Managerial Economics and Organizational Architecture, Chapter 6

Market structure

Managerial Economics and Organizational Architecture, Chapter 6

Market structureobjectives

Students should be able to

• Differentiate among the four archetypal market structures

• Distinguish between price takers and price searchers

Managerial Economics and Organizational Architecture, Chapter 6

Market structure

• What is a market?– All firms and individuals willing and able to

buy or sell a particular product

• What is market structure?– Defined by attributes of the market

environment

Managerial Economics and Organizational Architecture, Chapter 6

Market structure

• Perfect competition • Monopoly • Monopolistic competition • Oligopoly

Managerial Economics and Organizational Architecture, Chapter 6

Perfect competitioncharacteristics

• Many buyers and sellers

• Product homogeneity

• Low cost and accurate information

• Free entry and exit

Managerial Economics and Organizational Architecture, Chapter 6

Firm demand curveperfect competition

Managerial Economics and Organizational Architecture, Chapter 6

Firm supply

• Short run

• Long run

Managerial Economics and Organizational Architecture, Chapter 6

The firm’s short-run supply curve

Managerial Economics and Organizational Architecture, Chapter 6

The firm’s long-run supply curve

Managerial Economics and Organizational Architecture, Chapter 6

Competitive equilibrium

Managerial Economics and Organizational Architecture, Chapter 6

Barriers to entry

Incumbent reactions• Specific assets• Economies of scale• Excess capacity• Reputation effects

Incumbent advantages• Precommitment

contracts• Licenses and patents• Learning-curve effects• Pioneering brand

advantages

Managerial Economics and Organizational Architecture, Chapter 6

Monopoly

• Strong barriers to entry single supplier

• Profit maximization– faces market demand and sets MR=MC

• Unexploited gains from trade

Managerial Economics and Organizational Architecture, Chapter 6

Monopolist faces market demand

Managerial Economics and Organizational Architecture, Chapter 6

Monopolistic competition

• Multiple firms produce similar products

• Firms face downsloping demand curves

• Profit maximization occurs where MC=MR

• In the limit, firms compete away economic profits

Managerial Economics and Organizational Architecture, Chapter 6

Monopolistic competitor in the long run

Managerial Economics and Organizational Architecture, Chapter 6

Oligopoly

• A few firms produce most market output

• Products may or may not be differentiated

• Effective entry barriers protect firm profitability

• Firm interdependence requires strategic thinking

Managerial Economics and Organizational Architecture, Chapter 6

The Nash equilibrium

• An oligopolist does the best it can, given expectations of rival behavior

• Behaviors are noncooperative

• Duopolists considering a low price or a high price must consider rival’s response

• Nash equilibrium occurs when each firm does the best it can given rival’s actions

Managerial Economics and Organizational Architecture, Chapter 6

Determining the Nash equilibrium

Managerial Economics and Organizational Architecture, Chapter 6

The Cournot model• Duopolists A and B face industry demand

P=100-Q, Q=QA+QB

• Each firm takes the other’s output as fixed

E.g., PA=(100-QB*)-QA

• Marginal revenue for A is

MRA=(100-QB*)-2QA

• If MC=0, profit is maximized if

QA=50-.5QB, which is reaction function

Managerial Economics and Organizational Architecture, Chapter 6

Cournot equilibrium

Managerial Economics and Organizational Architecture, Chapter 6

Comparison of prices and outputamong different equilibria

Managerial Economics and Organizational Architecture, Chapter 6

The classic prisoners’ dilemma

Managerial Economics and Organizational Architecture, Chapter 6

The cartel’s dilemma