Market Structure and Performance

A.V.Raja Department of Economics University of Hyderabad

 What is meant by Market Structure How this is related to the idea of efficiency Ways of Measuring Market Power The link between Market structure and Profitability And how the concept of Natural Market Structures evolved

 the Market is an institution that makes exchange of goods and services possible. defined in terms of the control on price that firms enjoy in the manufacture of the product. depends upon number of firms that share the market for a particular product.

 WHY STUDY MARKET STRUCTURE? Optimal Allocation of Resources Market forces automatically direct resources into their best possible use only a particular kind of market structure leads to an Optimal allocation of resource Monopoly is shown to lead to the maximum deviation from the ideal allocation of resources.

Structure-Conduct- Performance (S-C-P) framework in Industrial Organization theory

market structure determines the conduct of a firm, that is, its pricing decisions, its strategy on advertising, and quality. These actions would have a bearing on the overall costs and revenues and so determine the performance (Efficiency or Welfare, profitability, Market share).

 the conduct and performance of firms in turn change the market structure of an industry The Perfectly Competitive Market Profits = Total Revenues (TR) Total Costs (TC). competitive pricing rule that maximizes profits is when the (given) price equals the Marginal Costs of Production. MONOPOLY

 Price is set above the marginal costs of production in order that the Monopolist maximizes his profits. OLIGOPOLY the number of firms is so as to make them interdependent upon each others actions. Many different Models of Oligopolistic behaviour: Independent prices model, Price setter models, Cartels and collusive behaviour non-price competition Imperfect Market Structures

Measures of PERFORMANCE: Profitability

Lerner index: the degree of monopoly power, L = (Price Marginal cost) / Price Market Value of the firm as an indicator of Profitability (if Capital markets are perfect, then the Total Value of the firms shares would contain all the relevant information about the firms future profitability.) Tobins Q :ratio of the Market value of the firm to its replacement cost of Capital to the firm

 Q = (Mc + Mp + Md) / A Where Mc + Mp is the value of the firms common and preferred stock, and Md is the outstanding Debt. A is the cost of replacing total assets. Q > 1 this is indicative of monopoly (WHY?) The Excess Value Ratio (EVR) EVR = (Market Value of the Firms Assets Book value of assets) / Sales revenue. A company's book value is its total assets minus intangible assets and liabilities.

The Price-Cost Margin: ratio of the profits to total Sales revenue. The Accounting rates of profit: Accounting rate of profit on Capital = Accounting profit- Interest Payments / Total assets Accounting rate of profit on Equity = Accounting profit / Book Value of shareholders equity. Accounting rate of profit on Sales = Accounting Profits / Sales Revenue.

MEASURES OF MARKET STRUCTURE:

Concentration ratios percentage of total market sales accounted for by a given number of leading firms For example, a four-firm concentration ratio is the total market share of the four firms with the largest market shares. Indian tyre industry is dominated by four players viz MRF, Apollo Tyres, JK Industries and Ceat and enjoys more than 70% of the total market share

Some Interesting Data[1]: Concentration level shows a marked increase in: Automobile tyre (MRF: 24%) Motorcycles (Hero Honda: 50%) Bicycles (Hero Cycles: 40%) Three-wheelers (Bajaj Auto: 75%) The Indian big three in automobiles, Maruti, Tata and Mahindra & Mahindra, have a market share of 65 percent in 2004. That is, CR3 is 65%. [1] K.V. Ramaswamy, State of Competition in the Indian Manufacturing Industry, (Ch 12).

 The Cumulative Market share of companies in the Indian Pharmaceutical Industry are: Market ShareTop 5 companies19% Next 6-10 companies11% Next 11-15 10% Next 16-209%Next 21-256% The rest add up to 45% Thus one can say that the IndianPharmaceutical Industry is Monopolistic in nature.

 The Herfindhal Index of concentration: size of firms in relationship to the industry and an indicator of the amount of competition among them. sum of the squares of the market shares of each individual firm. Gives more weight to larger firms. An example: two cases in which the six largest firms produce 90 % of the output: (A) All six firms produce 15%, (B) One firm produces 80 % while the five others produce 2 % each.

 The six-firm concentration ratio would equal 90 % for both case 1 and case 2, but in the first case competition would be fierce where the second case approaches monopoly. The Herfindahl index for these two situations makes the lack of competition in the second case strikingly clear: Case 1: Herfindahl index of 0.1360 Case 2: Herfindahl index of 0.6430

NATURAL MARKET STRUCTURES

market structures themselves evolve and are determined purely through the nature of the technologies that go into the manufacture of the product. nature of technology is such that economies of scale prevail for levels of output that are almost as large as the market demand for the product then the natural outcome in such an Industry would be a Natural Monopoly.

 Figure 1 always true that one firm would be the efficient way of producing
100 units of X. Thus a Natural Monopoly would be preferable to many firms.
AC

AC50

AC100 50 100

Figure 2

AC1 (2Y)

AC2 (2Y) AC1 (Y)

Suggested Readings: 1. Tirole, J. (1988) The Theory of Industrial Organization MIT Press 2. Hay and Morris (1991) Industrial Economics and Organization OUP 3. Varian H., Intermediate Economics: a Modern Approach, Chapters 2830, 31,33 4. Scherer, F. M. and D. Ross. 1990. Industrial Market Structure and Economic Performance, 3rd ed. Boston: Houghton Mifflin, Ch 5. 5. Schmalensee, R. 1989. "Inter-industry studies of structure and performance" in R. Schmalensee and R. D. Willig (eds.) Handbook of Industrial Organization. Amsterdam: North-Holland, Vol. 2, Ch. 16, pp. 951-1009. 6. Clarke, R., S. Davies, and M. Waterson. 1984. "The profitabilityconcentration relation: market power or efficiency?", Journal of Industrial Economics 32, pp. 43550. 7. Sharkey, WW (1982). The Theory of Natural Monopoly. Cambridge University Press, New York . 8. Griffiths, A. & Wall, S. (1991) Applied Economics. 4th ed. London, Longman