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Economics: Reading #1: The Firms and Market Structures, ..................…
Economics: Reading #1: The Firms and Market Structures
Monopolistic competition - Market and demand characteristic
Characteristics
Large number of independent sellers
Each firm has a relatively small market share
-> no significant pricing power
Firms need to focus on
average market price
, not the price of competitors
Too many firms in the industry
-> no price fixing
Differentiated products
Products are slightly different over the firms
->
close substitutes
for one another
Nature of Competition
Price, quality and marketing
->
quality is a significant product - differentiating characteristic
Entry
Low
barries to entry
Demand
Firms in monopolistic competition face
downward - sloping
and
highly elastic
demand curve
Supply
There is no well - defined supply function
Monopolistic Competition - The Optimal price and output for firms
Perfect competition
Short-run
Produce at MR = MC
-> Maximizing economic profits
Price for product = P*
*Positive economics profit
= P
- ATC
-> attract competitors to enter market
Vice versa if P* < ATC
Long-run
Entry of new firms shifts demand curve to the point ATC
= P
-> Still produce at MR = MC but
Economics profits = 0
-> no longer an incentive for new firms to enter the market
Monopolistic
Under monopolistic competition:
A firm generally produces lower output and charges higher price than under perfect competition.
P > MC,
(P - MC) = markup (1)
Each firms is producing the quantity for which ATC is not a minimum
-> excess capacity or inefficient scale of productioni
(2)
, the price is slightly higher than under perfect competition.
To be more attractive, Firms should focus on:
Product innovation
Advertising expenses
Brand name
Oligopoly - Market and demand characteristic
Characteristics
Small number of independent sellers
Firms enjoy substantial pricing power
A price change by one firm can be expected to be met by a price change by its competitors
-> firms' demand is interdepenndent
Differentiated products
The products offered by sellers are
close substitutes
for each other.
Nature of competition
Price, quality and marketing and other nonprice strategies
Entry
High barries to entry
Demand
Ologopoly markets' demand curves depend n the degtree of pricing interdependence:
(1) kinked demand curve
(2) collusion
(3) dominant firm
(4) nash equilibrium
Supply
There is no well - defined supply function
Kinked Demand curve model
Definition
Kinked demand curve model
is a model in which demand curve is not a straight line but has a different elasticity for higher and lower prices
Assumption
An increase in a firm's product price will not be followed by its competitors, but a decrease in price will:
Each firm believes that it faces a demand curve that is more elastic (flatter) above a given price (the kink in the demand curve) than it is beloew the given price
If firm raises its price above Pk, its competitors will remain at Pk, and it will lose market share because of highest price
->
decrease Total revenue -> should lower P to Pk
If firm decrease its price below Pk, other firms will match the price cut, and all firms will experience a relatively small increase in sales relative to any price reduction
->
increase Total revenue -> should raise P to Pk
=>
Pk, Qk is the profit-maximizing level of price and output
If the MC curve passes through the MR gap, the most profitable price and output combination remains unchanged (Qk, Pk), even when the marginal cost increases from MC(a) to MC(b)
=>
In reality, it is very difficult to find Pk
Cournot Model
Cournot model
has 2 firms competing with identical marginal cost curves
Each choose their preferred selling price based on the price the other firm chose in the previous period.
The equilibrium for an oligopoly with 2 firms (duopoly) is sell
the same amounts and same quantities, splitting the market equally
at the equilibrium price
-> no longer any additional profit by changing quantity
-> a stable equilibrium
The equilibrium price
is less than
the price a single monopolist would charge, but greater than the equilibrium price that would result under perfect competition.
Nash equilibrium
Definition
The Nash equilibrium is a game theory that none of the oligopolists can increase its profits by
unilaterally changing
its pricing stratergy
Assumption
The firms in the oligopoly market have interdependent actions, Each firm anticipates that the other firms will react to any change by doing the best they can
Each firm's actions are non-cooperative, with each firm making decisions that maximize its own profits, and
do not collude
in an effort to maximize joint profits
A Nash equilibrium is reached when
all firms are doing the beat they can, given the actions of their rivals
More successful when:
In general, collusive agreements to increase price in an ologopoly market will be more successful
(have less cheating)
when:
There are fewer firms or if one firm is dominant
Products are more similar (less differentiated)
Cost structures are more similar
Purchase Orders are relatively small and frequent
Retaliation by othe firms for cheating is more certain and more severe
The degree of external competition
Stackelberg and Dominant firm model
Stackelberg model
In the Stackelberg model, the leader firm chooses its output first and then the followe firm chooses after observing the leader's output
-> the leader firm has a distinct advantage, being a first mover
The leader can aggressively overproduct to force the follower to scale back or even punish/eliminate the weaker opponent
Dominant firm model
In this model, ther is a single firm that has a significantly large market share (> / = 40%) because of its
greater scale and lower cost structure
- the dominant firm (DF)
The market price is essentially determined by the dominant firm, and the other competitive firms (CF) take this market price as given
The competitive firms maximize profits by producing the quantity for which their marginal cost , MC(cf), equals P*, quantity Q(cf)
A price drcease by one of the competitive firms will lead to a decrease in price by the dominant firm, and competitive firms will decrease output and/or exit the industry in the long run.
=> increase the market share of the dominant firm
A Firm's Supply Function
Theory
Perfect competition
The short - run supply function for a firm under perfect competition is
its marginal cost curve above its average variable cost (MC above AVC).
The short-run market supply curve is constructed by summing the quantities supplied at each price across all firms in the market.
Imperfect competition
There is no well - defined supply function because firms face downward demand curve, the quantity supplied is for which MR = MC and the price is determined by the demand curve
Pricing strategy under each market structure
Perfect competition
Profits maximize: MR = MC
P = MR = MC
Monopolistic competition
Profits maximize: MR = MC
P> MR, MC (Because the firm's demand cuve is downward sloping)
Monopoly
Profits maximize: MR = MC
P> MR, MC (Because the firm's demand curve is downward sloping)
Oligopoly
The optimal pricing strategy depends on our assuptions about the reactions of other firms to each firm's actions: Kinked demand curve, Cllusion, Dominant firm model and Game theory
Concentraition measures in identifuing market structure
Many countries have introduced competition law to regulate the degree of competitioni and anti-monopoly
-> use
concentration measures
as an indicator of market power
2 Kinds of conentration measures
N-firm concentration ratio
Calculated as the sum or the percentage market shares of the largest N firms in a market
Simple to calculate and understand, but does not directly measure market power or elasticity of demand.
Relatively insensitive to mergers of 2 firms with large market shares
Herfindahl - Hirschman Index (HHI)
Calculate as the sum of the squares of the market shares of the largest firms in the market
Reduce the problem of
N-firm concentration ratio
when mergers between occur
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