Market Structure
Chapter 12
Structure-Conduct-
Performance Model
A model used for analysis of an industry
which holds that structure determines
conduct, which in turn determines
performance
Market Structure
The amount of competition that exists in a
market between producers
Perfect Competition
Monopoly
Oligopoly
Monopolistic Competition
Perfect
Competition:Conditions
So many buyers and sellers in the market,
no one of them can influence price
Homogeneous goods
Perfect knowledge
Perfect mobility
No barriers to entry or exit
Perfect Competition:Price
Determination
Normal profit- minimum level of profits in order to stay in
business
Abnormal profits – profits over and above normal profits
Firms will decide what level of output to produce by
setting the cost of producing the last unit of good equal to
the revenue gained from selling the last unit (marginal cost
= marginal revenue)
In perfect competition, as firms have perfect knowledge,
abnormal profits are unsustainable in the long run
Example of Perfect
Competition
Closest example is a fruit and vegetable
market
Monopoly: Characteristics
Has market power, and can decide price OR
quantity sold (not both)
Either no substitutes for the goods, or high
barriers to entry
Monopolist may use price discrimination
Price Discrimination
Consumers pay different prices for the same
good
Can occur when:
the producer is monopolistic and able to
control supply
there are groups of consumers with different
demand conditions
able to separate the groups
Compare and contrast
monopoly and perfect
competition
How do these two structures affect prices?
Choice of products? Innovation?
Oligopoly
A small number of producers supply a
market in which the product is
differentiated in some way
Oligopoly Characteristics
High interdependence between firms
A lack of price competition in the market
Lack of price competition leads to different
forms of non-price competition taking
place, such as branding and advertising
Price is determined by a price leader or by
collusion
Monopolistic Competition
Monopolistic competition exists when all
conditions for perfect competition exist
except for homogeneous goods
Goods are slightly different in some way
(technical or economic)
Abnormal prices may exist in the short-term
but cannot last for a long-time
Are These Theories Accurate?
Both perfect competition and monopolies
are unrealistic, while oligopolies and
monopolistic competition are more realistic
In oligopolistic markets, prices tend to be
sticky, but occasionally price wars occur
Price Wars: Mini-Case (P.340)
How do price wars affect firms in the
industry?
How do price wars affect buyers?
Porter’s 5 Forces Model
Structure of an industry and the ability of
firms to act strategically depend on the
relative strengths of five forces:
current competition
potential competition
threat of substitute products
power of buyers
power of suppliers
Current Competition
Competition can be determined by the 4
types of markets discussed before
BUT, according to Porter’s Model, firms
may change the structure of the industry
Firms in highly competitive markets may
dislike their lack of power over various
factors and try to change the situation,
which will change the level of competition
Potential Competition
Degree of potential competition depends
upon the existence and height of barriers to
entry and exit
Natural monopolies – industries where
competition would be wasteful (like public
utilities)
Economies of scale – cost benefits
associated with large operations
Economies of Scale:Sources
Technical economies – come from
increased specialization and indivisibilities
Marketing economies – spreading market
costs over a larger output, so average costs
are lower (bulk buying is often used)
Financial economies – easier and cheaper to
borrow capital
Risk diversification
Other Barriers to Entry
Legal
Brand loyalty
High initial capital investment
Contestable Market
A market in which there are no barriers to entry or
exit
All firms have access to the same technology, so
there are no cost barriers to entry
No unrecoverable costs to prevent firms from
leaving the market
What regulates the market behavior is not actual
but potential competition
Threat of Substitute Products
If there are no substitutes, producer of the
good will face little competition and have
high market power
Firms often differentiate to reduce the threat
of substitute goods
Power of Buyers
Monopsony - market where there is only one
buyer, and the buyer has the market power not the
seller (example: coal industry)
The existence of strong buyers and weak sellers
may benefit the market, or it could lead to higher
seller concentration as sellers come together to
counteract buyer power
The existence of strong sellers and weak buyers
may result in consumer rights groups forming to
protect buyers
Power of Suppliers
Where there are few suppliers, supplier
power will be high (can affect producers
costs)
The decision of whether to produce
components needed in the production
process or to buy from a supplier is covered
by transaction cost economics
Measuring Degree of Actual
Competition
Level of competition is measured by
concentration ratios
These measure:
the percentage of value added
total output
or employment
that is produced by the largest firms in the
industry (3 or 5 firms)
Reasons for High
Concentration
At the Minimum Efficient Scale of Production (MES)
point, all economies of scale have been taken by the firm
The higher the MES relative to the total output of the
industry, the fewer the number of firms operating in the
industry and therefore the higher the level of concentration
Firms in every industry face differing average cost curves
and therefore market structures will differ
In services, for example, the scope of economies of scale is
small, and the MES is small relative to the size of the total
market (industries are unconcentrated)
Structure-Conduct-
Performance Analysis:Airlines
What type of market is the airline industry?
How much market power do airlines have?
How does the market structure affect price?
What barriers to entry exist in the airline industry?
What is the level of seller competition? Buyer competition?
What demand factors affect the structure?
Supply factors?
How do airlines use pricing conduct to respond to industry structure?
Merger activity?
How has market structure and conduct affected airline performance?
Homework: Due 2nd Class
Next Week
Using the structure-conduct-performance
model, analyze an industry of your choice
This assignment is worth 10% of final grade