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. This supplement answers the last question of Topic 3, namely:What happens to a monopoly if smaller price-taking firms enter its market?It describes an alternative outcome of the situation when a firm has a knowledge advantage.Particularly, though present the advantage of the firm does not al
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1. Dominant Firm with a Competitive Fringe /supplement to Topic 3 Monopoly/
2. This supplement answers the last question of Topic 3, namely:
What happens to a monopoly if smaller price-taking firms enter its market?
It describes an alternative outcome of the situation when a firm has a knowledge advantage.
Particularly, though present the advantage of the firm does not allow it to decrease its marginal cost so much to prevent the entry of the high-cost firms. Based on Carlton and Perloff (2000)
3.
This supplement answers the last question of Topic 3, namely:
What happens to a monopoly if smaller price-taking firms enter its market?
It describes an alternative outcome of the situation when a firm has a knowledge advantage.
Particularly, though present the advantage of the firm is not big enough to allow it to decrease its marginal cost so much to prevent the entry of the high-cost firms. Based on Carlton and Perloff (2000)
4. If one firm is a price setter and faces smaller, price-taking firms, it is called a dominant firm.
The dominant firm typically has a large market share.
The smaller, price-taking firms are called fringe firms.
Fringe firms each have a very small share of the market, even though together they may have a substantial share of the market. Based on Carlton and Perloff (2000)
5.
Industries in which one firm has a large share of the industry are common (Pascale, 1984):
Photographic business: Kodak, 60%
Mainframe computer business: IBM, 68%
Commercial Jet Aircraft Business: Boeing, 60%;
Energy Sector: General Electric, 61%
Computer chips ceramics: Kyocera, 70-75%
Printer sales: Hewlett-Packard, 59% Based on Carlton and Perloff (2000)
6.
Three possible reasons are sufficient to create a dominant firm-competitive fringe market structure:
A dominant firm may have lower cost than fringe firms.
A dominant firm may have a superior product in a market with product differentiation.
A group of firms may collectively act as a dominant firm. Based on Carlton and Perloff (2000)
7.
There are at least four major causes of lower costs:
A firm might be more efficient than its rivals due to better management and/or patented technology.
An early entrant might have learned by experience how to produce more efficiently.
An early entrant may have had time to grow large optimally (in the presence of adjustment costs) so as to benefit from economies of scale.
The government may favor the original firm. Based on Carlton and Perloff (2000)
8.
There are at least four major causes of lower costs:
A firm might have better quality due to patented technology.
The quality superiority may be due to a reputation achieved through advertising.
Or through goodwill generated by its having been in the market longer.
Based on Carlton and Perloff (2000)
9.
Groups of firms in a market have an incentive to coordinate their activities to increase their profits.
A firm might have better quality due to patented technology.
The quality superiority may be due to a reputation achieved through advertising.
Or through goodwill generated by the firm having been in the market longer.
Based on Carlton and Perloff (2000)
10. Whether a dominant firm can exercise market power in the long run depends crucially on:
the number of firms that can enter the market
how their production costs compare to those of the dominant firm and
how fast they can enter.
The dominant firm-competitive fringe model could be examined under two alternative extreme assumptions with and without free entry.
Based on Carlton and Perloff (2000)
11.
Two key results emerge from an analysis of this model:
It is more profitable to be dominant than mere fringe firm.
(2) The existence of the fringe limits the dominant firms market power i.e. it is better to be a monopoly than dominant firm with competitive fringe.
Based on Carlton and Perloff (2000)
12.
Five crucial assumptions underlie the no-entry model:
1. There is one firm that is much larger than any other firm because of its lower production costs.
2. All firms, except the dominant firm, are price-takers, determining their output levels by setting marginal cost equal the market price p.
3. The number of firms in the competitive fringe is fixed no new entry could occur.
4. The dominant firm knows the markets demand curve, D(p).
5. The dominant firm can predict how much output the competitive fringe can produce at any given price i.e. the competitive fringe supply curve S(p)
Based on Carlton and Perloff (2000)
13.
The dominant firms problem is much more complex than that of a monopoly:
The fringe supply curve, S(p), is increasing in p.
(2) As dominant firm lowers its output and price rises, the competitive fringe output increases.
(3) The dominant firm must consider how the competitive fringe responds to its actions.
Based on Carlton and Perloff (2000)
14.
