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Market structures, characteristics

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Маркетинг и реклама

Market structure - the interconnected characteristics of a market, such as the number and relative strength of buyers and sellers and degree of collusion among them, level and forms of competition, extent of product differentiation, and ease of entry into and exit from the market.

Английский

2014-06-22

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  1.  Market structures, characteristics

Market structure- the interconnected characteristics of a market, such as the number and relative strength of buyers and sellers and degree of collusion among them, level and forms of competition, extent of product differentiation, and ease of entry into and exit from the market

Four basic types of market structure are (1) Perfect competition: many buyers and sellers, none being able to influence prices. (2) Oligopoly: several large sellers who have some control over the prices. (3) Monopoly: single seller with considerable control over supply and prices. (4) Monopsony: single buyer with considerable control over demand and prices.


We focus on those characteristics which affect the nature of competition and pricing – but it is important not to place too much emphasis simply on the market share of the existing firms in an industry.

Traditionally, the most important features of market structure are:

  •  The number of firms (including the scale and extent of foreign competition)
  •  The market share of the largest firms (measured by the concentration ratio – see below)
  •  The nature of costs (including the potential for firms to exploit economies of scale and also the presence of sunk costs which affects market contestability in the long term)
  •  The degree to which the industry is vertically integrated - vertical integration explains the process by which different stages in production and distribution of a product are under the ownership and control of a single enterprise. A good example of vertical integration is the oil industry, where the major oil companies own the rights to extract from oilfields, they run a fleet of tankers, operate refineries and have control of sales at their own filling stations.
  •  The extent of product differentiation (which affects cross-price elasticity of demand)
  •  The structure of buyers in the industry (including the possibility of monopsony power)
  •  The turnover of customers (sometimes known as “market churn”) – i.e. how many customers are prepared to switch their supplier over a given time period when market conditions change. The rate of customer churn is affected by the degree of consumer or brand loyalty and the influence of persuasive advertising and marketing

characteristics

Perfect competiton

Oligopoly

monopoly

Number of firms

many

Few

one

Type of products

homogeneous

Differentiated

limited

Barriers to entry

None

High

high

Pricing

Price takers

Price makers

Price makers

Economic efficiency

high

Low

low

Innovative behaviour

weak

Very strong

Potentially strong

  1.  Market barriers

Barriers to market entry include a number of different factors that restrict the ability of new competitors to enter and begin operating in a given industry. For example, an industry may require new entrants to make large investments in capital equipment, or existing firms may have earned strong customer loyalties that may be difficult for new entrants to overcome. The ease of entry into an industry in just one aspect of an industry analysis; the others include the power held by suppliers and buyers, the existing competitors and the nature of competition, and the degree to which similar products or services can act as substitutes for those provided by the industry.

In his book Competitive Strategy: Techniques for Analyzing Industries and Competitors, Michael E. Porter identified six major sources of barriers to market entry:

  1.  Economies of scale. Economies of scale occur when the unit cost of a product declines as production volume increases. When existing competitors in an industry have achieved economies of scale, it acts as a barrier by forcing new entrants to either compete on a large scale or accept a cost disadvantage in order to compete on a small scale. There are also a number of other cost advantages held by existing competitors that act as barriers to market entry when they cannot be duplicated by new entrants—such as proprietary technology, favorable locations, government subsidies, good access to raw materials, and experience and learning curves.
  2.  Product differentiation. In many markets and industries, established competitors have gained customer loyalty and brand identification through their long-standing advertising and customer service efforts. This creates a barrier to market entry by forcing new entrants to spend time and money to differentiate their products in the marketplace and overcome these loyalties.
  3.  Capital requirements. Another type of barrier to market entry occurs when new entrants are required to invest large financial resources in order to compete in an industry. For example, certain industries may require capital investments in inventories or production facilities. Capital requirements form a particularly strong barrier when the capital is required for risky investments like research and development.
  4.  Switching costs. A switching cost refers to a one-time cost that is incurred by a buyer as a result of switching from one supplier's product to another's. Some examples of switching costs include retraining employees, purchasing support equipment, enlisting technical assistance, and redesigning products. High switching costs form an effective entry barrier by forcing new entrants to provide potential customers with incentives to adopt their products.
  5.  Access to channels of distribution. In many industries, established competitors control the logical channels of distribution through long-standing relationships. In order to persuade distribution channels to accept a new product, new entrants often must provide incentives in the form of price discounts, promotions, and cooperative advertising. Such expenditures act as a barrier by reducing the profitability of new entrants.
  6.  Government policy. Government policies can limit or prevent new competitors from entering industries through licensing requirements, limits on access to raw materials, pollution standards, product testing regulations

