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Market Structures

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Objectives of Firms Marginal Revenue (MR)

Traditional theory 1. MR = AR

Profit maximisation

1. MC = MR

Alternative theories

Managerial theories

1. Managerial utility maximisation


2. Sales revenue maximisation
3. Growth maximisation

Behaviourial theories
Total Revenue (TR)
1. A variety of goals, eg. production, sales, market share,
1. Straight line from origin
profit
2. Aim to achieve a satisfactory performance for each goal

Perfect markets

1. Firms are price takers


2. No market power for firms

Imperfect markets

1. Firms are price setters


2. Varying extent of market power of firms

Market structures differ in terms of


Equilibrium Output
1. Nature of product
2. Ease of entry Marginal approach
3. Concentration of firms
4. Competition between firms

Equilibrium output for all market structures at MC = MR

Profits

Normal profit

1. TR = TC
2. Zero economic profit
3. No incentive for firms to leave or new ones to enter

Supernormal profits
1. MC = MR
2. Since P = MR, P = MC. Firm is allocative efficient.
1. TR > TC
2. Firms earns more than opportunity costs
Total approach
3. Entry of firms will depend on ease of entry
a. If barriers exist, profit level remains high 1. Point where vertical difference between TR and TC is the
b. If no entry barriers, profit level goes down to greatest
normal profit

Subnormal profits

4. TR < TC
5. Firms makes less than opportunity cost
6. Firms will cease production when
a. Revenue < Variable Cost, firm leaves in
short run
b. Revenue > Variable Cost, firm continues in
short run but leaves in long run

Perfect Competition

Short Run Profits


Characteristics

Supernormal Profits
1. Homogeneous products
2. No barriers to entry, hence a large number of small firms
3. Firms have no market power, price takers

Revenue Curves

Average Revenue (AR)

1. Same as demand curve of product


2. Perfectly elastic
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New firms will enter → Industry’s supply increases → Price falls Evaluation of Perfection Competition
until normal profit
Pros
Normal Profits
1. Allocative efficient, sum of consumer surplus and producer
surplus is maximum

Subnormal Profits

2. Production at least cost output, minimum efficient scale


3. Normal profit
4. Ease of movement of resources

Cons

1. Social efficiency is not attainable without government


intervention when externalities are present
2. Little incentive to innovate
3. Absence of product variety

Monopoly

Firm’s objective shifts to loss minimisation. Characteristics

Long Run Profits 1. No close substitutes


2. Strong barriers to entry
1. Normal profit 3. Only firm
2. Price = Minimum of AC (minimum efficient scale) 4. Strong market power

Barriers to Entry

1. Cost condition
a. Highly capital-intensive
b. Minimum efficient scale occurs at high
output
2. Legal barriers
3. Contrived barriers
a. Control of input supplies
b. Brand loyalty

Revenue Curves

From supernormal profits to long run equilibrium, AR/MR moves


down
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1. Different types of consumers (with different price elasticity


of demand) charged differently
2. Less elastic market charged higher

Two effects:

1. Absorption of consumer surplus by firm

Equilibrium
2. Allocatively efficient as in 1st degree

Pros
Supernormal profits due to:

1. Higher consumption level made possible


1. P > MC
2. Extra revenue is reinvested
2. Price discrimination 3. Enables firms to supply otherwise unprofitable goods
3. Lower costs from economies of scale
4. Incentive to innovate

Evaluation of Monopoly

Pros

1. Cost advantage
a. Economies of scale and R&D will lead to lower MC
b. Price can be lower and output (MC = MR) can be
higher than allocative efficient level of PC (P =
MC)
c. Lower MC → Larger consumer surplus
2. Research and development
3. Lower cost despite not producing at minimum efficient scale
Shaded area = Supernormal profits as MC is lower

Price Discrimination Cons

A practice of firms charging different prices for the same 1. Allocatively inefficient
products, unsupported by cost reasons 2. Higher price, lower output
a. Production at MC = MR and not P = MC
Conditions Necessary
b. Loss of consumer surplus

1. Markets are separable


2. Differing price elasticities of demand between markets
3. Resale of product not possible

1st Degree Price Discrimination

1. Different price for every customer


2. No consumer surplus left
3. Allocatively efficient (P = MC)

2nd Degree Price Discrimination

1. Charging differently according to blocks of consumption

3. Income inequality

Theory of Contestable Markets

1. Price, output and behaviour in an industry is determined by


the threat of competition
2. Monopolies forced to be more efficient and lower price to
prevent new entrants
3. Factors favouring contestability:
a. Free trade policy
b. Deregulation trend

Controlling Monopolies

3rd Degree Price Discrimination 1. Regulation on pricing and output


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2. Transferring monopoly to government (nationalisation)


3. Taxes
4. Legislations and anti-trust policies

Monopolistic Competition

Characteristics

1. Slightly differentiated products


2. Entry of firms is relatively easy
3. Many small firms
4. Mild market power due to slight product differentiation

Revenue Curve

1. Same as monopoly, with lower price elasticity

Short Run Profit

1. Supernormal profits

Monopolistic Competition leads to:

1. Higher price
2. Lower output
3. Higher AC

Comparison between Monopolistic Competition and


Monopoly

1. Lack of R&D due to normal profits


2. Monopolistic competition’s smaller scale leads to higher
costs

2. Normal profits Oligopoly

Characteristics

1. Differentiated products
2. Restricted entry of new firms
3. Few large firms
a. Two firms - Duopoly
4. Interdependence among firms

Alternative Theories of Oligopoly’s Price-Output

Non-collusive

1. Price rigidity with kinked demand

3. Subnormal profits a. Drop in price → others follow → revenue falls →


a. AC above AR demand is inelastic
b. Rise in price → others do not follow → revenue
Long Run Profit falls → demand is elastic

1. Supernormal profits → entry of new firms Collusive

a. Decrease in demand for firms → MR and AR shifts 1. Cartel


to the left and become more elastic 2. Dominant firm price leadership
2. Normal profits 3. Barometric firm price leadership
3. Output falls short of MES 4. ‘Rule of thumb’ pricing

Evaluation of Monopolistic Competition ➢ Collusion best when:


I. Few firms
Pros II. Identical products
III. Awareness of methods and common costs
1. Small margin of P > MC IV. No new competition
2. Economies of scale → lower LRAC, lower MC, higher output
Evaluation of Oligopoly
3. Product varieties

Pros
Cons

1. R&D
1. Allocative inefficient (P > MC)
2. Product differentiation
2. Excess capacity between LR output ant MES output
3. Lack of R&D
Cons
Comparison between Monopolistic Competition and
1. Allocatively inefficient (P > MC)
Perfect Competition
2. Wastage of resources
3. Smaller scale of production compared to monopoly
4. Firms may collude and behave as a monopoly

Non-Price Competition
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1. Product development and innovation


2. Marketing

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