Market Structures Different Kinds of Competition Václav Šebek 2015 Václav Šebek (FSS MU) Introduction to Economics 1/34 Q Competitive Markets O Monopoly Q Oligopoly Q Monopolistic Competition Václav Šebek (FSS MU) Introduction to Economics 2/34 Competitive Markets Outline Q Competitive Markets Q Monopoly O Oligopoly O Monopolistic Competition Václav Šebek (FSS MU) <□► < [f? ► < -E ► < -Ž ► -Š 'O Q, O Introduction to Economics 3/34 Competitive Markets CM Features Simple reference model applying only on few industries Many buyers and sellers with insignificant market shares Homogeneous product Everyone is a price-taker, no chance to change the price Firms can enter or exit the market freely in the Long-run, no entry-barriers No information barriers so that technology spreads freely (no patents, copyrights etc.) Václav Šebek (FSS MU) <□► < [f? ► < -E ► < -Ž ► Š 'O Q, O Introduction to Economics 4/34 riables Summary of presentation 05 Theory of Firms Quantity produced (Q), Price (P) Costs • Variable Costs (VC) - associated with quantity produced (the more we produce, the more it costs), usually cost of labor, every factor in the Long Term (LR) • Fixed Costs (FC) - payed once in Short Run (SR) and cannot be spared (the more we produce, it costs the same), usually cost of capital • Total Costs (TC) - TC = VC + FC • Average values of VC, FC and TC (AVC, AFC, AC) - AVC = vc FC at _ TC Q ' AFC = 9r, AC Q ' Q • Marginal Costs (MC) - change of TC with additional Q, MC = ^ » Revenues • Total Revenues (TR) - all items sold, TR = P.Q • Average Revenue (AR) - AR = TR/Q o Marginal Revenue (MR) - change of TR with additional Q, Maximizing Firm's Profit Profit: 7T=TR-TC Firm maximize its profit when MC = MR o = STR 5Q tr Maximizing Firm's Profit (Marginal Values) S/Q MC MC MAX MC Short Run Shut Down Decision Would the firm shut down facing such loss? S/Q MC Short Run Shut Down Decision Not necessarily. Depends whether variable costs are covered. Fixed costs have to be paid anyway. S/Q FC partially covered Q Firm's Supply Connection between price and quantity produced can be seen. Rising price encourages firm to produce more. A mc Firm's Supply yr atc avc ^ Break Even Point -> MRj = ARj = Pj Q Competitive Markets Market Equilibrium • There is no entry-barrier nor information constraint in competitive market. • When price is set (sellers are price-takers), only costs determine the profit. • Costs are determined by production function, ei technology. • But with free information exchange, every firm can acquire the best technology to achieve high profit! • What happens? Incoming producers (firms) together increase the total quantity (even if every one of them cannot do so alone), which result to decrease the price (remember Supply and Demand) so that: P = AVC MC MR Introduction to Economics 11 / 34 Market and Firm's Equilibria in LT • All firms produce at minimal AC (technologicaly optimal q) Example of ST Changes • Rising market demand increases price so producers are willing to produce more and make a profit. q* q Q* = Xiooo P*) and • market does not tend to price equal AC. Monopoly Some Monopoly Issues Government attitude towards monopolies • Avoiding monopolies - antitrust laws • Regulating natural m. • Public ownership Price discrimination - Monopolist able to sell at various prices (separate customers) may increase its profit and reduce DWL. $/Q Václav Šebek (FSS MU) <□► < [f? ► < -E ► < -Ž ► -Š 'O Q, O Introduction to Economics 19 / 34 Regulating Price in Monopoly • Price regulated exactly at P = AR = MC (and = MRreg) erase DWL • Monopolist's profit depends on its AC Oligopoly Outline Q Competitive Markets Q Monopoly Q Oligopoly O Monopolistic Competition Václav Šebek (FSS MU) <□► < [f? ► < -E ► < -Ž ► -Š 'O Q, O Introduction to Economics 21 / 34 Oligopoly Overview • Contrary to extreme examples of Competitive markets and Monopolies: • Few sellers with substantial market share • Each seller may set its production quantity and price, given the demand • Product of each seller is similar if not the same • Important: Action of one seller may have a large impact on the others • Examples: Crude oil, Car makers, Aviation industry, Airlines. .. • Two most famous oligopoly models: Bertrand and Cournot (see chap. 27 in Varian 2010) Introduction to Economics 22 / 34 Oligopoly Game Theory GT describes exactly this kind of relation: How people behave in strategic situations, ei