Weeks 7 & 8 Competition, market structures and business decisions

1. Weeks 7 & 8 Competition, market structures and business decisions

2. Examination structure 1.Exam duration 120 minutes writing time 2.Reading time 10 minutes 3.Total number of questions 5 4.Students must attempt all questions 5.Use of calculators is permitted Please note, original hand written notes or computer printouts or photocopies are not permitted in the exam this year.

3. Examination structure • Section 1. (Problem solving) • Q 1-4 • No questions just on definitions. All the questions are – problem solving • You must include the most relevant definitions as well diagrams where appropriate. • Brief verbal explanation should complement you numeric solution. • Section 2. (Research Question) • "Further reforming of the Australian taxation system is back on the agenda. In particular, different approaches to the restructuring of personal tax rates are currently being debated in the media.  Some advocate tax reduction targeting low to medium income earners. Others say that the top tax margin should be reduced because the gap between the corporate and personal tax rate is too high. High taxes are a reason for tax minimisation schemes." Using relevant elements of economic theory, discuss how each of the approaches may affect companies operating in Australia in the following industries: • Car manufacturing; and • Food

4. Structure Weeks 7-8 Competition, market structures and business decisions Week 9 Pricing strategies and practices Week 10 Business and Government. Weeks 5 - 6 Production and Costs Managerial Economics Week 11 Capital budgeting Weeks 3-4 Demand analysis and estimation Week. 12 Research question Business and current economic situation. Week 2 Basic economics principles: demand and supply. Week1 Introduction. The nature of managerial economic decision making

5. Competition, market structures and business decisions Learning objectives What is the market Structure How does competition affect business decisions in different market structures? Perfect competition; monopoly; oligopoly; monopolistic competition Competitive strategies. Measurement of market structures Market strategies in different market structures. Non-price competition. Multinational companies. Vertical and horizontal coordination.

6. Competition, market structures and business decisions Reading Mansfield, Chapters 11 & 12

7. The competitive environment in the market for any product is the market structure faced by the firm Is measured in terms of the number of the actual buyers and sellers plus potential entrants Barriers to entry and exit Capital requirements Price vs Non-price competition Etc Potential entrants pose a sufficiently credible threat of entry to affect price/output decisions of incumbents Competition, market structures and business decisions Market structures What is the market structure?

8. Competition, market structures and business decisions Market structures What is the market structure? The firm in competitive markets Non-perfect competition Perfect competition Monopoly Oligopoly Monopolistic competition

9. Competition, market structures and business decisions Market structures Perfect competition • Profit maximiser • Identical product • Very small share of the market • Price-taker • Produces a homogeneous product • Perfect information • No barriers to entry (legal, technological, or resource) • No technical progress • No investment lag - Immediate implementation of production decisions) • Homogeneous goals of the owners and managerial staff

10. The short-run supply curve corresponds with the portion of the marginal cost curve that lies above the average cost curve. In a perfectly competitive market, Where P<AC losses can be reduced by expanding production so long as added revenues exceed added costs Competition, market structures and business decisions Market structures Perfect competition The Firm Supply Curve Cost and revenue per unit ($) LRMC LRAC

11. The sum of quantities that individual firms supply at each price The sum of marginal cost curves of individual firms above their average variable cost curves Competition, market structures and business decisions Price per unit ($) Supply 10 8 6 4 2 0 50 100 150 200 250 300 350 400 Quantity per time period (millions) Market structures Perfect competition The Industry Supply Curve

12. Negatively sloped demand curve Positively sloped supply curve Competition, market structures and business decisions Price per Supply unit ($) 10 8 P = – $0.254 + $0.000025 Q 6 4 P = $40 – $0.0001 Q 2 Demand 0 50 100 150 200 250 300 350 400 Market structures Perfect competition Market price determination Quantity per time period (millions)

13. Competition, market structures and business decisions Market structures Perfect competition Demand Curve for a single firm • Horizontal • Competitive firm – price taker Price per unit ($) 10 8 Demand 6 4 2 0 50 100 150 Quantity per time period (000)

14. Competition, market structures and business decisions Cost and revenue per unit ($) LRMC LRAC M P P = AR = MR C N Q * Output per time period Market structures Perfect competition Optimal price/output decision in the short run

15. Competition, market structures and business decisions Market structures Perfect competition Optimal price/output decision in the long run Cost and revenue per unit ($) LRMC LRAC P = AR = MR P Q * Output per time period

16. Competition, market structures and business decisions Market structures Perfect competition Breakeven point Price, cost per unit ($) MC ATC AVC D 2.00 B 1.40 1.25 1.00 A 0 100 Output per time period

