Managerial Economics and Organizational Architecture, 5e Managerial Economics and Organizational Architecture, 5e Chapter 6: Market Structure McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc All Rights Reserved Managerial Economics and Organizational Architecture, 5e Market Structure • What is a market? • All firms and individuals willing and able to buy or sell a particular product • What is market structure? • Defined by attributes of the market environment 6-2 Managerial Economics and Organizational Architecture, 5e Market Structure • • • • Perfect competition Monopoly Monopolistic competition Oligopoly 6-3 Managerial Economics and Organizational Architecture, 5e Perfect Competition Characteristics • • • • • Many buyers and sellers Product homogeneity Low cost and accurate information Free entry and exit Best regarded as a benchmark 6-4 Managerial Economics and Organizational Architecture, 5e Firm Demand Curve Perfect Competition $ $ Price (in dollars) S P* P* Di = MRi = ARi D Q Quantity (market) Qi Quantity (firm i) 6-5 Managerial Economics and Organizational Architecture, 5e Firm Supply • Short run – Marginal cost curve above average variable cost – P* = SRMC • Long run – Long-run marginal cost curve above long-run average cost 6-6 Managerial Economics and Organizational Architecture, 5e The Firm’s Short-Run Supply Curve Costs per unit of output (in dollars) $ ATCi SRMCi Quantity (firm i) AVCi Qi 6-7 Managerial Economics and Organizational Architecture, 5e The Firm’s Long-Run Supply Curve Cost per unit of output (in dollars) $ LRMCi Quantity (firm i) LRACi Qi 6-8 Managerial Economics and Organizational Architecture, 5e Competitive Equilibrium $ $ Price and cost per unit of output (in dollars) LRMCi S0 LRACi P*0 P*0 S1 P*1 P*1 D0 Qi Q*i1 Q*i0 Quantity (firm i) Q*0 Quantity Q Q*1 6-9 Managerial Economics and Organizational Architecture, 5e Barriers to Entry Incumbent reactions Incumbent advantages • • • • Specific assets Economies of scale Excess capacity Reputation effects • Precommitment contracts • Licenses and patents • Learning-curve effects • Pioneering brand advantages 6-10 Managerial Economics and Organizational Architecture, 5e Monopoly • Single seller in an industry • Strong barriers to entry • Profit maximization – faces market demand and sets MR=MC • Unexploited gains from trade 6-11 Managerial Economics and Organizational Architecture, 5e Monopolist Faces Market Demand Price and cost per unit of output $ Profits P*= 105 Lost gains from trade MC = AC D Q*=95 Q MR Quantity 6-12 Managerial Economics and Organizational Architecture, 5e Monopolistic Competition • Multiple firms produce similar products • Firms face downward sloping demand curves • Profit maximization occurs where MC=MR • With free entry and exit, firms compete away economic profits • Examples – toothpaste, shampoo, restaurants, banks 6-13 Managerial Economics and Organizational Architecture, 5e Price and cost per unit of output (in dollars) Monopolistic Competitor in the Long Run LRACi LRMCi P*i Di Q*i Qi MRi Quantity (firm i) 6-14 Managerial Economics and Organizational Architecture, 5e Oligopoly • A few firms produce most market output • Products may or may not be differentiated • Effective entry barriers protect firm profitability • Firm interdependence requires strategic thinking • Examples – steel, autos, colas, airlines 6-15 Managerial Economics and Organizational Architecture, 5e The Nash Equilibrium • An oligopolist does the best it can, given expectations of rival behavior • Behaviors are noncooperative • Duopolists considering a low price or a high price must consider rival’s response • Nash equilibrium occurs when each firm does the best it can given rival’s actions 6-16 Managerial Economics and Organizational Architecture, 5e Determining the Nash Equilibrium Low Price $20 Low Price High Price TuInc $40 $40 $0 WonCo High Price $200 $400 $250 $200 6-17 Managerial Economics and Organizational Architecture, 5e The Cournot Model • Duopolists A and B face industry demand P=100-Q, Q=QA+QB • Each firm takes the other’s output as fixed E.g., PA=(100-QB*)-QA • Marginal revenue for A is MRA=(100-QB*)-2QA • If MC=0, the optimal output for A for the given output for B is QA=50-.5QB • which is the reaction curve for firm A 6-18 Managerial Economics and Organizational Architecture, 5e Cournot Equilibrium QB 100 a = Competitive equilibrium Firm A’s reaction curve Quantity of output by Firm B b = Cournot equilibrium c = Collusive (monopoly) equilibrium a 50 b 33.33 25 c 33.33 Firm B’s reaction curve 50 Quantity of output by Firm A 100 QA 6-19 Managerial Economics and Organizational Architecture, 5e Comparison of Prices and Output Among Different Equilibria $ Price (in dollars) 100 Collusio n 50 Cournot 33.34 MC = 0 50 Quantity 66.66 MR Competition Q 100 6-20 Managerial Economics and Organizational Architecture, 5e months months Avi—No confession Avi—No confession The Classic Prisoners’ Dilemma 18 months Bea—No confession Avi—Confession Avi—Confession months Bea—Confession Bea—No confession months 18 months 12 months 12 months Bea—Confession 6-21 Managerial Economics and Organizational Architecture, 5e Cartels • Occur when firms agree to set price and output levels • Generally illegal in the U.S • Self interest results in failure of the cartel • Repeated interaction increase the incentives to cooperate 6-22 Managerial Economics and Organizational Architecture, 5e $500 $500 AVInc—Low output AVInc—Low output The Cartel’s Dilemma BeaCo—Low output AVInc—High output AVInc—High output $150 $600 BeaCo—High output BeaCo—Low output $600 $150 $200 $200 BeaCo—High output 6-23 ... Managerial Economics and Organizational Architecture, 5e Market Structure • • • • Perfect competition Monopoly Monopolistic competition Oligopoly 6-3 Managerial Economics and Organizational Architecture, 5e. .. maximization – faces market demand and sets MR=MC • Unexploited gains from trade 6-11 Managerial Economics and Organizational Architecture, 5e Monopolist Faces Market Demand Price and cost per unit of... Managerial Economics and Organizational Architecture, 5e The Firm’s Long-Run Supply Curve Cost per unit of output (in dollars) $ LRMCi Quantity (firm i) LRACi Qi 6-8 Managerial Economics and Organizational Architecture, 5e