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ECO 211 Chapter 10, 14, 15.pdf

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ECO 211

Chapters  10,  14,  15  Concentra▯on,  Monopolis▯c  Compe▯▯on,  and  Oligopoly Varie▯es  of  Market  Structure w We  have  studied  the  two  extremes  of  market  structure  —  perfect  compe▯▯on  and  monopoly. w Most  industries  fall  somewhere  between  those  two,  differing  along  two  significant  scales: § Number  of  suppliers  of  output § The  degree  of  product  differen▯a▯on Monopolis▯c  Compe▯▯on w Monopolis▯c  compe▯▯on  is  a  market  structure  in  which  a  large  number  of  firms  compete  with  each  other  by   making  similar  but  slightly  different  products. w Making  a  product  slightly  different  from  the  product  of  a  compe▯ng  firm  is  called  product  differen▯a▯on. Oligopoly w Oligopoly  is  a  market  structure  in  which  a  small  number  of  producers  compete  with  each  other. w Some  oligopolies  (aluminum  can  manufacturing)  produce  iden▯cal  products. w Others  (automobiles)  produce  differen▯ated  products. Measures  of  Concentra▯on w Industries  in  which  only  a  few  firms  supply  all  the  output  are  said  to  be  concentrated. w Economists  have  developed  two  measures  of  concentra▯on: § The  four-­‐firm  concentra▯on  ra▯o § The  Herfindahl-­‐Hirschman  Index The  Four-­‐Firm  Concentra▯on  Ra▯o w The  four-­‐firm  concentra▯on  ra▯o  is  the  percentage  of  total  industry  sales  (in  dollars)  made  by  the  four  largest   firms. w The  range  of  this  measure  is  from  0  to  100. § 0  is  perfect  compe▯▯on § 100  means  there  are  four  or  fewer  firms  in  the  industry § Ra▯o  <  50  considered  compe▯▯ve Concentra▯on  Ra▯o  Calcula▯ons Smartphone  OS  Market  Share Concentra▯on  Ra▯o  Calcula▯ons Concentra▯on  Ra▯o  Calcula▯ons The  Herfindahl-­‐Hirschman  Index  (HHI)   w The  Herfindahl-­‐Hirschman  Index  (HHI)  is  the  sum  of  the  squared  market  shares  of  the  largest  50  firms  in  an   industry. w For  example,  if  there  are  four  firms  in  an  industry  with  market  shares  of  50%,  25%,  15%,  and  10%,  the  HHI  is: 50 +25 +15 +10  =  3,450 Using  the  HHI w A  monopoly  will  have  an  HHI  of  10,000  (100 ). w The  Jus▯ce  Department  defines  a  compe▯▯ve  market  as  one  with  an  HHI  less  than  1,000  (<100  is  regarded  as   highly  compe▯▯ve). w Markets  with  HHI  values  over  1,000  are  regarded  as  concentrated  (>2,000  is  regarded  as  highly  concentrated). Market  Structure Market  Structure  (Cont.) Limita▯ons  of  Concentra▯on  Measures w There  are  three  main  reasons  why  concentra▯on  ra▯os  may  be  misleading  as  measures  of  market  structure: § The  geographical  scope  of  the  market § Barriers  to  entry  and  firm  turnover § The  correspondence  between  a  market  and  an  industry Geographical  Scope  of  Market w Concentra▯on  ra▯o  calcula▯ons  are  based  on  na▯onal  market  data. w Some  goods  (such  as  newspapers)  are  sold  in  regional  markets. w Other  goods  and  services  (automobiles)  are  sold  in  global  markets. w In  either  case,  concentra▯on  ra▯os  are  misleading. Limita▯ons  of  Concentra▯on  Measures w Market  and  Industry § Markets  are  narrower  than  industries § Firms  make  many  different  products § Firms  switch  from  one  market  to  another Market  and  Industry w Concentra▯on  ra▯os  are  calculated  using  the  Standard  Industrial  Classifica▯on  (SIC)  codes  of  the  U.S.  Department   of  Commerce. w Markets  o▯en  do  not  correspond  neatly  to  industries. w Wes▯nghouse  is  classified  as  an  electrical  goods  and  equipment  producer.    They  actually  produce  many  other   non-­‐electrical  items. Barriers  to  Entry  and  Turnover w Measures  of  concentra▯on  do  not  tell  us  anything  about  the  extent  and  severity  of  barriers  to  entry  in  an   industry. w Even  in  markets  that  are  highly  concentrated,  there  may  be  compe▯▯on  if  entry  and  exit  cause  a  large  amount  of   turnover. Concentra▯on  Measures  for  the  U.S.  Economy w Motor  vehicles,  light  bulbs,  household  laundry  equipment,  chewing  gum,  and  breakfast  cereals  are  highly   concentrated  oligopolies. w Pet  food,  computers,  and  so▯  drinks,  are  moderately  compe▯▯ve w Women’s  clothing,  ice  cream,  concrete  blocks  and  bricks,  and  commercial  prin▯ng  are  highly  compe▯▯ve. Concentra▯on  Measures  in  the  United  States Market  Structures  in  the  U.S.  