Transcript No Slide Title

OHT 7.1
CHAPTER 7.
Analysis of monopoly markets
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The conditions for monopoly.
Price and output decisions in monopoly
markets.
Barriers to entry and exit.
Welfare costs of monopoly.
Possible dynamic gains from monopoly.
Assessing monopoly power.
Economic rent seeking behaviour.
J. Nellis and D. Parker, Principles of Business Economics. © Pearson Education Limited 2002.
Learning outcomes
OHT 7.2A
This chapter will help you to:
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Identify the circumstances and conditions under
which a monopoly is said to exist.
Recognise the main features of monopoly markets
in terms of price and output decisions.
Appreciate why a monopolist can be described as
being a price-maker.
Understand the importance and various forms of
barriers to entry in monopoly markets as means of
sustaining a position of market dominance.
Grasp the significance of monopoly power and the
impact on economic welfare in terms of allocative
and productive efficiency.
J. Nellis and D. Parker, Principles of Business Economics. © Pearson Education Limited 2002.
Learning outcomes
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OHT 7.2B
Assess the degree of monopoly power using
various methods of measuring market
dominance.
Appreciate the importance of potential
market entry in limiting monopoly power
(referred to as market contestability).
Understand the significance of rent seeking
behaviour.
J. Nellis and D. Parker, Principles of Business Economics. © Pearson Education Limited 2002.
Price and output decisions in monopoly markets
Figure 7.1 Price and output under monopoly
J. Nellis and D. Parker, Principles of Business Economics. © Pearson Education Limited 2002.
OHT 7.3
Barriers to entry and exit
OHT 7.4
Barriers to entry prevent competitors entering the market.
Important examples are the following:
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Patents and copyright
Government regulations, licences and state ownership
Tariffs and non-tariff barriers
The existence of natural monopolies.
Lower costs of production than competitors
Control of necessary factors of production and materials
Control of distribution channels
J. Nellis and D. Parker, Principles of Business Economics. © Pearson Education Limited 2002.
OHT 7.5
Even where there is no absolute barrier to entry,the monopolist may be
able to deter competitors by, for example:
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Predatory pricing or the threat of a price war and other action against
potential competitors.
Creating excess capacity ,which signals to potential suppliers that the
monopolist might react to competition by increasing output and thus
reducing the market price.
Creating brand loyalty ,including large-scale advertising expenditure.
High research and development expenditure ,as in the
pharmaceuticals industry.
A final barrier to entry is a barrier to exit .The main obvious barrier to
exit facing a firm occurs where there are appreciable sunk costs .
Sunk costs arise when there is a need for high capital investment by a
potential new entrant to match the production costs of the monopolist
and these are costs which cannot be recouped if the firm subsequently
decides to leave the industry.
J. Nellis and D. Parker, Principles of Business Economics. © Pearson Education Limited 2002.
OHT 7.6
The welfare losses associated with monopoly
fall into four main areas of concern.
These are:
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Higher prices, higher profits and lower
outputs.
Loss of consumer surplus.
Higher production costs.
Loss of consumer choice.
J. Nellis and D. Parker, Principles of Business Economics. © Pearson Education Limited 2002.
Higher prices, higher profits and lower
outputs than under perfect competition
Figure 7.2 The welfare costs of monopoly
J. Nellis and D. Parker, Principles of Business Economics. © Pearson Education Limited 2002.
OHT 7.7
OHT 7.8
Patents and monopoly power
J. Nellis and D. Parker, Principles of Business Economics. © Pearson Education Limited 2002.
Assessing monopoly power
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Profit rates, and
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Concentration ratios.
J. Nellis and D. Parker, Principles of Business Economics. © Pearson Education Limited 2002.
OHT 7.9
OHT 7.10
Profit rates
Lerner index =(P -MC)/P
J. Nellis and D. Parker, Principles of Business Economics. © Pearson Education Limited 2002.
OHT 7.11
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Simple concentration ratios
These ratios represent the extent of the market supplied by a given
number of firms. For example, a four-firm concentration ratio shows
the percentage of the market supplied by the four largest producers.
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Concentration ratios including market shares
One measure commonly used by government competition
authorities is the so-called Herfindahl 蓬Hirschman Index (HHI).This
index,when measuring the degree of competition in a market,takes
into account both the total number of firms in the market and their
relative size distribution. It is measured as follows:
n
Herfindahl-Hirschman Index (HHI) =
2
S
 i
i =1
Where Si represents the market shares of each of the i firms
in the market.