17. One firm in industry Profit-maximiser Faces market supply curve One product No close substitutes Price-maker No restrictions on resources Competition, market structures and business decisions Market structures Monopoly Basic Assumptions

18. Competition, market structures and business decisions Market structures Monopoly Price-maker’s demand curve Price per unit ($) 12 10 8 Demand 6 4 2 0 50 100 150 200 Quantity per time period

19. Produces the quantity maximising profit (P>AC) Operates at a price above marginal revenue Makes economic profit Restricts information Imposes barriers to entry (controlling markets, inputs and/or lobbing the government) Competition, market structures and business decisions Market structures Monopoly P, Cost MC AC D MR Q

20. Competition, market structures and business decisions Market structures In the “real life” A real competitive firm (compare to the “ideal” one): • A typical firm, if it is not a small one, is not owner-managed • Separation of ownership, long-term strategic and short-run current control (shareholders, board of directors, brunch managers) implies the segregation of objectives; • Natural, economic and legal barriers • Diversification (non-homogenous product, more than one kind of activity) • Technical progress • Different criteria for different time horizons (short-run operation vs long-run planning. • Price-making • Price/marketing strategies • Imperfect information • Investment lag

21. Competition, market structures and business decisions Market structures Оligopoly Element of the theory relevant to this subject • An oligopolistic industry is composed of a few firms selling identical or similar products in the same market • Each firm carefully watches decisions of competitors and often plans anti-strategies; they • either ignore each other • or form cartels • or a price leader appears, causing monopolistic price formation • Elements of non-profit maximisation appear. A sales- revenue producers more than a profit maximiser and charges a lower price.

22. Competition, market structures and business decisions Market structures Мonopolistic competition Neoclassical view • The market consists of n mono-product firms; • The products are viewed by the buyers as close though not perfect substitutes for one another; • Therefore, each of the sellers is a monopolist of its particular product variant with a limited degree of monopoly power. • Such a monopolist is enjoying a monopoly power and making economic profit during only a short period of time • from the introduction of an unique product or technology • until such a technology becomes available to rivals, or • until a new “more innovative” product is introduced by a rival.

23. Competition, market structures and business decisions Market structures Мonopolistic competition Price Costs MC AC Pmc Demand MR Q Qmc Quantity Short-run quantity, price and economic profit

24. Competition, market structures and business decisions Price Costs MC AC Pmc D MR Qmc Quantity Market structures Мonopolistic competition Price Costs MC AC D1 D2 Quantity MR1 MR2 Entry of new firms offering product substitutes shifts the demand and MR curves) Long-run equilibrium same costs, lower demand and excess capacity – low output high price decision

25. Competition, market structures and business decisions Market structures Мonopolistic competition Price Costs Price Costs MC MC AC AC Pmc Pac D1 D D2 MR Qac Quantity MR1 Quantity Qmc MR2 Long-run equilibrium– high output low price decision (corresponds to perfect Competition)

26. Competition, market structures and business decisions Monopolistic competition in High-Tech product markets Neoclassical monopolistic competition versus Market structures Мonopolistic competition – contemporary view • Cost functions are identical across firms • Non-zero marginal costs • Perfect availability of the technology used in the production of all product variants • the firms are characterised by different cost functions • Relatively low marginal costs • Each portion of cutting-edge technological information does not spill over immediately

27. Competition, market structures and business decisions Market structures Мonopolistic competition – contemporary view • Cutting-edge technology does not spill over immediately • For the time, each firm possesses some unique product-attributable elements of otherwise common technology • These unique elements make the product variants different • The differences are viewed by the buyers as differences in quality characteristics • We assume the simplest case: all the quality characteristics of each product can be aggregated into a scalar quality characteristic • Increase quality generates increase in consumer demand. • Increase in quality can be achieved by a firm only through increase in the cost of the first copy • Each firm is characterised by its cost elasticity of quality

28. Competition, market structures and business decisions Consumer Quality(costs) Consumer demand (Price,Quality) Price(costs, demand) High Tech Firm IT firm IT firm IT firm IT firm Market structures Мonopolistic competition – contemporary view • Aiming at increase in profit, High Tech firm struggles for consumer demand investing in the quality of its product. • Increase in quality is associated with increase in costs. • The firm sets the price to cover the costs and earn profit, depending on anticipated demand • Increase in quality causes increase in quantity demanded • Increase in price causes decrease in quantity demanded

29. Competition, market structures and business decisions Market structures Мonopolistic competition – contemporary view • To ensure economic profit, relative increase in demand, associated with increase in quality per unit of relative increase in cost should not be offset by relative decrease in demand per unit of relative increase in price; and • Otherwise, the firm is not competitive.

