4.1.5.6 - Market Structures

Monopoly power

The power of a firm to be a price maker rather than a price taker

Imperfect competition

Any market structure lying between the extremes of perfect competition and pure monopoly

Barriers to entry

An obstacle preventing firms entering a market and competing with incumbent firms

Barriers to exit

Factors that will prevent a firm from easily and cheaply exiting the market

Main types of barriers

1. Natural barriers

2. Artificial barriers

Indivisibilities

Production methods with high fixed costs in order to produce the first unit, may not be divisible below the economies of scale needed to produce the goods, so those memories are unavailable to smaller products.

Sunk costs

Costs that cannot be recovered if a firm wants to leave the market

Artificial barriers

Barriers erected by incumbent firms such as high levels or advertising expenditures or predatory pricing

Limit pricing

Prices set low enough to make it unprofitable for new firms to enter the market

Predatory pricing

Prices set below average costs with the aim of forcing rival firms out of business

Product differentiation

Marketing similar products with minor variations or the marketing of a range of different products

Concentration ratio

A ratio which indicates the total market share of the leading firms in the market. It is their output as a percentage of total market output

The objectives of firms

1. Profit maximisation

2. The divorce ownership of control

3. Growth maximisation

4. Market share maximisation

5. Survival

6. Satisficing

Profit maximisation

It occurs when total revenue is furthest above total cost of production

The divorce ownership of control

The owners and those who manage the firms are different groups with different objectives

Growth maximisation

Decision makers in a firm try to grow the firm as fast as possible even though this may conflict with profit maximisation

Market share maximisation

This happens when a firm maximises its percentage share of the market in which it sells its products. This objective tends to accompany growth maximisation

Survival

May become a main objective for firms making a loss

Satisficing

Achieving a satisfactory outcome rather than the best possible outcome

Main characteristics of a PC markets

1. Large number buyers and sellers

2. All buyers and sells have perfect information

3. Each producer can sell as much as they want at the market price

4. All products are identical/uniform/homogeneous

5. There are no barriers to entry and exit

Consumer surplus

The difference between what consumers are prepared to pay for a good and what they actually pay

Producer surplus

The difference between the market price which ffirm

Factors which influence monopoly power

1. The existence of barriers to entry

2. The number of competitors

3. Advertising

4. The degree of product differentiation

Barriers to entry

1. Natural / innocent barriers

2. Indivisibility

3. Artificial barriers

4. Predatory pricing

5. Limit pricing

Predatory pricing

Prices set below average costs (or very cheaply) with the aim of forcing rival firm out of business

Limit pricing

Prices set low enough to make it unprofitable for other firms to enter the market

Informative advertising

Provides consumers and producers with useful information about goods or services

Persuasive advertising

Attempts to persuade potential customer that a product has desirable characteristics that make it worth buying

Saturation advertising

This acts as a man-made barriers to market entry through flooding the market with information and persuasion about a firm’s product.

Product differentiation

Making a product different from other products design methods of production, functionality or packaging

Monopoly characteristics

1. Only one firm in the industry

2. Strong barriers to entry which prevent firms from entering the market

A profit maximising firm will always operate where…

MC=MR

Natural monopoly

When there is only room in the market for a firm

Static efficiency

Efficiency measured at a particular point in time. E.g productivity and allocative efficiency

Dynamic efficiency

Happens in the long run, leading to development of new products and productivity efficiency

Invention

Creates new ideas for products or processes

Innovation

Converts the results of invention into marketable products or services

Collusion

Co-operation between firms to act against the public interest; for example, to fix prices

Oligopoly

When just a few firms constitute a large proportion of the industry

Characteristics of Oligopoly

1. A few sellers have high market share (high concentration ratio)

2. Firms are interdependent

3. Often economies of scale and other barriers to entry

4. Product differentiation

Market conduct

The price and other market policies pursued by firms (market behaviour)

Importance of non-price competition

It helps build a strong ‘marketing’ barriers to entry & exit (sunk costs)

Methods of non-price competition

1. Mass media

2. Store loyalty cards

3. Home deliver

4. Extension of opening hours

5. Sales promotion such as coupons and special offers

6. Ease of online shopping

Non-collusive oligopoly

When firms in an oligopoly act independently in the sense that they do not form an agreement with each other

Limitations of kinked demand theory

1. Price stability may be due to other factors like upsetting customers

2. It doesn’t tell us how the price is set

3. The firm doesn’t explain price wars and if firms will even act this way

4. It ignores non-price competition

5. Research shows that oligopoly prices tend to be stable when demand conditions change in a predictable way

Price leadership

Setting prices in a market, usually by a dominant firm, which are then followed by the other firms in the market

Barometric price leadership

When one firm believes that the prices will go up or don and changes their prices and waits to see the reaction of other firms. If the other firms don’t change their prices, the barometric price leader will bring its prices back in the line with other firms.

Price agreements

An agreement between a firm, similar firms, suppliers or customers regarding the pricing of a product

Price war

When rival firms continuously lower prices to undercut each other

Game theory

The study of alternative strategies that oligopolies may choose to adopt depending on assumptions made about the behaviour of rivals

First mover advantage

The idea that by being the first to enter a new market, a business gains commercial advantage over its actual and potential rivals leading to higher revenue and profits overtime

Advantages of being a first mover

1. Firms can develop a significant competitive advantage through learning by doing

2. They can exploit internal economies of scale and also build brand loyalty

3. Consumer behaviour can be habitual

Risks of being the first mov

1. Employees from the first mover firms may leave to set up challenge brands

2. First movers are often unprofitable, the failure rate can be high

3. Second-movers can learn much better from first mover mistakes

Horizontal collusion

Price fixing market rigging between companies in the same industry and at the same stage or production

Vertical collusion

Occurs where a business in the same industry engage in anti-competitive practices at different stage of the supply chain

Problems of collusion

1. Inefficiency: collusion leads to inefficiency just as with monopolies

2. Consumers: collusion reduces consumer surplus and consumers suffer higher prices and lower quality

Monopolistic completion

Where many firms are present in a market, and they produce similar but differentiated products

Assumptions of monopolistic competition

1. There are many producers and consumers - the concentration ratio is low

2. Consumers perceive the non-price differences among products - competition is strong

3. Producers have some control over the price

4. Barriers to entry and exit are low

Evaluating monopolistic competition

1. Without economies of scale, monopolistic completion is both allocatively and productively inefficient compared to PC

2. Saturation in the market may lead to firms being unable to exploit fully economies of scale

Franchising

The government to auction the right to produce the good or service for a specified length of time