anticipating others behavior Firms in Comp. Mark, and Monopolies didn't have to care about other firms - they were either insignificant or the only one Firms in Oligopolies must take it into account =4> they are playing strategic game, so the GT is good way how to understand their behavior Václav Šebek (FSS MU) <□► < [f? ► < -E ► < -Ž ► -Š 'O Q, O Introduction to Economics 23 / 34 Oligopoly Prisoners Dilemma • Two suspects under arrest deciding separately strategy for interrogation. • Dilemma: Confess or Silence with different outcomes depending on others choice • The best outcome (1/1) cannot be achieved even if players act in collusion, risk of getting 20yrs sentence is way much high. B Confess Silence A Confess Silence 8/8 0/20 20/0 1/1 Introduction to Economics 24 / 34 Oligopoly Dominant Strategy and Nash Equilibrium • When there is a best solution for a player regardless of opponents choice it is dominant strategy • In this particular game, dominant strategy for both players is to confess, which is Nash equilibrium • NE - not necessarily the most effective outcome, but definitely one that can be reached in strategic encounter • Even though being silent =Hess time spent in prison, precaution and self-interest (or simply assuming others moves) lead to opposite strategy B Confess Silence A Confess Silence 8* / 8* 0 / 20* 20* / 0 1/1 Introduction to Economics 25 / 34 Oligopoly Cartel Limited number of sellers on the market may deliberately (in collusion) decrease their output in order to increase price and profit. Sellers would like to act as a monopolist, and set the highest price to achieve highest profit When the demand elasticity is low, price increase might be substantial Governments don't like cartels - extensive search for possible collusion and consequent bans Václav Šebek (FSS MU) Introduction to Economics 26 / 34 Cartel • Cartel members seeking monopolist's profit: VS. S MC(»S) ^SSss/^ ^----- AC X MR A Q IT ^SJR 1-— t--> • Is this really the best solution for all cartel members? Example • Imagine two oil producers with no marginal costs. Any additional barrel is simply taken out of pocket. Total production capacity of each producer is 6 mbpd. Demand schedule might look like this. Price ($/b) 0 10 20 30 40 50 60 70 80 90 Q (mbdp) 12 11 10 9 8 7 6 5 4 3 Profit (m$) 0 110 200 270 320 350 360 350 320 270 • In comp. market with MC = 0 price would be 0 and all 12 mbpd would be produced. • Monopolist would certainly choose Q = 6 with highes revenue/profit • Duopolistic cartel face a dilemma: • While producing 3 mbpd each with equal profit 180 m$ each producer is tempted to increase Qty • With total production 7 mbpd divided 4:3, producer with higher share enjoy 200 m$ profit vs 150 m$ of the other Oligopoly Oil Producer's Game What quantity should they choose? Iraq 3 4 Iran „ 4 180* / 180* 150 / 200* 200* / 150 160* / 160* Two dominant strategies =4> It is difficult to maintain low production and high price Václav Šebek (FSS MU) <□► < [f? ► < -E ► < -Ž ► -Š 'O Q, O Introduction to Economics 29 / 34 Cartel • Key problem of the cartel is its instability • Members always motivated to cheat • Game Theory is ususally apllied when inspecting oligopolies and cartels • Comparison with Competitive markets and Monopoly: • Price: CM < Oligopoly < Monopoly • Qty: CM < Oligopoly < Monopoly Václav Šebek (FSS MU) Introduction to Economics Monopolistic Competition Outline Q Competitive Markets Q Monopoly O Oligopoly Q Monopolistic Competition Václav Šebek (FSS MU) Introduction to Economics 31 / 34 Monopolistic Competition Overview Many sellers, many buyers Free entry Product differentiation - each seller meets down-sloped demand with its special product Price-making works like a monopolist's but free entry ensure that in industries (or products) with high profit attract newcomers =4>price and demand falls so that long-term profits tend to zero (like in competitive markets) Examples: • Books, Movies, Restaurants, Fashion, Shoes, Food etc. Václav Šebek (FSS MU) <□► < [f? ► < -E ► < -Ž ► -Š 'O Q, O Introduction to Economics 32 / 34 Monopolistic Competition Long Term Profit and Equlibrium Q Václav Šebek (FSS MU) <□► < [f? ► < -E ► < -Ž ► -Š 'O Q, O Introduction to Economics 33 / 34 References Monopolistic Competition Hal R. Varian. Intermediate Microeconomics. A Modern Approach. W. W. Norton & Company, 2010. Václav Šebek (FSS MU) Introduction to Economics 34 / 34