Week 4 - Market Structure and Definition and Competitor Analysis

Question 1

What is the Structure-Conduct-Performance Model?

Answer 1

Structure of the Market (Perf Comp,Monopoly etc.) determines Conduct

The conduct of the firm determines the performance of the firm

The performance of the firm is just legit the performance

Question 2

What factors determine the structure of the market?

Answer 2

Supply Conditions
Govt Policy
Demand Conditions
Performance of the firm

Question 3

What factors determine the Conduct of the firm?

Answer 3

Govt Policy and technological progress

Question 4

What factors determine the Performance of the Firm?

Answer 4

Govt Policy

Performance does determine the Govt policy and the tech progress based in performance determines conduct, supply and demand

Question 5

What do we describe markets by?

Answer 5

Described by degree of concentration

Two extremes in market structure: Perf Competition and Monopoly

Question 6

What are most markets like in real life?

Answer 6

Fall in between monopoly and perf competition (imperfect competitive firm)

Question 7

What are the features of an imperfectly competitive firm?

Answer 7

• Faces a downward-sloping demand curve
• Recognises its output price depends on the quantity of goods produced and sold
• Has some market or monopoly power and is therefore a price maker instead of a price taker.

Question 8

What are the two models of imperfect competition?

Answer 8

Monopolistic Comp:
-There are many sellers producing products that are close substitutes for one another, but which are nonetheless differentiated
-Each firm has only limited ability to influence its output price.
Oligopoly:
- an industry with a few producers
-each recognizing that its own price depends both on its own actions and those of its rivals.
-Oligopoly models (Cournot, Bertrand) focus on how firms react to each other’s moves

Question 9

What are Idiosyncratic Preferences?

Answer 9

Literally just personal preferences

With these preferences Horizontal Differentiation possible

Question 10

What are important sources to idiosyncratic preferences?

Answer 10

• Location
• Taste
• Search and Transportation costs (to discourage switching if prices raised)

Question 11

What is Vertical Differentiation?

Answer 11

Making a product “better than” the products of competitors. In theory, products A and B would be vertically differentiated if all consumers agreed that product A is higher quality. (BMW versus Skoda)

Question 12

What is Horizontal Differentiation?

Answer 12

Making a product distinctive from those of competitors. If products A and B were horizontally differentiated, some consumers would prefer product A and other consumers would prefer product B. (Coke versus Pepsi)

Horizontally differentiated products vary in certain product characteristics to appeal to dif consumer groups

Question 13

What occurs in monopolistic competition?

Answer 13

Since each firm’s demand curve downward sloping, price set above MC
- If price above AC, firm earns economic profit
- Existence of econ profit attracts new entrants until each firm’s econ profit is zero and/or take away market share
If price competition erosion of econ profit super quick

Question 14

How does Geography affect horizontal differentiation?

Answer 14

Grocery stores attract clientele based on their location

Consumers choose the store based on “transportation costs” and their attributes and willingness to travel to them to source the differentiation they desire

Transportation costs prevent switching for small differences in price

Question 15

How does entry and monopolistic competition link?

Answer 15

• Customer loyalty allows price to exceed MC and encourages entry
• Entry considered excessive if fixed costs go up due to entry without reduction in prices
• It entry increases variety by customers then entry cannot be considered excessive

Question 16

How does the Cournot Equilibrium explain strategic games? (Competition in quantities)

Answer 16

-Output will be less than the output under perfect competition because of strategic decisions, and prices and profits will be above perfectly competitive levels
-But as the number of firms increases, the output will drift towards perfect competition and prices and profits per firm will decline
Competing in Q is a conduct issue. Shows Nash equilibrium

Question 17

How does the Bertrand Duopoly explain strategic games? (Competition in prices)

Answer 17

Keep competing on price until price is equal to MC like perfect comp

2 firms in Bertrand produce same solution as infinite firms in perf comp

Question 18

In what situations can Bertrand or Cournot situations occur?

Answer 18

• If firms can adjust output quickly, Bertrand type competition ensure and fierce comp will reduce profits
• If output cannot be increased quickly Cournot competition is the result and concentration can result in market power that sustains prices and profitability.

Question 19

How does Bertrand Competition change with product differentiation?

Answer 19

• When the products of the rival firms are differentiated, the demand curves are different for each firm and so are reaction functions
• Equilibrium prices dif for each firm and exceed respective MC’s

Question 20

How does Cournot Competition change with product differentiation?