30. Competition, market structures and business decisions Competitive strategies in Imperfectly competitive markets • Not all industries offer the same potential for sustained profitability; • Not all firms are equally capable of exploring the profit potential that is available. • An effective competitive strategy in imperfectly competitive markets must be founded on the firms competitive advantage.

31. Competition, market structures and business decisions Competitive strategies in Imperfectly competitive markets • A competitive advantage is a unique or rare ability to create, distribute or service valued by customers. • It is a business-world analogue to what economists call comparative advantage or when one nation or region of the country is better suited to the production of one product than to the production of some other product • Above-normal rate of return require a competitive advantage that cannot easily be copied • In production; • In distribution; or • In marketing

32. Competition, market structures and business decisions Competitive strategies in Imperfectly competitive markets • Reasons for competitive advantage: • Access to a unique resource • (Exclusive) Access to a mineral deposit • (Exclusive)Access to a material • Efficient energy source • Unique climatic condition • Unique technology • Unique (specially qualified or very talented) labour force; or • Access to a unique market • A university bookshop • The rice market in Japan • etc

33. Competition, market structures and business decisions Non-price competition. Product differentiation Product differentiation refers to the increase in time of the number of product categories suppled and the number of items in each category • Historically, a step from oligopolistic to monopolistic competition

34. Competition, market structures and business decisions Non-price competition. Product differentiation A simple model of the reason for product differentiation • Considers constant quantity as well as non-changing AC and MC corresponding to this quantity • Producing a little bit different product a firm might hope to charge a higher price Price P* P Q Quantity

35. Competition, market structures and business decisions Non-price competition. Barriers to entry Price Absolute cost advantages: Ability of established firms to produce any given level of output at lower unit costs than potential entrants LAC* P* LAC P Quantity Q* Q

36. Competition, market structures and business decisions Non-price competition. Barriers to entry Economies of scale: Ability of established firms * To produce any given level of output greater than a certain level Q* at lower unit costs and * To restrict potential entrants who are not able to invest in that level of production Price LAC P D Q* Quantity

37. Competition, market structures and business decisions Non-price competition. Barriers to entry Product differentiation advantages: Variety of demand curves and common LAC. Some firms have advantage of technology or specialisation and are facing demand curves to the right of the critical one. Price LAC P* D1 D2 D2 Q* Quantity

38. Competition, market structures and business decisions Non-profit-maximising competition. • Appear as the result of • Ability to affect prices and • Separation of ownership and managerial control • Managers’ aim at stability and increase in salaries • Stability may be achieved through the increase in the scale of operations • Increase in sales (not in profit) affects manager’s remuneration • Banks and retailers would prefer to deal with firms increasing the volume of sales

39. Competition, market structures and business decisions Non-profit-maximising competition. P, Cost MC AC D MR Q Profit maximising decision

40. Competition, market structures and business decisions Non-profit-maximising competition. P, Cost • Increasing sales, the firm is moving to the right and downward the demand curve and, therefore, decreases price, • The limitation is AC curve. Some profit should be earned anyway D MR Q Profit maximising decision Sales maximising decision

41. Competition, market structures and business decisions Non-profit-maximising competition. P, Cost MC AC D MR Q Profit maximising decision

42. Competition, market structures and business decisions Non-profit-maximising competition. P, Cost MC Old sales maximising decision is a profit maximising decision at a new level of average cost AC D MR Q Old profit maximising decision New profit maximising decision

43. Competition, market structures and business decisions Measurement of market structures Seller concentration Seller concentration refers to the degree to which production for a particular market or or in a particular industry is concentrated in the hand of few large firms Measurement of concentration • number of firms in the market • size distribution of firms in the market

44. Competition, market structures and business decisions Measurement of market structures Seller concentration

45. Competition, market structures and business decisions Measurement of market structures Seller concentration C2542 - Paint Manufacturing in Australia KEY COMPETITORS (www.ibisworld.com.au/static/iwabout/SamIndPart.asp) MAJOR PLAYERS

46. Competition, market structures and business decisions Measurement of market structures Seller concentration Measurement of concentration

47. Competition, market structures and business decisions Measurement of market structures Seller concentration Measurement of concentration Diagrammatic approach 100% The curve of real (not equal distribution The curve of equal distribution of shares of the market among firms Cumulative % of output This distance measures concentration N No of firms cumulated from the largest

48. Competition, market structures and business decisions Multinational companies. Vertical and horizontal coordination. Diversification Vertical coordination Multinational company

49. Competition, market structures and business decisions Multinational companies. Vertical and horizontal coordination. Diversification Invest in production facilities to produce a product D Buys shares of a firm Y producing a good B A firm X producing a good A Invents a new product C

50. Competition, market structures and business decisions Multinational companies. Vertical and horizontal coordination. Vertical coordination A firm X producing a good A