Competition, market

structures and
business decisions
1
 Competition,
Competition,market
marketstructures
structuresand
and
business decisions
business decisions
Learning
Learningobjectives
objectives

What
Whatisisthe
themarket
marketStructure
Structure
How
Howdoes
doescompetition
competitionaffect
affect
business decisions in different
business decisions in different
market
marketstructures?
structures?

Perfect
Perfectcompetition;
competition;monopoly;
monopoly;
oligopoly; monopolistic
oligopoly; monopolistic
competition
competition
Competitive
Competitivestrategies.
strategies.
Measurement
Measurementof
ofmarket
marketstructures
structures
Market
Marketstrategies
strategiesinindifferent
different
market structures.
market structures.

Non-price
Non-pricecompetition.
competition.

Multinational
Multinationalcompanies.
companies.Vertical
Vertical
and horizontal coordination.
and horizontal coordination.

2
 Market
Marketstructures
structures

What is the market structure?

 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

3
 Market
Marketstructures
structures

Factors that Shape the Competitive Environment

 Product Differentiation
– R&D, innovation, and advertising are important in many
markets.
 Production Methods
– Economies of scale can preclude small-firm size.
 Entry and Exit Conditions
– Barriers to entry and exit can shelter incumbents from
potential entrants.
 Buyer Power
– Powerful buyers can limit seller power.

4
 Market
Marketstructures
structures

The
Thefirm
firminincompetitive
competitivemarkets
markets Non-perfect
Non-perfectcompetition
competition

Perfect
Perfect Monopoly
Monopoly
competition
competition

Oligopoly
Oligopoly

Monopolistic
Monopolistic
competition
competition

5
 Market
Marketstructures
structures “Perfect competition” – competitive markets

❖ 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
6
 Market
Marketstructures
structures “Perfect competition” – competitive markets

 Examples of Competitive Markets

– Agricultural commodities.
– Some prominent markets for intermediate goods and
services.
– Unskilled labor market.

7
 Market
Marketstructures
structures “Perfect competition” – competitive markets

 Profit Maximization Imperative

– Normal profit is return necessary to attract and maintain
capital investment.
– Efficient firms can earn normal profit.
– Inefficient firms suffer losses.
 Role of Marginal Analysis
– Set Mπ = MR – MC = 0 to maximize profits.
– MR=MC when profits are maximized.

8
 Market
Marketstructures
structures “Perfect competition” – competitive markets

Marginal Cost and Firm Supply

Short-run Firm Supply

– Competitive market price
(P) is shown as a
horizontal line because
P=MR.
– Firm’s marginal-cost curve
shows the amount of
output the firm would be
willing to supply at any
market price.
– Marginal cost curve is the
short-run supply curve so
long as P > AVC .

9
 Market
Marketstructures
structures “Perfect competition” – competitive markets

Long-run Firm Supply

Marginal cost curve

is the long-run
supply curve so
long as P > ATC.
In long run, firm
must cover all
necessary costs
of production and
earn a normal
profit.

10
 Market
Marketstructures
structures “Perfect competition” – competitive markets

Long Run Normal Profit

Equilibrium
With a horizontal market
demand curve, MR=P.
P=MR=MC=ATC.
There are no economic
profits.
All firms earn a normal rate
of return.

11
 Competition,
Competition,market
marketstructures
structuresand
andbusiness
businessdecisions
decisions
Market Perfect competition
Marketstructures
structures

Price, cost
per unit
Breakeven point Poff peak – break even price off
MC
peak. At this price the firm
ATC expects to return only
variable costs and can
AVC
Ppeak D produce quantity Qoff peak
Ppeak- break even price at peak.
This is when the firm
B expects to return both fixed
Poffpeak and variable costs
producing quantity Qpeak

Q peak
0 Qoffpeak
12 Output per time period
 Competition,
Competition,market
marketstructures
structuresand
andbusiness
businessdecisions
decisions
Market
Marketstructures
structures “Perfect competition” – competitive markets

Competitive Market Supply Curve

Market Supply With a Fixed Number of
Competitors
Supply is the sum of competitor
output.
Market Supply With Entry and Exit
Entry results in more firms,
increased output, a rightward
shift in the supply curve, and
drives down prices and profits.
Exit reduces the number of firms,
decreases the quantity of
output, shifts the supply curve
leftward, and allows prices and
profits to rise for remaining
competitors.

