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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
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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)
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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
Q*0
Quantity
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
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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
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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
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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)
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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
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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
High
Price
TuInc
$20
$40
Low
Price
$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
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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
Collusion
50
Cournot
33.34
MC = 0
0
50
Quantity
66.66
MR
Competition
Q
100
6-20
Managerial Economics and Organizational Architecture, 5e
2 months
2 months
Avi—No confession
Avi—No confession
The Classic Prisoners’ Dilemma
18 months
Bea—No confession
Avi—Confession
Avi—Confession
0 months
Bea—Confession
Bea—No confession
0 months
18 months
12 months
12 months
Bea—Confession
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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
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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