J. Nellis and D. Parker, Principles of Business Economics. © Pearson Education Limited 2002.
OHT 7.12A
Key learning points
• A pure monopoly exists when a single firm supplies the
entire market for a good or service.
• Monopoly is associated with supernormal profits and with
high barriers to entry to the market that protect the
monopolist’s market dominance.
• The monopolist’s demand curve will be downward sloping,
implying that more can be sold at lower price.
• Monopolists are price-makers and profits are maximised
where marginal revenue(MR) equals marginal costs (MC).
• Barriers to entry prevent competitors entering the market,
examples being patents and copyright, government
regulations, licences and state ownership,tariffs and nontariff barriers,natural monopolies,lower costs of production
than competitors, control of necessary factors of production
and control over distribution channels.
J. Nellis and D. Parker, Principles of Business Economics. © Pearson Education Limited 2002.
OHT 7.12B
Key learning points
• Sunk costs arise when there is a need for high capital
investment by a potential new entrant to match the production
costs of the monopolist and these are costs which cannot be
recouped if the firm subsequently decides to leave the industry.
• The welfare losses associated with monopoly,compared with a
competitive industry, fall into four main areas of concern,namely:
防higher prices,higher profits and lower outputs;
僕loss of consumer surplus;
防higher production costs;
僕loss of consumer choice.
• There are,however,possible dynamic gains from monopoly
involving:
貌economies of scale and scope;
吠increased product and process innovation through increased
investment in R&D.
• A contestable market occurs where there are no barriers to the
entry of firms into the market.
J. Nellis and D. Parker, Principles of Business Economics. © Pearson Education Limited 2002.
Key learning points
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OHT 7.12C
The degree of monopoly power (dominance) in a
market can be assessed using:
朴profit rates;
- concentration ratios;
- the Herfindahl 蓬Hirschman Index.
Economic rent is earnings over and above those
necessary to maintain an input in its present use (or its
opportunity cost ).
Rent seeking behaviour exists when economic
agents attempt to earn economic rents.
J. Nellis and D. Parker, Principles of Business Economics. © Pearson Education Limited 2002.
OHT 8.1
CHAPTER 8.
Analysis of monopolistically
competitive markets
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The conditions for monopolistic competition.
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Price and output decisions in the short run and
long run.
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The implications of monopolistic competition.
J. Nellis and D. Parker, Principles of Business Economics. © Pearson Education Limited 2002.
OHT 8.2
Learning outcomes
This chapter will help you to:
• Identify the circumstances and conditions under
which monopolistic competition is said to exist.
• Recognise the main features of monopolistically
competitive markets in terms of price and output
decisions.
• Appreciate the role of product differentiation in
competitive markets and the importance of
branding as a competitive strategy.
• Understand the economic welfare costs associated
with monopolistic competition.
• Differentiate between market equilibrium under
conditions of monopolistic competition in both the
short run and long run.
J. Nellis and D. Parker, Principles of Business Economics. © Pearson Education Limited 2002.
OHT 8.3
Conditions for monopolistic competition
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There is a large number of firms competing in the
market ensuring that each firm has an
insignificantly small share of the total market.
Each firm has the same,or very similar,costs of
production.
There is free entry to, and exit from ,the market
place.
The firms produce and sell goods or services
which are similar (and hence they are substitutes
for each other)but not identical to their rivals.
Firms,therefore,compete by trying to ensure
product differentiation for their goods or services.
J. Nellis and D. Parker, Principles of Business Economics. © Pearson Education Limited 2002.
Price and output decisions in monopolistic competition
Figure 8.1 Monopolastic competition: short run
J. Nellis and D. Parker, Principles of Business Economics. © Pearson Education Limited 2002.
OHT 8.4
Price and output decisions in monopolistic competition
Figure 8.2 Monopolastic competition: long run
J. Nellis and D. Parker, Principles of Business Economics. © Pearson Education Limited 2002.
OHT 8.5
OHT 8.6
Implications of monopolistic competition
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Competition will lower prices and profits as in a
perfectly competitive market. However,the price
will remain higher and the output lower than
under perfect competition .
Production occurs at less than optimum scale
and,as a result,there is excess capacity in the
market .
