Concentrated Markets

Content
• Monopoly
• Oligopoly
• Price makers and price takers
• Growth of firms
• Sources of monopoly power
• Model of the monopoly
• Collusive and non collusive oligopoly
• Interdependence in oligopolistic markets
• Price discrimination
• Consumer and producer surplus
• Contestable and non contestable markets
• Market Structure, Static Efficiency, Dynamic Efficiency and Resource Allocation
 Monopolies
• Monopoly – this is where there is a single producer
in the market
• Features:
– One producer is able to charge relatively high prices
– New products are rarely introduced
– Resources are not used efficiently
– Monopolies have market power
– Monopolies are able to set prices – price setters
 Oligopolies
Few firms in the market who are interdependent in their
actions
– Firms consider competitors reactions when changing prices /
introducing new products
– There is a high degree of competition
– Businesses try and avoid price competition preferring non price
competition
– Products are branded and differentiated from each other
– Can be many take-overs
– Collusion may occur leading to cartels being formed
 Price makers and price takers
• In pure monopolies the firm is a price maker as they
are able to take the markets demand curve as their
own
• The monopoly firm is able to set the price anywhere
on this demand curve
• The ability of the monopoly firm to set price is
dependent on price elasticity of the product – if
demand is elastic it will limit the firms price setting
power
 Price takers
• Firms in perfect competition are price takers
• All businesses have to accept the price that is set
by the market
• Firms are not able to set their own price
Factors that influence the ability of a firm to
be a price maker
• Only firms in pure monopolies can be price makers
• This means that there must be:
– Barriers to entry and exit
– Only one producer / firm in the market
– Imperfect knowledge
• In reality this is seldom the case and pure
monopolies rarely exist
Factors that influence the ability of a firm to
be a price maker
• Very few markets are dominated by just one firm – it is more likely
that they are dominated by a few major firms who are able to act as
price makers
• Barriers to entry do exist in many markets however they may be
overcome in a number of ways including:
– Takeovers from outside / inside the industry
– Growing markets
– Increased overseas competition
– Transfers of brand names between sectors of the economy in companies that
differentiate their product offerings
 Price Makers
• As pure monopolies rarely exist having one firm as
a price maker is unlikely
• If firms are able to set prices in a market the extent
to which they can is influenced by price elasticity for
that market, the more inelastic the demand for a
product the more a firm can set the price
 The Growth Of Firms
• Growth is often a key objective of firms
• Business grow for a number of reasons including:
– To increase profits
– To decrease costs
– To dominate the market
– To reduce risk
– To fulfil objectives of management
 Internal and External Growth
• Businesses can choose to grow internally by selling
more of their products or externally by acquiring /
merging with another firm
• Internal growth is often referred to as organic
growth
• Internal growth is slower
 External growth - Takeovers
• Takeovers are where one firm gains control of
another firm
• The amount a firm pays to takeover another firm is
dependent on its perceived value
• Attacker firms often pay a premium to shareholders
in order to secure their shares
• Bids can be hostile or welcome
• Hostile bids have a greater degree of risk
 Mergers
• Mergers occur when at least two firms join together
to form one organisation
• Mergers and takeovers can take the following
forms:
– Horizontal – firms join together who are at the same
stage in the production process
– Vertical – firms join together who are at different stages
in the production process
– Conglomerate – firms in different markets join together
 Why do firms merge ?
