market structure

• Contestable markets: A market is said to be contestable if firms can enter/ exit freely. Barriers to entry, specifically sunk costs, are low.
• Sunk costs: Costs that cannot be recovered:

  Advertising

  Rent

  Research & Development

  Labour costs

  Depreciation
• Contestability allows monopoly to make supernormal profits as barrier to entry and sunk costs are low. This allows entry into the market , This causes competition to increase leading to price wars i.e Prices fall to stay competitive and leads to normal profits + no market share.
• Contestability allows monopoly to make supernormal profits as barrier to entry and sunk costs are low. This allows limit pricing , This causes firms to defend against competition leading to price wars i.e Prices fall to stay competitive and leads to normal profits + retain market share.
• key results of contestability is

  The threat of competition can lead to the same results as having actual competition …

  … as long as sunk costs are low and “hit-and-run” profits are possible.

  •Then a monopoly can be forced to use limit pricing …

  … resulting in an uncompetitive market being allocatively efficient.
• •Perfect Competition implies the market is contestable.•

  Contestability does not imply the market is competitive.•

  You should be able to find a situation where both N and P are low!
• Contestable identifiers:

  •Low barriers

  •Low sunk costs

  •Competition

  •New entry

  •Low prices

  •Limit pricing

  •Low profits
• Uncontestable identifiers:

  •High barriers

  •High sunk costs

  •Monopoly power

  •No entry

  •High prices

  •High prices

  •Supernormal profits
• Anti trust / regulatory implications

  •Can be used to argue for weaker antitrust/ monopoly laws and more deregulation (as these act as barriers to entry).

  •Rather than simply observe that a monopoly exists, look for consumer exploitation (high prices) and try to reduce barriers to entry.

  •Allow limit pricing even though it too is anti-competitive and creates barriers?
• Monopoly (power):

  Pure: Defined as there being only a single seller (100% market share)

  Legal: When a firm has more than x% market share.•New UK CMA: 40%

  •Old UK CC: 25%

  •EU CC: 50%

  •Natural: When an industry cannot sustain competition/ more than one firm.

  •Price Discrimination: When firms set differentprices, for different people, for the same production – requires some degree of monopoly power + other requirements.
• Monopoly power assumptions:

  Price maker (downwards sloping D)

  Profit maximisation (MC=MR)
• Monopoly power analysis

  Business objectives

  Consumer surplus

  Producer surplus

  Allocative efficiency

  Deadweight loss
• Monopoly power examples;

  De Beers – Diamonds

  Standard Oil

  Luxottica – Glasses

  Google – Search Engine

  Microsoft – PCs
• monopoly power evaluations:

  Barriers to entry

  Efficiencies
• Monopoly power allocative efficiency

  Disadvantages : High prices, less choice, lower consumer surplus

  Advantages : Innovation quality
• Monopoly power productive efficiency

  Disadvantages : Diseconomies of scale

  Advantages : Economies of scale
• Monopoly power dynamic efficiency

  Disadvantages : Less incentive to invest

  Advantages : More profits to invest
• Monopoly power x-inefficiency

  Disadvantages : less incentive to cut costs

  Advantages : Has "learnt by doing" has experience
• Price discrimination (3rd degree) Assumptions:

  Price maker

  Firm set different prices – based on PED

  CRS
• Price discrimination (3rd degree) Analysis:

  Consumer & producer surplus

  A.E. and DWL
• Price discrimination (3rd degree) Examples:

  Airlines, trains, uber, cinemas, electricity, student discount.

  Amazon: Search in pairs for the same product.
• Price discrimination (3rd degree) evaluations:

  Monopoly Power

  Screen and segment consumers (may increase costs)

  Prevent resale (may increase costs)

  Production differentiation!
• Natural monopoly assumptions:

  Profit maximising monopolist

  Short run: Huge fixed costs, low variable costs, no crowding out.

  Long run: Huge economies of scale, no diseconomies of scale
• Natural monopoly Analysis:

  N?

  Consumer & producer surplus

  A.E. and DWL
• •Oligopolistic Competition: A market that is dominated by a few large firms. These firms produce differentiated products and can compete through price and/or non-price strategies.
• •N-firm concentration ratio: is calculated as the sum of the market share (%) held by the largest “n” firms. Generally, the greater the concentration ratio, the less competitive the market is.
• •The Prisoner's Dilemma: A situation where two players each have two options whose outcomes depends crucially on the simultaneous choice made by the other, often formulated in terms of two prisoners separately deciding whether to confess to a crime.
• key results for game theory

  A) Cooperation maximises joint producer surplus.

  But is inherently unstable (especially in the short-run, even with communication

  B) Players have a strong incentive to undercut.

  It is always the best response/ dominant strategy in this case.

  C) The stable, competitive (Nash) equilibrium is the worst possible outcome for both players.

  Yet, no firm has a profitable incentive to deviate from this point.
• Collusion

  However, in the long run,  it may be possible to cooperate/ collude to achieve greater individual/ joint profits. Possible through: Repetition, communication, punishment, patience

  •Overt Collusion: Open cartel (OPEC)•

  implicit Collusion: Covert secret (BA vs Virgin)•

  Tacit Collusion: No communication at all... (Price leadership: petrol stations, energy providers, restaurants)

  •Note: All are deemed anticompetitive! Some are just easier to spot
• N Evaluation for oligopoly

  • As the number of firms increases, we expect more competition/ less (stable) collusion
• M Evaluation for oligopoly

  • If one firm is larger than another, price leadership may occur
  • Predatory pricing if the larger firm has economies of scale
• Regulator Evaluation for oligopoly 


  • How strict are regulators when it comes to investigating/ fining collusive behavior
• A Evaluation for oligopoly 


  • Only two possible actions? Firms can compete in many different ways – later
• t Evaluation for oligopoly 


  • Short run vs long run time period
  • Simultaneous vs sequential pricing
• |PED| and/or XED > 1 Evaluation for oligopoly

  What if firms aren't producing strong substitutes? They may be able to increase their prices and make more profit due to inelastic demand that is coming from brand loyalty and successful advertising campaigns
• Rational: Nash equilibrium predictions assume everyone is rational, and everyone knows everyone else is rational
• Credible threats Evaluation for oligopoly 


  • Are punishment strategies credible? Only if they do not hurt the punisher in the process. MAD!
• Pricing strategies

  Price wars / undercutting

  Limit pricing

  Predatory pricing
• Non - pricing strategies

  Advertising

  Research + Development

  Organic / inorganic growth
• Advertising as a non pricing strategies

  If you think advertising is a “waste” of money, you can think of it as a:

  Signal: Only profitable companies can “waste” money advertising. Signal of quality?

  Strategy: I don’t want to advertise but I must in case my competitor does!