13
 Competition,
Competition,market
marketstructures
structuresand
andbusiness
businessdecisions
decisions
Market Perfect competition
Marketstructures
structures

Market price determination

 Negatively sloped demand
curve
 Price
Positively sloped supply curve per Supply
unit ($)
10

8 P=–$0.254 + Q
$0.000025
6

4
P= $40
–$0.0001
Q
2
Demand

0 50 100150200250300350400
14 Quantity per time period (millions)
 Competition,
Competition,market
marketstructures
structuresand
andbusiness
businessdecisions
decisions
Market Monopoly
Marketstructures
structures

Basic Properties

 One firm in industry

 Profit-maximiser
 Faces market demand curve
 One product
 No close substitutes
 Price-maker
 No restrictions on resources
 Blockaded entry and/or exit
 Imperfect dissemination of information
 Opportunity for economic profits in long-run equilibrium.

15
 Competition,
Competition,market
marketstructures
structuresand
andbusiness
businessdecisions
decisions
Market Monopoly
Marketstructures
structures

 Examples of Monopoly
– Electricity utilities,
– Gas
– Water
– Public Tramsport
– Telecommunications

16
 Competition,
Competition,market
marketstructures
structuresand
andbusiness
businessdecisions
decisions
Market Monopoly
Marketstructures
structures
Profit Maximization in Monopoly Markets
 Price/Output Decisions
 A monopoly firm is the
market.
 Market and firm demand
curve slopes downward.
 Monopoly demand curve is
always above the marginal
revenue curve, P = AR > MR.
 Monopoly position allows
above-normal profits.
P > AC in long-run
equilibrium.
 Set Mπ = MR - MC = 0 to
maximize profits.
 MR=MC at optimal output.

17
 Competition,
Competition,market
marketstructures
structuresand
andbusiness
businessdecisions
decisions
Market Monopoly
Marketstructures
structures
Social Costs of Monopoly
 Monopoly Underproduction
Monopolists produce too little
output.
Monopolists charge prices that
are too high.
 Deadweight Loss from Monopoly
Monopoly markets creates a
loss in social welfare due to
the decline in mutually
beneficial trade activity.
There is also a wealth transfer
problem associated with
monopoly.
Under monopoly,
consumer surplus is
transferred to producer
surplus.

18
 Competition,
Competition,market
marketstructures
structuresand
andbusiness
businessdecisions
decisions
Market Monopoly
Marketstructures
structures

Social Benefits From Monopoly

 Economies of Scale
Monopoly is sometimes the natural result of vigorous competitive
forces.
In natural monopoly, LRAC declines continuously and one firm is
most efficient.
Some real-world monopolies are government-created or government-
maintained.
 Invention and Innovation
Public policy sometimes confers explicit monopoly rights to spur
productivity.

19
 Competition,
Competition,market
marketstructures
structuresand
andbusiness
businessdecisions
decisions
Market Monopoly
Marketstructures
structures

Monopoly Regulation

 Dilemma of Natural Monopoly

Monopoly has the potential for efficiency.
Unregulated monopoly can lead to economic profits and
underproduction.

ECW3830 COMPETITION AND REGULATION

20
 Competition,
Competition,market
marketstructures
structuresand
andbusiness
businessdecisions
decisions
Market Monopoly
Marketstructures
structures

Monopsony

 Buyer Power
Oligopsony exists when there are only a handful of
buyers.
Monopsony exists if there is only one buyer.
Buyer power can be used to obtain less than competitive
market prices.

21
 Competition,
Competition,market
marketstructures
structuresand
andbusiness
businessdecisions
decisions
Market Monopoly
Marketstructures
structures

 Bilateral Monopoly
Illustration
Unrestrained
monopoly gets
higher than
competitive market
prices.
Unrestrained
monopsony gets
lower than
competitive market
prices.
Monopoly/monopson
y confrontation
breeds
compromise.