С википедии побольше(все выше перечисленные +) :

  •  barrier to entry.
  •  Inelastic demand - One strategy to penetrate a market is to sell at a lower price than the incumbents. This is ineffective with price-insensitive consumers.
  •  Intellectual property - Potential entrant requires access to equally efficient production technology as the combatant monopolist in order to freely enter a market. Patents give a firm the legal right to stop other firms producing a product for a given period of time, and so restrict entry into a market. Patents are intended to encourage invention and technological progress by guaranteeing proceeds as an incentive. Similarly, trademarks and servicemarks may represent a kind of entry barrier for a particular product or service if the market is dominated by one or a few well-known names.
  •  Network effect - When a good or service has a value that depends on the number of existing customers, then competing players may have difficulties in entering a market where an established company has already captured a significant user base.
  •  Predatory pricing - The practice of a dominant firm selling at a loss to make competition more difficult for new firms that cannot suffer such losses, as a large dominant firm with large lines of credit or cash reserves can. It is illegal in most places; however, it is difficult to prove.
  •  Restrictive practices, such as air transport agreements that make it difficult for new airlines to obtain landing slots at some airports.
  •  Research and development - Some products, such as microprocessors, require a large upfront investment in technology which will deter potential entrants.
  •  Supplier agreements - Exclusive agreements with key links in the supply chain can make it difficult for other manufacturers to enter an industry.
  •  Sunk costs - Sunk costs cannot be recovered if a firm decides to leave a market. Sunk costs therefore increase the risk and deter entry.
  •  Tariffs - Taxes on imports prevent foreign firms from entering into domestic markets.
  •  Vertical integration - A firm's coverage of more than one level of production, while pursuing practices which favor its own operations at each level, is often cited as an entry barrier as it requires competitors producing it at different steps to enter the market at once.
  •  Zoning - Government allows certain economic activity in specified land areas but excludes others, allowing monopoly over the land needed.

It is important to note that barriers to market entry can change over time, as an industry matures, or as a result of strategic decisions made by existing competitors.

3.  Perfect competition

CHARACTERISTICS:

The four key characteristics of perfect competition are: (1) a large number of small firms, (2) identical products sold by all firms, (3) perfect resource mobility or the freedom of entry into and exit out of the industry, and (4) perfect knowledge of prices and technology.

These four characteristics mean that a given perfectly competitive firm is unable to exert any control whatsoever over the market. The large number of small firms, all producing identical products, means that a large (very, very large) number of perfect substitutes exists for the output produced by any given firm.

This makes the demand curve for a perfectly competitive firm's output perfectly elastic. Freedom of entry into and exit out of the industry means that capital and other resources are perfectly mobile and that it is not possible to erect barriers to entry. Perfect knowledge means that all firms operate on the same footing, that buyers know about all possible perfect substitutes for a given good and that firms actually do produce identical products.

How many firms are needed in a perfectly competitive industry, such that each is so small it has absolute no market control? There is no actual number that answers this question. This is due partly to the fact that perfect competition is an idealized market structure that does not exist in the real world. It is also partly due to the notion that the number of firms is not as important as the result... that no firm has market control. Perfectly competitive firm faces a horizontal, or perfectly elastic, demand curve. With this horizontal demand curve, marginal revenue is equal to average revenue, both of which are also equal to price.

Efficiency of Perfect Competition

  •  Firms will be allocatively efficient P=MC
  •  Firms will be productively efficient. Lowest point on AC curve
  •  Firms have to remain efficient otherwise they will go out of business.
  •  Firms are unlikely to be dynamically efficient because they have no profits to invest in research and development.
  •  If there are high fixed costs, firms will not benefit from efficiencies of scale.

