Introduction to Competition Theory - Philip Boulton

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					  Introduction to
Competition Theory
  MICROECONOMICS APRIL 2010
     How do Economists classify
          competition?
There are four major theoretical
frameworks:
• Perfect Competition
• Monopoly
• Monopolistic Competition
• Oligopoly (including Duopoly)
 Introduction to Perfect Competition
            Assumptions:
• The industry is made up of a very large number of
  firms.
• Each firm is so small relative to the size of the industry,
  that it is not capable of altering its own output to have
  a noticeable effect upon the output of the industry as a
  whole.
• A firm cannot affect the supply chain of the industry
  and so cannot effect the price of the product.
• Individual firms have to sell at whatever price is set by
  demand and supply in the industry as a whole. The
  individual firms are “price takers”
           The Assumptions of
           Perfect Competition
• The firms all produce exactly identical
  products. Their goods are “homogeneous”.
• It is not possible to distinguish between a
  good produced in one firm and good
  produced in another.
• There are no brand names and there is no
  marketing to attempt to make good different
  from each other.
           The Assumptions of
           Perfect Competition
• Firms are completely free to enter or leave
  the industry.
• This means that firms already in the industry
  do not have the ability to stop new firms from
  entering it and are also free to leave the
  industry, if they wish.
• There are no barriers to entry or barriers to
  exit.
           The Assumptions of
           Perfect Competition
• All producers and consumers have a perfect
  knowledge of the market.
• The producers are fully aware of market price,
  costs in the industry and the workings of the
  market.
• The consumers are fully aware of prices in the
  market, the quality of the products and the
  availability of goods.
Perfect Competition in the Real World
• Although we generally say the perfect
  competition is completely theoretical, there
  are some industries in the world, that get
  quite close to be perfectly competitive
  markets.
• The industries most often used an examples
  by economists are usually agricultural
  markets.
          Agricultural Markets and
            Perfect Competition
Case Study: Wheat European Union
• There are some large wheat farms in the EU, but they
  are very small in relation to the whole wheat-growing
  industry.
• An individual farm could increase its output many
  times over without have any noticeable effect on total
  supply of wheat in the EU.
• A single farm is not able to affect the price of wheat in
  the EU, since it cannot shift the industry supply curve.
• The farm has to sell at whatever the industry price is.
• In addition wheat is wheat, and so there is no way to
  tell one farm’s wheat from another.
      Introduction to Monopoly
• There is one firm producing the product, so
  the firm is the industry.
• Barriers to entry exist, which stop new firms
  from entering the industry and maintains the
  monopoly.
• As a consequence of barriers to entry, the
  monopolist may be able to make abnormal
  profits in the long run.
    What firms are monopolies?
• Whether a firm really is a monopoly depends
  upon how narrowly we define the industry.
• While Microsoft may be the only producer of
  a particular kind of software, it does not have
  a monopoly on all software.
• The important question here is not whether
  the firm is a monopoly, but rather how much
  monopoly power the firm has.
  The Extent of Monopoly Power
Key Questions

• To what extent is the firm able to set
  its own prices without worrying about
  other firms?

• To what extent can it keep people out
  of the industry?
 The Strength of Monopoly Power
• The strength of monopoly power possessed by
  a firm will really depend upon how many
  competing substitutes are available.
• For example, the underground railway in a city
  may have the monopoly of underground
  travel, but it will face competition from other
  industries, such as buses, taxis and private
  transport.
           Introduction to
       Monopolistic Competition
• The theory of monopolistic competition was
  developed by the American Economist Edward
  Chamberlin (1899-1967).
• He was dissatisfied with two extreme theories
  that existed at the time – perfect competition
  and monopoly.
• He wanted to devise something more realistic
  that would sit between the two existing
  theories.
What is monopolistically competitive
            market?
• In simple terms a monopolistically competitive
  market is one with many competing firms
  where each firm has a little bit of market part.
• This is why we have the term “monopolistic”
  as firms have some ability to set their own
  prices.
          The assumptions of
        monopolistic competition
• The industry is made up of a fairly large
  number of firms.
• The firms are small, relative to the size of the
  industry. This means that the actions of one
  firm is unlikely to have a great effect on any of
  its competitors.
• The firms assume that they are able to act
  independently of each other.
          The assumptions of
        monopolistic competition
• The firms all produce slightly differentiated
  products.
• This means that is possible for a consumer to
  tell one firm’s product from another.
• Firms are completely free to enter or leave the
  industry. There are no barriers to entry or
  exist.
   How is Monopolistic Competition
   different to Perfect Competition ?
• The most significant difference from perfect
  competition, is that in monopolistic competition,
  there is product differentiation.
• Product differentiation exists when a good or
  service is perceived to be different from other
  goods or services in some way.
• Products may be differentiated by brand name,
  colour, appearance, packaging design, quality of
  service, skill levels and many other methods.
     Examples of Monopolistically
        Competitive Industries
• Examples of monopolistically competitive
  industries are car mechanics, plumbers and
  jewellers.
How is the market structure different?
• Although it may appear to be a small
  difference from the assumptions of perfect
  competition, this leads to a markedly different
  market structure.
• As the products are differentiated there will
  some extent of brand loyalty.
        Introduction to Oligopoly
              Assumptions:
• Oligopoly is where a few firms dominate an
  industry.
• The industry may have quiet a few firms or not
  many, but the key factor is that a large
  proportion of the industry’s output is shared
  by just a small number of firms.
• What constitutes a small number varies, but a
  common indicator of concentration in an
  industry is known as the concentration ratio.
         Concentration Ratios
• Concentration ratios are expressed in the form
  of CRx where X represents the number of the
  largest firms.
• For example: CR4 would show the percentage
  of market share or output held by the largest
  four firms in the industry.
• The higher the percentage, the more
  concentrated is the market power of the four
  largest firm.
                  Duopoly
• Two firms dominate an industry, instead of 3
  or 4.
• Duopoly is part of Oligopoly theory and it is
  generally not considered a separate field of
  study.
            Classifying Competition in
                Specific Industries
Industry    Competition Classification   Why do you say that??
(1) US
Domestic
Airline
Industry
(2)
US
Car
Industry

