Market Structure and Competition Notes

Market Structure and Competition

Perfect Competition

• Infinite number of sellers.
• Identical products - perfect substitutes.
• No barriers to entry or exit.
• No economic profit in the long run.
• Highest output, lowest prices.
• Marginal Revenue (MR) curve is horizontal.
• Break-even point where Marginal Cost (MC) intersects Average Total Cost (ATC).
• Price (P) = $5, illustrating no economic profit.
• Quantity (Q) represents the output level.

Monopoly

• One seller, no substitutes.
• Barriers to entry exist.
• Economic profit in the long run.
• Higher prices, lower output.
• Quantity is determined where MC equals MR.
• Price is determined by where the quantity intersects the demand curve.
• Example shows:
  • MC = $10
  • ATC = $12
  • Price = $22
  • Economic Profit (EP) = $30, calculated as EP = (Price - ATC)

Imperfect - Monopolistic Competition

• Many sellers.
• No barriers to entry or exit.
• Firms differentiate through quality, price, and marketing.
• Economic profits in the short run.
• No long-run economic profits.
• Innovation and new products are important.
• Price equals ATC at the minimum ATC.
• Example:
  • Price = $18

Oligopoly

• Few sellers and barriers to entry exist, allowing collusion.
• Firms can act like a monopoly by restricting output and raising prices.
• Cartels are unstable because sellers have an incentive to break agreements.

Market Structure Summary

Perfect Competition and Monopoly: Models vs. Reality

• Models help us understand reality but aren't reality themselves.
• Using models can create a flawed view of competition.

Economic Model Influences Antitrust Policy

• Factors considered:
  • Number of firms.
  • Profitability.
  • Barriers to entry and exit.
  • Substitutes.
• Question: Is perfect competition the right benchmark?

Entry and Exit

• The key feature of market structure is the ease of entry and exit.
• Competition depends on freedom of entry & exit.
• Monopoly depends on barriers to entry & exit.

Barriers to Entry

• A barrier is more than just an obstacle or hurdle; it's a significant impediment that's hard to overcome.
• A good test to identify a barrier: Could major companies like Google, Amazon, or Apple overcome it if they wanted to?
• Capital is generally not a barrier; many firms have substantial cash reserves.
• Currently, 13 firms have over 1T$$ cash on hand, including Apple, Microsoft, and Google.

Market Structure Continuum

• Firms exist somewhere along a continuum between perfect competition and monopoly.
• The continuum ranges from rivalrous competition to no competition.
• Closer to perfect competition: No barriers to entry exist, many firms, and strong substitutes.
• Closer to monopoly: Barriers to entry exist, one firm, and no substitutes.

Market Structure Continuum: Extreme Competition

• If there are no barriers to entry, firms exist on a continuum of competition.
• Perfect competition: numerous firms, less differentiated products.
• Imperfect competition: more differentiated products.

Importance of the Entrepreneur

• Frank Knight: entrepreneur assumes risk.
• Israel Kirzner: competition = discovery procedure.
• Joseph Schumpeter: "creative destruction".

Creative Destruction

• The process of creating new products, features, ideas, and business models involves the destruction of old ones.
• It is never the candle maker that creates the lightbulb.

Substitution

• Everything has a substitute.
• "Competition is not about substituting two things which are identical, but about substituting one thing for another that is not exactly alike, and often is quite different, but are treated as if they were substantially the same by consumers."

Monopoly Prices

• It’s not a monopoly if there aren’t monopoly prices.
• Highly concentrated markets with firms losing money indicate another explanation.
• Some markets are highly concentrated because other firms are not willing to lose money.

Porter's Five Competitive Forces

• Awareness of the five forces can help a company understand its industry's structure and establish a more profitable, less vulnerable position.
• Strategy = Differentiation. Firms need to create a sustainable competitive advantage.

Business Strategy

• Low price or differentiation = false choice.
• Differentiation leads to sustainable competitive advantage.
• High-value consumers get low prices + high quality.
• Low levels of competition can lead to a world of monopolies.
• Competition exists in various sectors like airlines, software, retailing, outsourcing, and communications.

Defining Your Business

• Firms must not define their markets too narrowly.
• "People do not want to buy a ¼ inch drill, they want a ¼ inch hole."

Market Evolution

• Mainframe Computers (1964-1970s): IBM.
• Distributed Computing (1980s-1990s): Apple, Microsoft.
• Internet Computing (1996-2000s): Yahoo, Myspace.
• Mobile Computing (2008-Today): Google, Amazon, Facebook.
• Examples given relate to railroads, transportation (Pan Am, FedEx), and telephone/communications.
• The Dow Jones Industrial Average in 1979 included various companies, illustrating market dynamics.

The Market as a Process

• Competition is the driving force of the market.
• Prices and profits coordinate resources.
• Entrepreneurs create innovations.
• The positions of firms are not fixed in time or place.
• Monopoly is a temporary phenomenon.

Market Structure Theory

• Market structure is a tool to analyze competition and strategy where there is not one single answer.
• Barriers to entry are central, but most things are not barriers in the long run or given certain events.
• Capital: Many firms have significant cash reserves.
• Brand loyalty is fragile (examples: Tesla, Twitter, Elon Musk).
• If a barrier is not absolute, it is a hurdle; what matters is the size of the hurdle versus the size of the economic profits.
• Don't overestimate barriers' strength.
• Market structure theory hinges on barriers making entry impossible, not just difficult.
• If barriers are not absolute, they are hurdles, meaning entry isn't easy or inexpensive.
• If economic profits are high enough, someone will enter, even if it's difficult and costly.
• Don't underestimate substitutes.
• Competition is a process that takes place in time; understanding it requires focusing on the process.