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Economics for Managers by y Paul Farnham Ch t 8 Chapter Market Structure: Monopoly and Monopolistic Competition © 2005 Prentice Hall, Inc. 8.1 Market Power Market power: ability of a firm to influence the prices of its products d t and d develop d l strategies t t i to earn profits over longer periods of time Monopoly: single firm producing product with no close substitutes Price-searchers: firms in imperfect competition © 2005 Prentice Hall, Inc. 8.2 Monopoly Model with Positive Economic Profit Figure 8.1a 8 1a MC PM A ATC ATCM B MR 0 © 2005 Prentice Hall, Inc. QM D Q 8.3 Monopoly Model with Losses Figure g 8.1b MC B ATC ATCM PM A MR 0 © 2005 Prentice Hall, Inc. QM D Q 8.4 Monopoly Model Monopolist maximizes profits by producing where MR = MC and earns positive iti economic i profit fit due to barriers to entry The Th monopolist li t could ld suffer ff losses if ATC is greater than price at the profit profit-maximizing maximizing level of output (see next slide) The model has no supply curve © 2005 Prentice Hall, Inc. 8.5 Comparing Monopoly and d Perfect P f tC Competition titi Figure 8.2 82 MC ATC P2 MC P1 D=P=MR 0 QPC © 2005 Prentice Hall, Inc. ATC 0 QM Q1 MR Q 8.6 Comparing Monopoly and d Perfect P f tC Competition titi Monopolistic firm must seek out optimal p price, p , which depends p on demand and cost conditions Firms with market power might pursue other profit goals Price is higher and output lower under monopoly than under perfect competition © 2005 Prentice Hall, Inc. 8.7 Barriers to Entry Economies of scale and mergers Barriers created by government Input barriers Brand loyalties Consumer lock-in and switching costs Network N t k externalities t liti © 2005 Prentice Hall, Inc. 8.8 Economies of Scale and d Mergers M Exist when a firm’s LRAC slopes downward or when lower production d ti costs t are associated i t d with larger scale of operation Can C actt as a b barrier i to t entry t in i different industries Mergers M are particularly ti l l important i t t in technology, media, and telecommunications © 2005 Prentice Hall, Inc. 8.9 Barriers Created b G by Governmentt Licenses Patents and copyrights • Public good • Cost of exclusion Regulation © 2005 Prentice Hall, Inc. 8.10 Input Barriers Control over raw materials Barriers in financial capital markets • Larger firms can get lower interest rates • Smaller firms need more collateral for loans • Smaller firms are p perceived as riskier © 2005 Prentice Hall, Inc. 8.11 Consumer Lock-In and S it hi Switching Costs C t When consumers become locked into certain types yp or brands and would incur substantial switching costs if they changed Although lock-in types are dominant,, they y represent p managerial strategies that can be used elsewhere to gain market power © 2005 Prentice Hall, Inc. 8.12 Consumer Lock Lock-In In Costs Contractual commitments Durable purchases Specialized suppliers Search S h costs t Loyalty programs © 2005 Prentice Hall, Inc. 8.13 Consumer S it hi Switching Costs C t Replacement of equipment Learning a new system Converting data to a new format Funding F di off new supplier li Combined buyer and seller search costs Lost benefits from current supplier © 2005 Prentice Hall, Inc. 8.14 Managerial Rule of Thumb: U i Using Lock-in L k i as Strategy St t Managers can • Use lock-in as a competitive p strategy • Be prepared to offer customers concessions i and d attractive tt ti terms t • Sell to influential buyers and attract buyers b ers with ith high switching s itching costs • Increase customer commitment and entrenchment © 2005 Prentice Hall, Inc. 8.15 Network Externalities Act as a barrier to entry because the value of a p product depends p on number of customers using the product Can be considered demand-side economies of scale,, in contrast to supply-side economies © 2005 Prentice Hall, Inc. 8.16 Measures of M k t Power Market P Managers can use measures to better understand the markets • Lerner Index: measure of market power that focuses on the difference between a firm’s product price and marginal cost of production d ti L = (P – MC) P © 2005 Prentice Hall, Inc. 8.17 Cross Elasticity off Demand D d Percentage change in the quantity demanded of g good X relative to the percentage change in the price of good Y The higher the cross elasticity, the g greater the potential p substitution between goods © 2005 Prentice Hall, Inc. 8.18 Concentration Ratios Measure market power by focusing on share of the market held by the largest firms fi Assume that the larger the share of the market k t held h ld by b few f firms, fi the th more market power those firms have © 2005 Prentice Hall, Inc. 8.19 Herfindahl-Hirschman I d Index Uses information about market shares of firms in the industry Is the sum of the squares of the market share of each firm in the industry The U.S. Justice Dept. uses it to evaluate competitive efforts of mergers © 2005 Prentice Hall, Inc. 8.20 Antitrust Issues Federal (country) or supranational (EU) legislation that limits market power of firms and regulates how firms use their market power to compete p © 2005 Prentice Hall, Inc. 8.21 Focus of the Horizontal M Merger Guidelines G id li Definition D fi iti off the th relevant l t market k t Level of seller competition in that market Possibility that a merging firm might affect price and output Nature and extent of entry into the market Extent to which any cost savings and efficiencies could offset increase in market power © 2005 Prentice Hall, Inc. 8.22 Managerial Rule of Thumb: U d Understanding t di Antitrust A tit t Laws L Managers must work within antitrust constraints Because of generalities and ambiguities, managers may not know whether their actions are illegal g unless the government g initiates litigation © 2005 Prentice Hall, Inc. 8.23 Assumptions of M Monopolistic li ti Competition C titi Product differentiation exists among g firms Large number of firms exist No N iinterdependence t d d exists i t among these firms Entry by new firms is relatively easy © 2005 Prentice Hall, Inc. 8.24 Monopolistic Competition, L Long Run R and d Short Sh t run Figure 8.4 84 MC P1 MC ATC ATC P2 MR 0 Q1 © 2005 Prentice Hall, Inc. D Q MR D 0 Q2 Q 8.25 Managerial Rule of Thumb: Market Power in Monopolistic Competition Managers must develop a variety of strategies g to maintain market power when faced with intense competition They can exploit geographic advantages, g , offer improved p customer service, become part of a cooperative to lower cost, and d develop l specialized i li d niches i h © 2005 Prentice Hall, Inc. 8.26 Summary of Key Terms Antitrust laws Barriers to entry Concentration ratios Herfindahl-Hirschman H fi d hl Hi h I d Index Lerner Index Lock-in and switching costs © 2005 Prentice Hall, Inc. 8.27 Summary of Key Terms Market power Monopolistic competition Monopoly Network N t k externalities t liti Price-searcher © 2005 Prentice Hall, Inc. 8.28 Do you have any questions? © 2005 Prentice Hall, Inc. 8.29