(3)
Breakfast
Cereal
Market
           Classifying Competition in
               Specific Industries
Industry   Competition Classification   Why do you say that??
(4)
Online
Search
Engines
(5)
Bottled
Water
Industry
(6)
Office
Computer
Software
            Classifying Competition in
                Specific Industries
Industry    Competition Classification   Why do you say that??
(1) US
Domestic
Airline
Industry
(2)
US
Car
Industry

(3)
Breakfast
Cereal
Market
           Classifying Competition in
               Specific Industries
Industry   Competition Classification   Why do you say that??
(7)
Global
Wine
Industry
(8)
Global
Sugar
Industry
(9)
Global
Oil
Industry
(10)
Social
Network
Sites
Stimulus 1:
What do they mean by
industry
consolidation?

What impact would
this have on
competition?




Source
http://vhirsch.com/blog/wp-
content/uploads/2009/09/m
arket-domination.jpg
http://www.cartoonstock.com/newscartoons/cartoonists/mba/lowres/mban1698l.jpg
Stimulus 2.


In practical terms
how do companies
outrun the
competition?




Source
http://www.co2partners.com/images/c
artoons/competition.jpg
     Stimulus 3

     The expression
     `being one step
     ahead of the
     competition` in
     real term means…




Source:
http://www.cartoonstock.com/low
res/dcr0443l.jpg
                                                          Stimulus 4


                                                          What do they
                                                          mean by the
                                                          expression
                                                          `In this
                                                          business it’s
                                                          Dog Eat
                                                          Dog`…?



Source:
http://www.cartoonstock.com/newscartoons/cartoonists/jgr/lowres/jgrn830l.jpg
                                                                         Stimulus 5

                                                                         Which one of
                                                                         these pricing
                                                                         strategies do
                                                                         you feel is
                                                                         the most
                                                                         effective?

                                                                         What does
                                                                         the cartoon
                                                                         say about
                                                                         the existing
                                                                         competition?




Source: http://www.fastupfront.com/pics/small-business-competition.jpg
Stimulus 6


Why are
patents so
important in
highly
competitive
industries?
Stimulus 7


What do we mean
by `anti-trust`?

How does it relate
to competition?
Stimulus 8
Explain the current battle betwee Microsoft and Google.
Who will win?
                                                                                      Stimulus 9

                                                                                      Explain
                                                                                      the
                                                                                      symbolism
                                                                                      in this
                                                                                      cartoon.




http://www.seppo.net/cartoons/albums/cartoons/global/economy/eu_vs_microsoft_04.jpg
   Source: http://www.cartoonstock.com/lowres/ssm0019l.jpg

Stimulus 10.   Why has Bill Gates made some lawyers very rich?
Stimulus 11

In the past
how did
Microsoft
make its
products
incompatible
with
competitors?

Provide
examples
Stimulus 11


Why does
absolute
power
corrupt
absolutely in
the corporate
world?
Stimulus 12

What does this say about
the relative market power
in this industry?

Who are the competitors to
these companies? Why do
they have less market
share?




Source
http://4.bp.blogspot.com/_wgns7
r5yd8c/Sjuv_ALuu8I/AAAAAAAAH
1M/4POUXzI3b2M/s400/Dynamic
+Duopoly.jpg
 Stimulus 13: What is the key message(s) from this cartoon?


Source: http://www.stopunfaircardfees.eu/uploads///images/PaymentCard-TollPort.jpg
Source: http://www.jaunted.com/files/6193/BransonNoBA.jpg


Stimulus 14: Who is featured in this picture?    What are the key issues?
Stimulus 15: What illegal activity may be taking place in this cartoon? Why?
Would it be hard to prove? How common is this in the real business world?
 Stimulus 16. In a paragraph response, explain the messages from this cartoon?


Source: http://www.rudebarbs.com/images/antitrust.jpg
                                                           Stimulus 17

                                                           How does this
                                                           cartoon relate
                                                           to a previous
                                                           question?




Source: http://www.johnsonbottini.com/images/cartoon.jpg
Source: http://tyrannybusters.org/images/home/duopoly.gif

				
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