Changes in Long Run Equilibrium

  •  1. The Effect of an Increase in Demand for the Industry.
  •  If there is an increase in demand there will be an increase in price Therefore the Demand curve and hence AR will shift upwards. This will cause firms to make supernormal profits.
  •  This will attract new firms into the market causing price to fall back to the equilibrium of Pe
  •  2. An increase in firms costs
  •  The AC curve will increase therefore AR< AC
    Firms will now start making a loss and therefore firms will go out of business.
    This will cause supply to fall causing prices to increase

Monopoly profit maximization

To understand the behavior of the monopoly, we start with the profit-maximizing goal of the firm. In graph above, profits at maximized at Point A, where MR=MC. After the firm determines the level of output where profits are maximized, it looks at the demand curve and charges the price, P*, that consumers are willing to pay for this level of output. If the firm charges a higher price than P*, then sales will be less than Q* and marginal revenue exceeds marginal cost (MR>MC). Conversely, if the firm charges a pric

e below P*, it will be producing where MR<MC and profits will fall from their optimal level where MR=MC. Graphically, the firm finds Point B along the demand curve, a point that corresponds to the profit maximizing output level found at Point A where MR=MC.

In summary:

  •  The monopolist first determines profit maximizing output where MR=MC, Point A and output level Q*.
  •  It then charges a price that consumers are willing to pay for Q* level of output, Point B on the demand curve and price P*.


4barriers to entry in monopolies

Barriers to entry are designed to block potential entrants from entering a market profitably. They seek to protect the monopoly power of existing (incumbent) firms in an industry and therefore maintain supernormal (monopoly) profits in the long run. Barriers to entry have the effect of making a market less contestable .

Types of barriers:

Structural ( economies of scale, vertical integration, control of essential resources..)

Strategic (predatory pricing/limit pricing, marketing/product differentiation)

Legal barriers (patents,licences, copyrights..)

Lerner Index of monopoly power

The structure-conduct-performance approach has led to attemps to quantitavely estimate the market power concentrated in the hands of a few firms in an industry. Our analysis of monopoly suggests that market power creates a gap between marginal cost and price. This led economist Abba Lerner to propose the Lerner index of monopoly power which is:

              

The LMP is zero for pure competitors because price equals marginal cost. Marginal cost and price in Figure 2 are both $30 at competitive output Qc (point a); LMP = (30 30)/30 = 0. The exercise of market power increases the Lerner index because the equilibrium gap between price and marginal cost rises. Monopoly output and price in Figure 2 are Qm and $50 respectively (point b), so LMP = (50 30)/50 = .40. While a rising LMP may reflect growing market power, the marginal cost data required to calculate this index are not generally available, requiring economists to turn to other measures of monopoly power.

price discrimination

A monopolist may be able to engage in a policy of price discrimination. This occurs when a firm charges a different price to different groups of consumers for an identical good or service, for reasons not associated with the costs of production. It is important to stress that charging different prices for similar goods is not price discrimination. For example, price discrimination does not does not occur when a rail company charges a higher price for a first class seat. This is because the price premium over a second-class seat can be explained by differences in the cost of providing the service.

CONDITIONS REQUIRED FOR PRICE DISCRIMINATION TO WORK

There are basically three main conditions required for price discrimination to take place.

Monopoly power

Firms must have some price setting power - so we don't see price discrimination in perfectly competitive markets.

Elasticity of demand

There must be a different price elasticity of demand for the product from each group of consumers. This allows the firm to extract consumer surplus by varying the price leading to additional revenue and profit. 

Separation of the market

The firm must be able to split the market into different sub-groups of consumers and then prevent the good or service being resold between consumers. (For example a rail operator must make it impossible for someone paying a "cheap fare" to resell to someone expected to pay a higher fare. This is easier in the provision of services rather than goods. 

The costs of separating the market and selling to different sub-groups (or market segments) must not be prohibitive. 

Examples of price discrimination

There are numerous good examples of discriminatory pricing policies. We must be careful to distinguish between discrimination (based on consumer's willingness to pay) and product differentiation - where price differences might also reflect a different quality or standard of service.