• Mergers and takeovers are ways for businesses to
grow
• Firms decide to merge / take over due to synergy
• Synergy is where the performance of the new firm
is greater than the performance of the separate
firms
• Synergy is created by shared resources, ideas and
skills
 Management Buyouts
• Where managers in a business take it over by
buying a controlling interest in its shares
• Managers may do this as they think they can turn
the business around, or if shareholders lose interest
in a particular part of the business
• Manager often need to borrow money to finance
MBOs
• MBOs are risky however if successful they allow
managers to reap plenty of rewards
 Joint Ventures
• Joint ventures occur when two businesses set up a third
business together to develop a new product, enter a new
market etc
• Joint ventures are set up to achieve a specific objective or
project for both parties
• There are benefits for both parties from these relationships
• Sony and Ericsson enjoyed a joint venture where they
worked together to develop mobile phones
 Outsourcing
• Outsourcing allows a business to contract out some of their
operations to a third party to perform
• Outsourcing of production overseas has allowed
businesses to reduce their costs e.g. call centres locating
overseas in lower wage countries
• Outsourcing has been driven by technological change,
pressure on profit and costs and an increase in the level of
competition
 Sources of Monopoly Power
• Monopoly power is influenced by the following
factors:
– Barriers to entry
– Number of competitors
– Advertising
– Degree of product differentiation
 Sources of Monopoly Power
• The larger and more expensive the barriers to entry the
greater the monopoly power
• The smaller the number of competitors in the market the
greater the monopoly power
• The greater the advertising spend and more recognisable
the brand name the greater the monopoly power
• The larger the degree of product differentiation the greater
the extent of the monopoly power :
The Model Of Monopoly
 Monopoly Model
• In the monopoly model the average revenue curve
is the same as the demand curve
• Where total revenue exceeds total costs the firm is
able to make supernormal profits
 Collusive Oligopoly
• Collusion occurs where the firms work together to
reduce uncertainty in the market
• Firms may become involved in price fixing or cartels
to act as though they are the only firm in the market
and therefore can set prices
• This is illegal in the UK and EU
 Price fixing and collusion
• Price fixing is where all firms in the market try and control
supply to achieve a “monopoly” like situation
• For this to happen producers need to have an influence
over supply
• This is most likely when the market is dominated by a few
large firms, demand is inelastic, market demand doesn’t
fluctuate and you can easily quantify the output of each firm
 Price leadership and collusion
• Where one firm is dominant in the oligopoly they
often take the role of price leader setting the price
for the market
• Tacit collusion – is where companies are engaging
in behaviours which minimise the response of
competitors
• In the UK the supermarket business could be seen
as behaving in a way similar to tacit collusion
 Non Collusive Oligopoly
• Oligopolies are markets which have the following
features:
– A few large firms
– Entry barriers
– Non price competition
– Product branding and differentiation
– Interdependence in decision making
 Oligopolies
• Firms operating in oligopolies tend to invest heavily in new
machinery and processes to try and reduce their cost
structure and make more profits
• Research and development expenditure is also high as
businesses try and differentiate their products from their
competitors
• Businesses in oligopolies use advertising and marketing to
build strong brand recognition which allows them to
compete on factors other than price and acts as a barrier
to entry for new firms
 Non Price competition
• In oligopolies the majority of competition is non-price
• This aims to influence demand and build brand recognition
• Methods include:
– Better customer service
– Discounts on upgrades
– Free deliveries and installation
– Extended warranties
– Credit facilities
– Longer opening hours
– Product branding
– After sales service
 Price Wars
• Firms tend to compete on non price factors as
competing on price can lead to price wars
• Price wars occur when one competitor lowers its
price, then others will lower their prices to match . If
one of the firms reduces their price below the
original price cut, then a new round of reductions is
begins.
 Entry Barriers
• Oligopolies have a number of barriers to entry
– Size of the firms in the market means they can influence
output and price
– Larger firms can exploit economies of scale
– Branding and brand recognition
Interdependence in Oligopolies – Kinked
Demand Curve
• Firms in an oligopoly face a kinked
demand curve
• If they raise price above P* the
demand curve is relatively elastic as
people will switch to buying substitute
products from competitors
• If they drop price below P* they face
an inelastic demand curve as other
firms will also cut prices so few gains
in quantity demanded occur
 Interdependence in Oligopolies – Game
Theory
• Game theory looks at the players in a game or firms
in a market
• In making decisions each player has a number of
choices
• Each player is influenced by their own actions and
the actions of other players
• Game theory can be used to illustrate the
interdependence of firms in an oligopoly
 Price Discrimination
• Price discrimination is where a firm charges different prices
for the same product to different consumers
• The most common example is peak and off peak pricing for
travel
• For price discrimination to work the following conditions are
needed:
– Differences in price elasticity of demand between markets
– Barriers to prevent consumers switching between suppliers
 Price Discrimination
1. Perfect Price Discrimination – this is where the firm
charges whatever the market will bear.
• This means the producer can transfer all of the consumer
surplus to producer surplus.