Based on Carlton and Perloff (2000)
15.
The market demand curve D(p) is above the residual demand curve Dd(p) at prices above and equal to it at prices below .
The fringe firms meet some or all of the demand if price is above .
They drop out of the market and leave all of the demand to the dominant firm if price falls below .
The dominant firms marginal revenue curve (MRd) is derived from its residual demand curve and has two distinct sections.
If the competitive fringe produces positive levels of output, Dd(p) lies below D(p), and MRd is flatter.
Where the two demand curves coincide MRd is steeper. Based on Carlton and Perloff (2000)
16.
The optimal output of the dominant firm is determined by the following 2-step procedure:
Determine the residual demand curve of the dominant firm.
It is given by the horizontal difference between the market demand curve and the competitive fringes supply curve:
(2) Act like a monopoly with respect to the residual demand.
The dominant firm maximizes its profits by picking a price (or output level) so that MR=MC. Based on Carlton and Perloff (2000)
17.
Because the marginal revenue curve has two sections, there are two possible types of equilibria:
The dominant firm charges a high price, so that it makes economic profits and the fringe firms also make profits or break even.
(2) The dominant firm sets a price so low that the fringe firms shut down to avoid making losses and the dominant firm becomes a monopoly. Based on Carlton and Perloff (2000)
18.
This type of equilibrium occurs if the dominant firms costs are not substantially less than those of the fringe firms.
MCd crosses the upper downward sloping segment of MRd.
Respectively, the dominant firm chooses to produce Qd level of output at price p.
Since no new entrants are able to enter, fringe firms each makes a positive profit ?d.
The dominant firms average cost is lower than that of the fringe firms, so it makes more total profits as well.
Still the dominant firm makes lower profits than if it were a monopoly. So, the fringe hurts the dominant firm and benefit consumers. Based on Carlton and Perloff (2000)
19.
This type of equilibrium occurs if the dominant firms costs are extremely low compared to the fringe firms.
MC*d crosses the lower downward sloping segment of MRd.
Respectively, the dominant firm chooses to produce Q*d level of output at price p*.
Because p* is below the fringe firms shutdown point , the fringe firms drop out the market.
As a result, market output, Q*, equals the dominant firms output Q*d.
Still the dominant firm makes lower profits than if it were a monopoly. So, the fringe hurts the dominant firm and benefit consumers. Based on Carlton and Perloff (2000)
20.
This model retains all the assumptions made for the preceding model,
except that now an unlimited number of competitive fringe firms may enter the market.
Fringe firms cannot make profits in the long run: they either break even or are driven out of business.
As long as the dominant firm has some cost or other advantage, it can gain and hold indefinitely a large share of the market.
This is an industry with easy entry, and yet one firm has the lions share of the market, presumably because it has superior products, a superior sales force, or has generated goodwill with buyers. Based on Carlton and Perloff (2000)
21.
Based on Carlton and Perloff (2000)
22.
As the number of firms grows large, the fringes supply curve becomes horizontal.
The residual demand curve facing the dominant firm is also horizontal at , so it coincides with the MR curve.
Below , both curves slope downward. Again the MR curve jumps at the quantity where the kink in the residual demand curve occurs.
Based on Carlton and Perloff (2000)
23.
As in the model with fixed entry because the marginal revenue curve has two sections, there are two possible types of equilibria:
If the dominant firms marginal cost is relatively high, so that it intersects the horizontal portion of the MRd curve.
The equilibrium price is . A dominant firm can make positive profits, competitive firms just break even.
(2) If the dominant firms marginal cost is lower, so that it hits the downward-sloping portion of the MRd curve.
The equilibrium is the same as in the second fixed-entry equilibrium. The dominant firm is a monopoly, and the potential supply of fringe firms is irrelevant. Based on Carlton and Perloff (2000)
24.
A low-cost dominant firm has market power even though it competes with other firms.
A profit-maximizing dominant firm does not attempt to drive out fringe firms at all costs.
Its behavior depends on how great its cost advantage over fringe firms is and on how easily other firms can enter.
If a large number of price-taking firms can enter the market whenever a profit opportunity occurs, the dominant firm is unable to charge prices substantially above the competitive price.
Even if fringe firms do not enter a market, the threat of their entry may cause a monopoly to set a lower price than it would in the absence of the fringe. Based on Carlton and Perloff (2000)