In practice,markets that approximate to the
monopolistically competitive model tend to be
associated with non-price competition including
branding and other efforts to differentiate the
product .
J. Nellis and D. Parker, Principles of Business Economics. © Pearson Education Limited 2002.
OHT 8.7
Figure 8.3 Long-run equilibrium: comparison of perfect and monopolistic
competition
J. Nellis and D. Parker, Principles of Business Economics. © Pearson Education Limited 2002.
OHT 8.8A
Key learning points
• A monopolistically competitive market is one in which there
is a high degree of competition with a large number of firms
selling very similar,but not identical, products or services.
• Each firm faces a downward sloping demand curve
because the products or services are differentiated in some
way.This means that average revenue exceeds marginal
revenue (i.e.AR >MR).
• The short-run equilibrium in a monopolistically competitive
market occurs when profits are maximised. This,as always, is
the output associated with the condition that marginal revenue
equals marginal cost,i.e.MR =MC.
• In the short-run, supernormal profits can exist which act as
an incentive for new firms to enter the industry supplying close
substitute products or services.
• As new firms enter the market,the demand curve facing each
firm shifts to the left and becomes more price elastic because
of the larger number of suppliers and choice of products or
services available in the market.
J. Nellis and D. Parker, Principles of Business Economics. © Pearson Education Limited 2002.
Key learning points
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OHT 8.8B
In the long-run equilibrium, all of the supernormal
profits are competed away and only normal profits now
exist,determined by the condition that AR =ATC (longrun).
Each firm in monopolistic competition produces an
output,in the long run,which is lower than that at which
ATC is minimised, i.e.production occurs at a suboptimal scale resulting in excess capacity in the
industry.
The price paid by consumers in monopolistically
competitive markets is higher than under perfect
competition (P >MC). Thus the higher price may be
interpreted as the cost to consumers of having the
choice of selecting from a range of differentiated
products.
J. Nellis and D. Parker, Principles of Business Economics. © Pearson Education Limited 2002.
OHT 9.2A
Learning outcomes
This chapter will help you to:
• Identify the market conditions which lead to oligopolistic behaviour
and outcomes.
• Appreciate the nature of business behaviour in oligopolistic
markets where there is a small number of producers of
homogeneous or, more commonly, differentiated products or
services.
• Understand how the price and output decisions of one firm in an
oligopolistic market may impact on the price and output decisions
of rival firms.
• Recognise that interdependence and expected reactions amongst
firms are central to understanding behaviour in oligopolistic
markets.
• Realise the different ways in which oligopolists compete using
various product differentiation strategies.
J. Nellis and D. Parker, Principles of Business Economics. © Pearson Education Limited 2002.
OHT 9.2B
Learning outcomes
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Gain insights into two central models which attempt to
identify the behaviour of firms operating in oligopolistic
markets, namely the kinked demand curve and game
theory.
Appreciate why oligopolistic markets are prone to anticompetitive behaviour on the part of firms, including priceleadership and collusion of various forms.
J. Nellis and D. Parker, Principles of Business Economics. © Pearson Education Limited 2002.
Conditions of oligopoly
OHT 9.3
Oligopoly, like monopolistic competition situations, is a form of
imperfect competition and is without doubt the most common form
of market structure in developed economies. An oligopoly market
is associated with the following conditions:
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Few suppliers and many buyers.
Homogeneous or, more commonly, differentiated
products.
Barriers to entry into the market 紡allowing firms to
exercise some degree of market power.
Mutual interdependence between firms in the industry
穆such that actions on the part of one or more firms can be
expected to provoke competitive reactions on the part of
other firms.
Each firm has sufficient market power to prevent it from
being a price-taker,but at the same time there is sufficient
interfirm rivalry to rule out the firm treating the market
demand curve as identical to its own.
J. Nellis and D. Parker, Principles of Business Economics. © Pearson Education Limited 2002.
OHT 9.4
Theories of oligopoly behaviour
Several theories of oligopoly have been developed based on
different assumptions about:
(a) competitors’ behaviour;
(b) the extent and form of entry and exit barriers;and
(c) the likelihood of collusion between suppliers
All of the theories have in common, however, the uncertainty
which exists in oligopolistic markets regarding outcomes.The
nature and importance of rivals’ reactions are captured in two
central models of oligopoly behaviour,namely:
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The kinked demand curve.