22
 Competition,
Competition,market
marketstructures
structuresand
andbusiness
businessdecisions
decisions
Market In the “real life”
Marketstructures
structures

A “real” firm in a market place

(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
23 • Investment lag
 Competition,
Competition,market
marketstructures
structuresand
andbusiness
businessdecisions
decisions
Market
Marketstructures
structures Oligopoly and Monopolistic Competition

Contrast Between Monopolistic Competition and Oligopoly

 Monopolistic Competition
• Large number of sellers that offer differentiated products.
• Normal profit opportunity in long-run equilibrium.
 Oligopoly
• Few sellers.
• Economic profits are possible in long-run equilibrium.
 Dynamic Nature of Competition
• Timely market structure information is required for managerial
investment decisions

24
 Competition,
Competition,market
marketstructures
structuresand
andbusiness
businessdecisions
decisions
Market
Marketstructures
structures Мonopolistic competition

• 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.

25
 Competition,
Competition,market
marketstructures
structuresand
andbusiness
businessdecisions
decisions
Market
Marketstructures
structures Мonopolistic competition

Price
Costs MC
AC

Pmc

MR Demand
Q
Qmc Quantity

Short-run Monopoly Equilibrium

Monopolistically competitive firms take
26 full advantage of short-run monopoly.
 Competition,
Competition,market
marketstructures
structuresand
andbusiness
businessdecisions
decisions
Market
Marketstructures
structures Мonopolistic competition

Price
MC Price
Costs AC
Costs MC AC

Pmc

D2 D1
D
MR
MR1 Quantity
MR2 Qmc Quantity

Long-run equilibrium
same costs, lower
Entry of new firms demand and excess
offering capacity – low output
product substitutes high price decision
27 shifts the demand
With differentiated
 Competition,
Competition,market
marketstructures
structuresand
andbusiness
businessdecisions
decisions
Market
Marketstructures
structures Мonopolistic competition

rice Price
osts MC AC MC
Costs AC

Pmc
Pac

D2 D1 D
MR

MR1 Quantity Qmc Qac Quantity

MR2
Long-run equilibrium same Long-run equilibrium– high output
costs, lower demand and low price decision (corresponds to
excess capacity – low perfect
output high price decision Competition)
With homogenous products, P=AC
With differentiated
at minimum LRAC.
28 products, P=AC at a
point above minimum
This is a competitive market
equilibrium with
 Competition,
Competition,market
marketstructures
structuresand
andbusiness
businessdecisions
decisions
Market
Marketstructures
structures Oligipoly

 Oligopoly Market Characteristics

• Few sellers.
• Homogenous or unique products.
• Blockaded entry and exit.
• Imperfect dissemination of information.
• Opportunity for above-normal (economic) profits in long-run
equilibrium.
 Examples of Oligopoly
• National markets for aluminum, cigarettes, electrical equipment,
filmed entertainment, ready-to-eat cereals, etc.
• Local retail markets for gasoline, food, specialized services, etc.

29
 Competition,
Competition,market
marketstructures
structuresand
andbusiness
businessdecisions
decisions
Market
Marketstructures
structures Oligipoly

Cartels and Collusion

 Overt and Covert Agreements

• Cartels operate under formal agreements.
 Powerful cartels function as a monopoly.
• Collusion exists when firms reach secret, covert agreements.
 Enforcement Problem
• Cartels are typically rather short-lived because coordination
problems often lead to cheating.
• Cartel subversion can be extremely profitable.
• Detecting the source of secret price concessions can be extremely
difficult.

30
 Competition,
Competition,market
marketstructures
structuresand
andbusiness
businessdecisions
decisions
Market
Marketstructures
structures Oligipoly

Cartels and Collusion

31
 Competition,
Competition,market
marketstructures
structuresand
andbusiness
businessdecisions
decisions
Market
Marketstructures
structures Oligipoly

Oligopoly Output-Setting Models

 Cournot Oligopoly
 Cournot equilibrium
output is found by
simultaneously solving
output-reaction curves for
both competitors.
 Cournot equilibrium
output exceeds monopoly
output but is less than
competitive output.

