used as a comparison they are not necessarily meant to

BE reality!

` When looking at real world examples, focus on the behaviour of the firm inrelation to what the model predicts would happen that gives the basis for

analysis and evaluation of the real world situation.` Regulation or the threat of regulation may well affect

the way a firm behaves.

` Remember that these models are based on certain assumptions in thereal world some of these assumptions may not be valid, this allows us todraw comparisons and contrasts.

`

The way that governments deal with firms may be based on a generalassumption that more competition is better than less!

a presentation on market structure group members

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