• This could hypothetically happen if a monopolist was able
to segment the market precisely however it is very
unlikely to occur in real life
 Price Discrimination
2. Second degree price discrimination – where packages of
products that are surplus to requirements are sold at lower
prices
• This often happens with last minute holiday deals where
businesses are selling off their spare capacity to gain some
revenue
• In the low cost airline sector firms operate a strategy
opposite to this where the cheapest flights are those you
book the furthest in advance
 Price Discrimination
3. Peak and Off Peak pricing – this is where a
different price is charged due to the time of day /
year
• During peak times there is more demand for the
product so higher prices can be charged – demand
is likely to be more inelastic
• Examples of peak / off peak include rail travel,
holidays and phone calls
 Price Discrimination
4. Third degree price discrimination – Charge different
prices for different products to different market
segments
• Markets are usually segmented by time or
geographical area
• E.g. having one price for the UK and one for the
USA
 Advantages and Disadvantages of Price
Discrimination
Advantages Disadvantages
• Increases profit for the firm • Reduction in size of consumer
• Increase in size of producer surplus
surplus
• Firms may be able to exploit
economies of scale
• Can be used to cross subsidise
goods with high social benefits
 Consumer and Producer Surplus
• Consumer surplus – This is the difference between what a
person would be willing to pay and what they actually pay
to buy a product.
• It is the area below the demand curve and above the price
• Producer surplus – This is the difference between the price
where a producer would be willing to provide a product and
the actual price the product is sold
at
Consumer Surplus
• The consumer surplus is
shown by the shaded area
on the diagram
• At a price P1 all
consumers in the shaded
area would pay more for
the good and therefore
they gain extra benefits
from the lower price
 Producer / Consumer Surplus and
Efficiency
• If the market is perfectly competitive at equilibrium
price and quantity consumer and producer surplus
will be maximised
• This represents the most efficient output level
 Price Discrimination and Producer /
Consumer Surplus
• If first degree price discrimination occurs then the
consumer surplus is removed and transferred to
producer surplus
• Other forms of price discrimination also reduce the
consumer surplus and increase the producer
surplus
 Consumer Surplus and Monopoly
• In Monopolies the consumer surplus is reduced
• Some of this reduction is passed to producers in the
form of the producer surplus
Contestable and Non Contestable Markets
• Contestability markets are where there is one firm (or a
small number of firms) and due to freedom of entry and
exit, the firm (or firms) face competition from potential new
entrants and so operates like a perfectly competitive market
• In reality there are barriers to contestability to most markets
• The majority of markets are contestable to some extent
• The degree of contestability is dependent on barriers to
entry
 Conditions for Contestability
• The following conditions need to apply for pure market
contestability:
– Freedom of entry and advertisement
– Absence of sunk costs – these are costs that a business has to
pay to enter the industry that cant be recovered or recouped
– Perfect information
• Contestability means that businesses in a market will make
pricing and output decisions based on the threat of
competition
• Markets are become increasingly contestable due to
globalisation
 Efficiency, Dynamic
Efficiency and Resource
Allocation
• Productive efficiency – is the level of production that
makes the most cost effective use of the factors of
production
• Allocative efficiency – is the level of production
where no resources are wasted, no one can be
better off without anyone else being worse off
• Perfectly competitive markets exhibit productive
and allocative efficiency
• .
 Market Structure, Static
Efficiency, Dynamic
Efficiency and Resource
Allocation
• Efficiency is influenced by a number of factors
including:
– research and development
– investment in human and non-human capital
– Technological change.
– Candidates should be able to compare and discuss the
• The more competitive a market is the greater the
allocative efficiency of resources
 Summary
• Monopolies operate where there is one firm in the market, they are able to set prices and have high
barriers to entry
• Oligopolies have a few firms in the market, high brand recognition and heavy competition on non price
factors
• Price makers are able to set the price for the market whereas price takers have to accept the market
price
• Growth of firms – firms grow internally and externally through organic growth or mergers, takeovers, joint
ventures and management buyouts
• Outsourcing is increasingly being used by firms to grow their operations
• Monopolies have power as they are able to influence the price for the whole market
• The model of the monopoly shows how the monopolist takes the industry demand curve as their own
• Collusive and non collusive oligopoly – collusive oligopolies work together to set prices, non collusive
oligopolies do not
• Interdependence in oligopolistic markets – companies take decisions based on the expected decisions
of others, all decisions are influenced by those of others and influence them
• Price discrimination is where you charge a different price for the same product to different consumers
• Consumer and producer surplus show the extra benefits to producers and consumers of a certain price
• Contestability looks at the threat of entry of new firms to the market
• Market Structure influences the allocation of resources within an economy