Some examples worth considering include:

  •  Cinemas and theatres cutting prices to attract younger and older audiences
  •  Student discounts for rail travel, restaurant meals and holidays
  •  Car rental firms cutting prices at weekends

\

MONOPSONY

A market characterized by a single buyer of a product. Monopsony is the buying-side equivalent of a selling-side monopoly. Much as a monopoly is the only seller in a market, monopsony is the only buyer. While monopsony could be analyzed for any type of market it tends to be most relevant for factor markets in which a single firm is the only buyer of a factor. The term was first introduced by Joan Robinson in her influential book, The Economics of Imperfect Competition.

In monopsony :

The market demand curve is the marginal value curve ; price(average expenditure) less than marginal expenditure; buyers continue to purchase as long as marginal value exceeds the marginal expenditure.

In a bilateral monopoly there is both a monopoly (a single seller) and monopsony (a single buyer) in the same market.

In such, market price and output will be determined by forces like bargaining power of both buyer and seller. A bilateral monopoly model is often used in situations where the switching costs of both sides are prohibitively high.

Bilateral monopoly situations are commonly analyzed using the theory of Nash bargaining games.

An example of a bilateral monopoly would be when a labor union (a monopolist in the supply of labor) faces a single large employer in a factory town (a monopsonist).

 

Natural  monopoly

A natural monopoly exists in an industry where a single firm can produce output such as to supply the market at a lower per uni-cost than can two or more firms. The telephone industry, electricity and water supply are often cited as examples of natural monopolies.

As with all monopolies, a monopolist who has gained his position through natural monopoly effects may engage in behavior that abuses his market position, which often leads to calls from consumers for government regulation. Government regulation may also come about at the request of a business hoping to enter a market otherwise dominated by a natural monopoly.

Regulatory responses:

  •  setting legal limits on the firm's behaviour, either directly or through a regulatory agency
  •  setting up competition for the market (franchising)
  •  setting up common carrier type competition
  •  setting up surrogate competition ("yardstick" competition or benchmarking)
  •  requiring companies to be (or remain) quoted on the stock market
  •  public ownership

oligopoly

o-market structure in which only a few sellers offer similar or identical products.

Duopoly – oligopoly with only 2 suppliers

The three most important characteristics of oligopoly are: (1) an industry dominated by a small number of large firms, (2) firms sell either identical or differentiated products, and (3) the industry has significant barriers to entry

Profit maximisation conditions: An oligopoly maximises profits by producing where marginal revenue equals marginal costs.

Ability to set price: Oligopolies are price setters rather than price takers.

Entry and exit: Barriers to entry are high. The most important barriers are economies of scale, patents, access to expensive and complex technology, and strategic actions by incumbent firms designed to discourage or destroy nascent firms. Additional sources of barriers to entry often result from government regulation favoring existing firms making it difficult for new firms to enter the market]

Number of firms: "Few" – a "handful" of sellers. There are so few firms that the actions of one firm can influence the actions of the other firms.

Long run profits: Oligopolies can retain long run abnormal profits. High barriers of entry prevent sideline firms from entering market to capture excess profits.

Product differentiation: Product may be homogeneous (steel) or differentiated (automobiles).

Interdependence: The distinctive feature of an oligopoly is interdependence. Oligopolies are typically composed of a few large firms. Each firm is so large that its actions affect market conditions. Therefore the competing firms will be aware of a firm's market actions and will respond appropriately. This means that in contemplating a market action, a firm must take into consideration the possible reactions of all competing firms and the firm's countermoves.

Cournot-Nash model

The Cournot-Nash model is the simplest oligopoly model. The model assumes that there are two “equally positioned firms”; the firms compete on the basis of quantity rather than price and each firm makes an “output decision assuming that the other firm’s behavior is fixed.” The market demand curve is assumed to be linear and marginal costs are constant. To find the Cournot-Nash equilibrium one determines how each firm reacts to a change in the output of the other firm. The path to equilibrium is a series of actions and reactions. The pattern continues until a point is reached where neither firm desires “to change what it is doing, given how it believes the other firm will react to any change.”The equilibrium is the intersection of the two firm’s reaction functions. The reaction function shows how one firm reacts to the quantity choice of the other firm. For example, assume that the firm 1’s demand function is P = (M - Q2) - Q1 where Q2 is the quantity produced by the other firm and Q1 is the amount produced by firm 1,and M=60 is the market. Assume that marginal cost is CM=12. Firm 1 wants to know its maximizing quantity and price. Firm 1 begins the process by following the profit maximization rule of equating marginal revenue to marginal costs. Firm 1’s total revenue function is RT = Q1 P= Q1(M - Q2 - Q1) = M Q1- Q1 Q2 - Q12. The marginal revenue function is .