32
 Competition,
Competition,market
marketstructures
structuresand
andbusiness
businessdecisions
decisions
Market
Marketstructures
structures Oligipoly
Stackelberg Oligopoly

• Stackelberg model posits a first-mover advantage.

• Price wars severely undermine profitability for both leading and
following firms.
• Price signaling can reduce uncertainty in oligopoly markets.
• Price leadership occurs when firms follow the industry leader’s
pricing policy.

33
 Competition,
Competition,market
marketstructures
structuresand
andbusiness
businessdecisions
decisions
Market
Marketstructures
structures Oligipoly
Stackelberg Oligopoly
• Price leader sets the
price at P2
• Profit is maximised at
Q1 .
• The follower(s) will
supply the combined
output of Q4-Q1
• At P3- Follows will
supply everything
At P1 – the leader will
supply everything at
no economic profit

34
 Competition,
Competition,market
marketstructures
structuresand
andbusiness
businessdecisions
decisions
Market
Marketstructures
structures Oligipoly

Oligopoly Price-Setting Models

 Bertrand Oligopoly:
Identical Products
– The Bertrand model
focuses upon the
price reactions.
– The Bertrand model
predicts a
competitive market
price/output
solution in
oligopoly markets
with identical
products.

35
 Competition,
Competition,market
marketstructures
structuresand
andbusiness
businessdecisions
decisions
Market
Marketstructures
structures Oligipoly

Oligopoly Price-Setting Models

 Bertrand Oligopoly:
Identical Products
– The Bertrand model
focuses upon the
price reactions.
– The Bertrand model
predicts a
competitive market
price/output
solution in
oligopoly markets
with identical
products.

36
 Competition,
Competition,market
marketstructures
structuresand
andbusiness
businessdecisions
decisions
Market
Marketstructures
structures Game Theory Basics

 Types of Games
– Zero-sum game: offsetting gains/losses.
– Positive sum game: potential for mutual gain.
– Negative-sum game: potential for mutual loss.
– Cooperative games: joint action is favored.
 Role of Interdependence
– Sequential games: moves in succession.
– Simultaneous-move game: coincident moves.
 Strategic Considerations

37
 Competition,
Competition,market
marketstructures
structuresand
andbusiness
businessdecisions
decisions
Market
Marketstructures
structures Game Theory Basics

Prisoner’s Dilemma

 Classic Riddle
– Rational behavior can give suboptimal result.
– Rationality can hamper beneficial cooperation.
 Business Application
– Dominant strategy gives best result regardless of moves by
other players.
– Secure strategy gives best result assuming the worst
possible scenario.
 Broad Implications

38
 Competition,
Competition,market
marketstructures
structuresand
andbusiness
businessdecisions
decisions
Market
Marketstructures
structures Game Theory Basics

Nash Equilibrium

 Nash Equilibrium Concept

– Neither player can improve their payoff through a unilateral
change in strategy.
– Nash equilibrium concept is broader than the concept of a
dominant strategy equilibrium.
– Every dominant strategy equilibrium is also a Nash
equilibrium.
– Nash equilibrium can exist where there is no dominant
strategy equilibrium.
 Nash Bargaining

39
 Competition,
Competition,market
marketstructures
structuresand
andbusiness
businessdecisions
decisions
Market
Marketstructures
structures Game Theory Basics

Infinitely Repeated Games

 Role of Reputation
– Infinitely repeated games occur over and over again without
boundary or limit.
– Firms receive sequential payoffs that shape current and
future strategies.
– Reputations for high quality give consumers confidence for
repeat transactions.
 Product Quality Games
– In a one-shot game, poor quality can fool customers.
– In an infinitely repeated game, poor quality is shunned by
customers.