Answer 20

When products are differentiated, price cutting is not as effective a way to stealing business
At some point (prices still above marginal costs), reduced contribution margin from price cuts will not be offset by increased volume by customers switching

PROVES HOW DIFFERENTIATION IS A SOLUTION TO MITIGATE AGAINST INCENTIVES TO REDUCE PRICE BELOW COMPETITORS

Question 21

What are the two ways to measure the structure of the market?

Answer 21

N firm concentration ratio:
- Combined market share of the N largest firms
N typically equals 4 or 5

Herfindahl Index
Sum of the squared market shares of each firm in the industry (If market perfect or monopolistic best to use this)

SEE EXAMPLE IN NOTES

Question 22

What is the relationship between concentration and the four classes of market structure in practice?

Answer 22

SEE TABLE IN NOTES

Question 23

What are the conditions for stronger price competition in Practise in Imperfectly Competitive Markets?

Answer 23

Even if ideal conditions of perf comp are not perfect, price competition can be met from two or more conditions:

• There are relatively large number of sellers and/or the market is contestable
• Customers perceive the product to be homogenous (strength of substitutes)
• There is excess capacity, which creates downward price pressure, particularly when exit is not an option for a period of time and capacity is industry specific

Question 24

What are the problems in the measurements for the structure of the market?

Answer 24

It is difficult to measure the size of the “economic” market

• Domestic vs. international
• Related but differentiated products (tea and coffee)
• Geographically specific markets

Buyer concentration

Question 25

How do we measure market power?

Answer 25

Via the Price-cost margin:
The Lerner Index = (P-MC)/P

Can also be demonstrated as (P-MC)/P = -1/E

• In perf comp market e = infinity
• In perf comp market P=MC

Question 26

How is the Lerner Index altered?

Answer 26

MC can be difficult to observe for firms so maybe identify AVC
- Implies LR constant returns to scale
So price cost margin becomes
(P-AVC)/P = -1/E + (r+δ) (pkK/PQ)

Question 27

What is the added term in the new price cost margin reflect?

Answer 27

The share of capital costs in total revenue which we can interpret as link to profitability and/or capital intensity of production

Question 28

What are the empirical problems of measuring market concentration?

Answer 28

Assume that market concentration is exogenously determined – but this is in fact endogenously determined by economic conditions in the industry

• Scale (and scope) economies
• Cost advantages (R&D and innovation)
• Can incumbents influence regulation?
• Concentration of buyers

Question 29

What is Bresnahan and Reiss’s argument on concentration and price via locally provided services?

Answer 29

For locally provided services (doctors,plumbers etc.) there is a entry threshold (pop needed to support given no of sellers) - Increases fourfold between 1 and 2 sellers

Bresnahan and Reiss state that intensity of price comp reaches max at 3 local sellers

SEE EMPIRICAL EXPLANATION IN NOTES

Question 30

What is the antitrust definition of Identifying Competitors?

Answer 30

For Antitrust purposes market considered to be well defined and the competitors in it would be well identified:
- Merging with a competitor would lead to a small but significant non-transitory increase in price (SSNIP)

Question 31

So what does the SSNIP show?

Answer 31

Calculates the residual elasticity of demand of the firm e.g. how change in prices by the firm affects its own demand

Question 32

How can you identify competitors via related products?

Answer 32

In practice, any firm who produces a substitute product is a competitor

-Two products tend to be close substitutes when
they have similar performance characteristics
-they have similar occasion for use and
-they are sold in the same geographic area

Question 33

What are Performance Characteristics?

Answer 33

Describe what the product does to/for the customer

e. g from automobile:
- Seating capacity, curb appeal

Question 34

What is Occasion for use?

Answer 34

• Products may share characteristics but may differ in the way they are used

Orange juice and cola are beverages but are used in different occasions

Another example: Hiking shoes are used in a different context than other sports shoes

Question 35

What are ways to Identify firms producing related products?

Answer 35

• Cross price elasticity of demand
• Price Correlation Across time - If firms’ prices move together it is indicative that their products may be competing with each other
• Firms in the same standard industrial classification (SIC)

Question 36

How do we do identify competitor identification via geography?

Answer 36

When a firm sells in different geographical areas, it is important to be able identify the competitor in each area.

Rather than rely on geographical demarcations, the firm should look at the flow of goods and services across geographic regions and understand differentiation in the market

Examples – Supermarkets, Cinemas, Airports

Question 37

How do identifying competitor in the area?

Answer 37

Step 1: Locate the catchment area. (where the customers come from)

Step 2: Find out where the residents of the catchment area buy their products or services

With some products like books and drugs being sold over the internet identifying geographic competition becomes more difficult