RM = CM

M - Q2 - 2Q1 = CM

2Q1 = (M-CM) - Q2

Q1 = (M-CM)/2 - Q2/2 = 24 - 0,5 Q_2 [1.1]

Q2 = 2(M-CM) - 2Q2 = 96 - 2 Q_1 [1.2]

Equation 1.1 is the reaction function for firm 1. Equation 1.2 is the reaction function for firm 2.

To determine the Cournot-Nash equilibrium you can solve the equations simultaneously. The equilibrium quantities can also be determined graphically. The equilibrium solution would be at the intersection of the two reaction functions. Note that if you graph the functions the axes represent quantities. The reaction functions are not necessarily symmetric. The firms may face differing cost functions in which case the reaction functions would not be identical nor would the equilibrium quantities.

Bertrand model

The Bertrand model is essentially the Cournot-Nash model except the strategic variable is price rather than quantity.

The model assumptions are:

There are two firms in the market

They produce a homogeneous product

They produce at a constant marginal cost

Firms choose prices PA and PB simultaneously

Firms outputs are perfect substitutes

Sales are split evenly if PA = PB

The only Nash equilibrium is PA = PB = MC.

Neither firm has any reason to change strategy. If the firm raises prices it will lose all its customers. If the firm lowers price P < MC then it will be losing money on every unit sold.

The Bertrand equilibrium is the same as the competitive result.Each firm will produce where P = marginal costs and there will be zero profits. A generalization of the Bertrand model is the Bertrand-Edgeworth Model that allows for capacity constraints and more general cost functions. According to this model, each firm faces a demand curve kinked at the existing price. The conjectural assumptions of the model are; if the firm raises its price above the current existing price, competitors will not follow and the acting firm will lose market share and second if a firm lowers prices below the existing price then their competitors will follow to retain their market share and the firm's output will increase only marginally. 

If the assumptions hold then:

The firm's marginal revenue curve is discontinuous (or rather, not differentiable), and has a gap at the kink

For prices above the prevailing price the curve is relatively elastic

For prices below the point the curve is relatively inelastic

The gap in the marginal revenue curve means that marginal costs can fluctuate without changing equilibrium price and quantity.Thus prices tend to be rigid.

The Stackelberg leadership model 

-is a strategic game in economics in which the leader firm moves first and then the follower firms move sequentially. It is named after the German economist Heinrich Freiherr von Stackelberg who published Market Structure and Equilibrium (Marktform und Gleichgewicht) in 1934 which described the model.

In game theory terms, the players of this game are a leader and a follower and they compete on quantity. The Stackelberg leader is sometimes referred to as the Market Leader.

There are some further constraints upon the sustaining of a Stackelberg equilibrium. The leader must know ex ante that the follower observes his action. The follower must have no means of committing to a future non-Stackelberg follower action and the leader must know this. Indeed, if the 'follower' could commit to a Stackelberg leader action and the 'leader' knew this, the leader's best response would be to play a Stackelberg follower action.

Firms may engage in Stackelberg competition if one has some sort of advantage enabling it to move first. More generally, the leader must have commitment power. Moving observably first is the most obvious means of commitment: once the leader has made its move, it cannot undo it - it is committed to that action. Moving first may be possible if the leader was the incumbent monopoly of the industry and the follower is a new entrant. Holding excess capacity is another means of commitment

In comparison with other oligopoly models,

  •  The aggregate Stackelberg output is greater than the aggregate Cournot output, but less than the aggregate Bertrand output.
  •  The Stackelberg price is lower than the Cournot price, but greater than the Bertrand price.
  •  The Stackelberg consumer surplus is greater than the Cournot consumer surplus, but lower than the Bertrand consumer surplus.
  •  The aggregate Stackelberg output is greater than pure monopoly or cartel, but less than the perfectly competitive output.
  •  The Stackelberg price is lower than the pure monopoly or cartel price, but greater than the perfectly competitive price.


 

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