Economy w Between  1939  and  1980,  the  U.S.  economy  became  increasingly  compe▯▯ve. § In  1980,  three-­‐fourths  of  the  value  of  goods  and  services  produced  in  the  U.S.  was  sold  in  markets  that  are   highly  compe▯▯ve. § Monopolies  accounted  for  only  about  5%  of  total  sales. § Since  1980,  there  has  been  even  more  compe▯▯on  (global  trading),  but  have  also  been  many  mergers  of   oligopolies  leading  to  greater  concentra▯on  in  certain  oligopolis▯c  industries  (i.e.  telecommunica▯ons) Monopolis▯c  Compe▯▯on § Monopolis▯c  compe▯▯on  is  a  market  with  the  following  characteris▯cs: § A  large  number  of  firms. § Each  firm  produces  a  differen▯ated  product. § Firms  compete  on  product  quality,  price,  and  marke▯ng. § Firms  are  free  to  enter  and  exit  the  industry. Monopolis▯c  Compe▯▯on w Large  Number  of  Firms § The  presence  of  a  large  number  of  firms  in  the  market  implies: § Each  firm  has  only  a  small  market  share  and  therefore  has  limited  market  power  to  influence  the  price  of   its  product. § Each  firm  is  sensi▯ve  to  the  average  market  price,  but  no  firm  pays  a▯en▯on  to  the  ac▯ons  of  the  other,   and  no  one  firm’s  ac▯ons  directly  affect  the  ac▯ons  of  other  firms. § Collusion,  or  conspiring  to  fix  prices,  is  impossible. Monopolis▯c  Compe▯▯on w Product  Differen▯a▯on § Firms  in  monopolis▯c  compe▯▯on  prac▯ce  product  differen▯a▯on,  which  means  that  each  firm  makes  a   product  that  is  slightly  different  from  the  products  of  compe▯ng  firms. Monopolis▯c  Compe▯▯on w Compe▯ng  on  Quality,  Price,  and  Marke▯ng § Product  differen▯a▯on  enables  firms  to  compete  in  three  areas:  quality,  price,  and  marke▯ng. § Quality  includes  design,  reliability,  and  service. § Because  firms  produce  differen▯ated  products,  each  firm  has  a  downward-­‐sloping  demand  curve  for  its  own   product. § But  there  is  a  tradeoff  between  price  and  quality. § Differen▯ated  products  must  be  marketed  using  adver▯sing  and  packaging. Monopolis▯c  Compe▯▯on w Entry  and  Exit § No  barriers  to  entry  in  monopolis▯c  compe▯▯on,  so  firms  cannot  earn  an  economic  profit  in  the  long  run. w Examples  of  Monopolis▯c  Compe▯▯on § Figure  13.1  on  the  next  slide  shows  market  share  of  the  largest  four  firms  and  the  HHI  for  each  of  ten   industries  that  operate  in  monopolis▯c  compe▯▯on. Monopolis▯c  Compe▯▯on § The  red  bars  refer  to  the  4    largest  firms. § Green  is  the  next  4. § Blue  is  the  next  12. § The  numbers  are  the  HHI. Output  and  Price  in  Monopolis▯c  Compe▯▯on w Short-­‐Run  Economic  Profit § A  firm  that  has  decided  the  quality  of  its  product  and  its  marke▯ng  program  produces  the  profit   maximizing  quan▯ty  at  which  its  marginal  revenue  equals  its  marginal  cost    (MR  =  MC). § Price  is  determined  from  the  demand  curve  for  the  firm’s  product  and  is  the  highest  price  the  firm  can   charge  for  the  profit-­‐maximizing  quan▯ty. Output  and  Price  in  Monopolis▯c  Compe▯▯on § Figure  13.2(a)  shows  a  short-­‐run  equilibrium  for  a  firm  in  monopolis▯c  compe▯▯on. § It  operates  much  like  a  single-­‐price  monopolist. Output  and  Price  in  Monopolis▯c  Compe▯▯on § Firm  produces  the  quan▯ty  at  which  price  =  marginal  cost  &  sells  that  quan▯ty  for  highest  possible  price. § It  earns  an  economic  profit  (as  in  this  example  when  P  >  ATC) Output  and  Price  in  Monopolis▯c  Compe▯▯on w Long  Run:  Zero  Economic  Profit § In  the  long  run,  economic  profit  induces  entry. § And  entry  con▯nues  as  long  as  firms  in  the  industry  earn  an  economic  profit—as  long  as  (P  >  ATC). § In  the  long  run,  a  firm  in  monopolis▯c  compe▯▯on  maximizes  its  profit  by  producing  the  quan▯ty  at  which   its  marginal  revenue  equals  its  marginal  cost,  MR  =  MC. Output  and  Price  in  Monopolis▯c  Compe▯▯on § As  firms  enter  the  industry,  each  exis▯ng  firm  loses  some  of  its  market  share.  The  demand  for  its  product   decreases  and  the  demand  curve  for  its  product  shi▯s  le▯ward. § The  decrease  in  demand
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