MANAGERIAL DECISION MAKING

F.  Market Structure

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1.  Perfect competition

Ex. - Financial markets

a.  Conditions

(1)  Large number of firms supplying goods and services to large numbers of consumers

(2)  No barriers to new firms entering the market

• Typical firm earns zero economic profit

(3)  All firms produce and sell identical standardized products

• Competition only with respect to price

• Consumers have perfect information about prices

• All goods sell at a single price

(4)  Firms and consumers are price takers

• Firms take price as given => no control over price

• Price determined by supply and demand

2.  Monopoly

• Only one seller of a product

Ex. - Xerox, AMA, NCAA

a.  Barriers to entry

(1)  Economies of scale

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(2)  Capital requirements

• Production, research

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(3)  Pure quality and cost advantages

• Superior technology, more efficient management, economies of scope, learning

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(4)  Product differentiation

• Preference for product or brand created by advertising or marketing

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(5)  Control of resources

• Raw materials, scientific talent, location

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(6)  Patents, copyrights, and other legal barriers

• Patent - exclusive right to make, use, or sell an invention for 20 years

• Applies to ideas, processes, or systems in addition to inventions

Wacky Patents

• Copyrights - intellectual property

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(7)  Strategic barriers

• Limit pricing, threat of retaliatory pricing, advertising and brands, excess productive capacity

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b.  Monopoly behavior

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c.  Monopolistic competition

• Differentiated product - some control over price

• Large number of firms

• Free entry into market

3.  Oligopoly

• Small number of interdependent firms

a.  Measurement

(1)  Concentration ratio

• % of sales accounted for by top firms (4, 8, 20)

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CR₁ > 90 => effective monopoly

CR₄ < 40 => effectively competitive

40 < CR₄ < 60 => loose oligopoly (monopolistic competition)

CR₄  > 60 => tight oligopoly

1997 concentration ratios

• Difficult to define relevant market

• Imports not counted

(2)  Herfindahl-Hirschman Index (HHI)

HHI = s₁² + s₂² + . . . + s_n²

s_i =market share of firm i

Ex. -

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(a)  Properties

• All firms considered

• More unequal market shares => higher index

• More firms => lower index

(b)  Department of Justice Merger Guidelines

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b.  Concentration and prices

• Positive relationship between prices and concentration; less competition => higher prices

• Concentration (monopoly) could lead to increased efficiency, lower costs

c.  Other dimensions of competition

(1)  Bundling

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(2)  Mixed bundling

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(3)  Tying

• Firm selling one product requires or attempts to require purchase of another product

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• Ensures performance of first product

• Price discrimination

• Gain buyers for complementary product