Managerial Economics and Organizational Architecture, 5e

Managerial Economics and

Organizational Architecture, 5e

Chapter 6:
Market Structure

Copyright © 2009 by The McGraw-Hill Companies, Inc. All Rights Reserved.

McGraw-Hill/Irwin
 Managerial Economics and Organizational Architecture, 5e

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

6-2
 Managerial Economics and Organizational Architecture, 5e

Market Structure
• Perfect competition
• Monopoly
• Monopolistic competition
• Oligopoly

6-3
 Managerial Economics and Organizational Architecture, 5e

Perfect Competition
Characteristics
• Many buyers and sellers
• Product homogeneity
• Low cost and accurate information
• Free entry and exit
• Best regarded as a benchmark

6-4
 Managerial Economics and Organizational Architecture, 5e

Firm Demand Curve

Perfect Competition
$ $

S
Price (in dollars)

P* P* Di = MRi = ARi

D
Q Qi
Quantity (market) Quantity (firm i)

6-5
 Managerial Economics and Organizational Architecture, 5e

Firm Supply
• Short run
– Marginal cost curve above average
variable cost
– P* = SRMC
• Long run
– Long-run marginal cost curve
above long-run average cost
6-6
 Managerial Economics and Organizational Architecture, 5e

The Firm’s Short-Run Supply Curve

$

ATCi
Costs per unit of output (in dollars)

SRMCi
AVCi

Qi 6-7
Quantity (firm i)
 Managerial Economics and Organizational Architecture, 5e

The Firm’s Long-Run Supply Curve

$

LRMCi LRACi
Cost per unit of output (in dollars)

Qi 6-8

Quantity (firm i)
 Managerial Economics and Organizational Architecture, 5e

Competitive Equilibrium
$ $
Price and cost per unit of output (in dollars)

LRMCi LRACi S0

P*0 P*0

S1

P*1 P*1

D0

Qi Q
Q*i1 Q*i0 Q*0 Q*1

Quantity (firm i) Quantity 6-9

 Managerial Economics and Organizational Architecture, 5e

Barriers to Entry
Incumbent reactions Incumbent advantages
• Specific assets • Precommitment
• Economies of scale contracts
• Excess capacity • Licenses and patents
• Reputation effects • Learning-curve effects
• Pioneering brand
advantages

6-10
 Managerial Economics and Organizational Architecture, 5e

Monopoly
• Single seller in an industry
• Strong barriers to entry
• Profit maximization
– faces market demand and sets MR=MC
• Unexploited gains from trade

6-11
 Managerial Economics and Organizational Architecture, 5e

Monopolist Faces Market Demand

$
Price and cost per unit of output

Profits

P*=
105 Lost gains
from trade

MC = AC
D
Q
Q*=95
MR
Quantity 6-12
 Managerial Economics and Organizational Architecture, 5e

Monopolistic Competition
• Multiple firms produce similar products
• Firms face downward sloping demand
curves
• Profit maximization occurs where MC=MR
• With free entry and exit, firms compete away
economic profits
• Examples – toothpaste, shampoo,
restaurants, banks
6-13
 Managerial Economics and Organizational Architecture, 5e

Monopolistic Competitor
in the Long Run
Price and cost per unit of output (in dollars)

LRACi

LRMCi

P*i

Di

Qi 6-14
Q*i
MRi
Quantity (firm i)
 Managerial Economics and Organizational Architecture, 5e

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
• Examples – steel, autos, colas, airlines
6-15
 Managerial Economics and Organizational Architecture, 5e

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
6-16
 Managerial Economics and Organizational Architecture, 5e

Determining the Nash Equilibrium

Low TuInc High
Price Price

$20 $40
Low
Price
$40 $0

WonCo

High
$200 $400
Price
$250 $200

6-17
 Managerial Economics and Organizational Architecture, 5e

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, the optimal output for A for the given
output for B is
QA=50-.5QB
• which is the reaction curve for firm A
6-18
 Managerial Economics and Organizational Architecture, 5e

Cournot Equilibrium
QB

100 Firm A’s reaction curve a = Competitive equilibrium

b = Cournot equilibrium
Quantity of output by Firm B

c = Collusive (monopoly) equilibrium

a
50

b
33.33
c
25 Firm B’s reaction curve

QA
33.33 50 100
Quantity of output by Firm A 6-19
 Managerial Economics and Organizational Architecture, 5e

Comparison of Prices and Output

Among Different Equilibria $

100
Price (in dollars)

Collusion
50

Cournot
33.34

Competition
MC = 0
Q
0 50 66.66 100 6-20
MR
Quantity
 Managerial Economics and Organizational Architecture, 5e

The Classic Prisoners’ Dilemma

Avi—No confession
Avi—No confession
2 months 18 months

2 months 0 months
Bea—No confession Bea—Confession

Avi—Confession
Avi—Confession

0 months 12 months

18 months 12 months
6-21
Bea—No confession Bea—Confession
 Managerial Economics and Organizational Architecture, 5e

Cartels
• Occur when firms agree to set price and
output levels
• Generally illegal in the U.S.
• Self interest results in failure of the cartel
• Repeated interaction increase the
incentives to cooperate

6-22
 Managerial Economics and Organizational Architecture, 5e

The Cartel’s Dilemma

AVInc—Low output
AVInc—Low output
$500 $150

$500 $600
BeaCo—Low output BeaCo—High output
AVInc—High output

AVInc—High output
$600 $200

$150 $200

BeaCo—Low output BeaCo—High output 6-23