Game theory.
J. Nellis and D. Parker, Principles of Business Economics. © Pearson Education Limited 2002.
The kinked demand curve
Figure 9.1 The kinked demand curve
J. Nellis and D. Parker, Principles of Business Economics. © Pearson Education Limited 2002.
OHT 9.5
OHT 9.6
Figure 9.2 Oligopoly profit maximisation and cost changes
J. Nellis and D. Parker, Principles of Business Economics. © Pearson Education Limited 2002.
Game theory
OHT 9.7
A game occurs when there are two or more interacting
decision-takers (players ) and each decision or
combination of decisions involves a particular
outcome (pay-off ).
J. Nellis and D. Parker, Principles of Business Economics. © Pearson Education Limited 2002.
OHT 9.8
The Prisoner’s Dilemma
J. Nellis and D. Parker, Principles of Business Economics. © Pearson Education Limited 2002.
OHT 9.9
Figure 9.3 Pay-off matrix for firms A and B with low and high promotional
spending
J. Nellis and D. Parker, Principles of Business Economics. © Pearson Education Limited 2002.
OHT 9.10
Price leadership under oligopoly
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Dominant firm price leadership.
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Barometric price leadership.
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Collusive price leadership.
J. Nellis and D. Parker, Principles of Business Economics. © Pearson Education Limited 2002.
OHT 9.11
Collusion in oligopoly markets
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Explicit collusion includes the creation of a
restrictive practice or cartel between producers,
where prices may be jointly set and markets shared
out.
Tacit collusion occurs where firms do not formally
collude but nevertheless undertake actions that are
likely to minimise a competitive response, e.g.
avoiding price cutting or not attacking each other ’s
market.
Price leadership is a form of tacit collusion.
J. Nellis and D. Parker, Principles of Business Economics. © Pearson Education Limited 2002.
OHT 9.12
Figure 9.4 Duopoly: cheating as the dominant strategy
J. Nellis and D. Parker, Principles of Business Economics. © Pearson Education Limited 2002.
OHT 9.13
Figure 9.5 Duopoly: co-operation as the dominant strategy
J. Nellis and D. Parker, Principles of Business Economics. © Pearson Education Limited 2002.
OHT 9.14A
Key learning points
• Oligopoly is the term used to describe markets where a
small number of firms compete, supplying relatively
homogeneous or differentiated products.
• Duopoly refers to an oligopolistic market where there
are only two firms competing.
• There is a high degree of mutual interdependence
between firms in oligopoly markets and the actions of
one firm are likely to lead to competitive reactions by the
other firms.
• Each firm has sufficient market power to prevent it from
being a price-taker, although interfirm rivalry will prevent
each firm from treating the market demand curve as
identical to its own.
• Several theories of oligopoly have been Developed,
each having in common the uncertainty which exists
regarding outcomes.
J. Nellis and D. Parker, Principles of Business Economics. © Pearson Education Limited 2002.
Key learning points
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OHT 9.14B
The kinked demand curve theory is concerned with the
reactions of firms to an increase or reduction in the price
charged by one of the firms in the market.This model is
associated with price rigidity (‘sticky’ prices).
Game theory explores more complex oligopoly situations
based on interacting decision-takers (players)and different
outcomes (pay-offs) associated with different competitive
strategies.
The results of game theory are assessed using a pay-off
matrix and an equilibrium outcome,where each player
chooses his best strategy given the actions of the other
players,is called a Nash equilibrium .
A maximin strategy involves a player choosing the best
possible outcome from among the set of worst possible
outcomes.
A maximax approach involves choosing the strategy that has
the best possible outcome.
J. Nellis and D. Parker, Principles of Business Economics. © Pearson Education Limited 2002.
Key learning points
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OHT 9.14C
A minimax strategy involves a player minimising the
maximum opportunity loss associated with what might turn
out to be a wrong decision.
A dominant strategy occurs where the same behaviour is
suggested by different strategies by other players.
The Prisoner ’s Dilemma highlights how two or more
players,acting in their best personal interest,may choose an
inferior outcome than if they had colluded.This analysis
neatly illustrates why firms have incentives to form cartels.
Oligopoly markets are associated with price leadership,
involving dominant, collusive and barometric pricing
behaviour.
J. Nellis and D. Parker, Principles of Business Economics. © Pearson Education Limited 2002.