Market Structures, Objectives

T3 CC3 (keywords)

Profit Max

MC=MR

Revenue Max

MR=0

Sales max

AC=AR

Allocative efficiency

MC=AR or P=MC

Productive efficiency

MC=AC

Market Concentration

the degree to which the output of an industry is dominated by its largest producers.

Market Share

the proportion of sales revenue in a market taken by a firm or a group of firms calculated as (TR firm /TR market ) x 100

Concentration Ratio

The combined market share of the n largest firms in the industry. For instance, a five firm concentration ratio of 60 per cent shows that the five largest firms in the industry have a combined market share of 60 per cent.

Oligopoly

a market where a small number of interdependent firms compete with each other.

High barriers to entry (BTN) and exit (BTX)

factors which make it difficult or impossible for firms to enter or exit an industry and compete with existing firms. Therefore supernormal or subnormal profits respectively can persist.

Product differentiation

aspects of a good or service which serve to distinguish one product from another such as product formulation, packaging, marketing or availability.

Price Wars

a situation where several firms in a market repeatedly lower their prices to outcompete other firms; the objective may be to gain or defend market share. To avoid price wars, non-price competition is often preferred

Predatory pricing

an anti-competitive and illegal strategy in which a firm sets price to be just above or at the average variable cost in the short run, in an attempt to force out a rival/s from the market and achieve market dominance. If there is a risk of future predatory pricing, this may act as a barrier to entry.

Limit Pricing

when a firm, rather than short-run profit maximising, sets a low enough price to deter new entrants from coming into its market – this is an example of a barrier to entry.

Non-price competition (differentiation)

all forms of competitive action other than through the price mechanism – non-price elements of the so-called marketing mix 4Ps i.e. product, place, and promotion

Price Stability

prices in oligopolistic markets seem to change far less than in perfectly competitive markets, even when costs change. One model which can help explain the price stability seen in oligopolistic markets is the so-called kinked demand curve

Kinked demand curve theory (in non-collusive oligopoly)

the theory that oligopolists face a demand curve that is kinked at the current price. The effect of this is to create a situation of price stability.

Collusion

collective agreements between producers which restrict competition – this can be overt (open or formal) or tacit (silent or informal)

Collusive Oligopoly

when firms in an oligopolistic industry form a cartel and collude, typically to restrict output and raise prices and profits.

Non-collusive/ competitive oligopoly

when firms in an oligopolistic industry compete amongst themselves and there is no collusion yet they are still interdependent

Uncertainty

characteristic of competitive oligopoly e.g. reactions of rivals to increased price may be unpredictable.

Overt / formal collusion

when firms make agreements among themselves to restrict competition, typically by reducing output, raising prices and keeping potential competitors out of the market i.e. communication (usually just verbal to avoid detection) has taken place between the firms.

Tacit / informal collusion

when firms cooperate without any formal agreement having been reached or even without any explicit communication between the firms having taken place. Firms monitor each other’s behaviour closely; ‘unwritten rules’ develop which define ways in which firms may or may not compete. An example is price leadership

Cartel

an agreement between firms on price and output normally with the intention of maximising their joint profits.

Price Leadership

When one firm, the price leader, sets its own prices and other firms in the market set their prices in relationship to the price leader. Firms who market to consumers that they are “never knowingly undersold” or who claim to be monitoring and matching the cheapest price in a given geographical area are effectively involved in tacit collusion. However, regulators may choose to overlook this if it results in better outcomes for consumers in the form of lower prices.

Game Theory

the analysis of situations in which players are interdependent.

Interdependence

the actions of one firm will directly affect all other firms in the industry.

Penetration Pricing

involves setting a relatively low initial entry price, usually lower than the intended established price, to attract new customers. The strategy aims to encourage customers to switch to the new product because of the lower price.

Price Skimming

involves setting a high price before other competitors come into the market. This is often used for the launch of a new product which faces little or no competition – usually due to some technological features. Such products are often bought by ‘early adopters’ who are prepared to pay a higher price to have the latest or best product in the market.

Cost-plus pricing/ Markup pricing

where a business determines the final selling price of a product by adding a specific fixed percentage — the “markup” — to the average cost of producing one unit. Instead of looking at what competitors are charging or what customers are willing to pay, this method focuses entirely on internal costs and a desired profit margin.

Product line pricing

used when you have more than one product in a line (e.g. printers sold cheaply and cartridges at much higher price), more commonly known as a loss leader or ‘bait & hook’

Contestable Market

A market with low entry and exit barriers.

Stakeholders

groups who have an interest in the activity and performance outcomes of a business.

Orthodox economic theory

assumes shareholders to be the dominant force and hence short-term profit-maximisation is assumed to prevail

Managerial theory

assumes that firms wish to maximise managerial objectives rather than profit; this will be most apparent where there is a divorce of ownership (shareholders) and control (directors), with the former suffering from asymmetric information

Organisational theory

assumes that a firm is a coalition of different groups such as shareholders, managers and workers.

Behavioural economics

studies human behaviour and decision-making, by integrating economics with psychology, pioneered by American economist, Herbert Simon. Behavioural economists examine the decisions that are taken within complex business organisations, made up of various groups of stakeholders who have different objectives.

Satisficing

achieving a satisfactory objective acceptable to all the competing member groups of the coalition that makes up the firm.

Public sector organisations

Owned and controlled by the state

Private Sector organisations

Those owned by individuals or groups of individuals.

Niche Market

a focused, targetable portion of a market, a narrowly defined group of potential customers.

Organic/internal growth

occurs when a firm increases its size through investment in capital equipment or an increased labour force.

External growth

growth through merger or takeover

Merger

the integration of two or more firms maintaining shared ownership and control.

Takeover

the acquisition of one firm by another where control passes to the acquiror.

Horizontal Integration

the joining of two firms in the same industry at the same stage of production (e.g. food delivery app Just Eat buying rival Hungry House)

Vertical Integration

the joining of two firms at different production stages in the same industry

Forward (‘downstream’) vertical integration

involves a firm buying another further down the supply chain (e.g. fashion brand Burberry bought their Chinese franchisees)

Backward (‘upstream’) vertical integration

involves a firm buying another back up the supply chain (e.g. yoghurt manufacturer Müller buying Robert Wiseman Dairies)

Conglomerate integration

a merger between two firms producing unrelated products (e.g. Google buying green energy start-up and airborne wind turbine pioneer Makani Power)

Synergy

the so called 2+2=5 concept; when the combined entity resulting from the joining of two or more firms is more valuable than the sum of the component parts (e.g. by eliminating duplicated back office functions).

Dyssynergy

opposite of synergy, 2+2=3 due to, say, a clash of cultures.

Asset Stripping

occurs when a predator takes over a target company because it feels that the market price of the target’s assets is higher than its stock market value suggests. The assets can be stripped out individually and sold in total for more than the price the predator pays to acquire the company.

Shareholder value

increasing the wealth of shareholders (owners) by paying dividends and/or causing the share price to increase.

Demerger

when a firm splits into two or more independent businesses.