40
 Competition,
Competition,market
marketstructures
structuresand
andbusiness
businessdecisions
decisions
Market
Marketstructures
structures Game Theory Basics

Finitely Repeated Games

 Uncertain Final Period

– Finitely repeated games have limited duration.
– With end point uncertainty, a finitely repeated game mirrors
an infinitely repeated game.
 End-of-game Problem
– Enforcing end-of-game performance is difficult.
– Solution: simply extend the game!
 First-mover Advantages
– Benefits earned by the player able to make the initial move in
a sequential move or multistage game.

41
 Competition,
Competition,market
marketstructures
structuresand
andbusiness
businessdecisions
decisions
Competitive
Competitivestrategies
strategiesininImperfectly
Imperfectlycompetitive
competitive
markets
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.

42
 Competition,
Competition,market
marketstructures
structuresand
andbusiness
businessdecisions
decisions
Competitive
Competitivestrategies
strategiesininImperfectly
Imperfectlycompetitive
competitive
markets
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

43
 Competition,
Competition,market
marketstructures
structuresand
andbusiness
businessdecisions
decisions
Competitive
Competitivestrategies
strategiesininImperfectly
Imperfectlycompetitive
competitive
markets
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
44
 Competition,
Competition,market
marketstructures
structuresand
andbusiness
businessdecisions
decisions
Non-price
Non-pricecompetition.
competition.
Product
Productdifferentiation
differentiation

Product
Product differentiation
differentiation
refers
refersto
tothe
theincrease
increasein
intime
timeof
ofthe
thenumber
numberof
of
product
productcategories
categoriessuppled
suppledand
andthe
thenumber
numberof
ofitems
items
in
ineach
eachcategory
category

■ Historically, a step from oligopolistic to monopolistic

competition

45
 Competition,
Competition,market
marketstructures
structuresand
andbusiness
businessdecisions
decisions
Non-price
Non-pricecompetition.
competition.
Product
Productdifferentiation
differentiation

A simple model of the reason for product differentiation

Price • Considers constant
quantity as well as non-
changing AC and MC
corresponding to this
quantity
P*
• Producing a little bit
P different product a firm
might hope to charge a
higher price

Q Quantity

46
 Competition,
Competition,market
marketstructures
structuresand
andbusiness
businessdecisions
decisions
Non-price
Non-pricecompetition.
competition.
Barriers
Barriersto
toentry
entry

Price Absolute cost advantages:

Ability of established firms to

produce any given level of output
at lower unit costs than potential
P* LAC*
entrants
P LAC

Q* Q Quantity

47
 Competition,
Competition,market
marketstructures
structuresand
andbusiness
businessdecisions
decisions
Non-price
Non-pricecompetition.
competition.
Barriers
Barriersto
toentry
entry

Economies of scale:

Ability of established firms

Price
* To produce any given level of output
greater than a certain level Q* at
LAC lower unit costs and
* To restrict potential entrants who are
not able to invest in that level of
production
P
D

Q* Quantity
48
 Competition,
Competition,market
marketstructures
structuresand
andbusiness
businessdecisions
decisions
Non-price
Non-pricecompetition.
competition.
Barriers
Barriersto
toentry
entry

Product differentiation
advantages:

Price Variety of demand curves

and common LAC.
LAC
Some firms have advantage of
P* technology or specialisation and
are facing demand curves to the
right of the critical one.
D1
D2
D2

Q* Quantity
49
 Competition,
Competition,market
marketstructures
structuresand
andbusiness
businessdecisions
decisions
Non-profit-maximising
Non-profit-maximisingcompetition.
competition.

Appear
Appear as
as the
theresult
result of
of
••Ability
Ability to
to affect
affect prices
prices and
and
••Separation
Separation of
of ownership
ownershipand
andmanagerial
managerial control
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
50
 Competition,
Competition,market
marketstructures
structuresand
andbusiness
businessdecisions
decisions
Non-profit-maximising
Non-profit-maximising
competition.
competition.

P, Cost MC

AC

D
MR

Profit
maximising
51 decision
 Competition,
Competition,market
marketstructures
structuresand
andbusiness
businessdecisions
decisions
Non-profit-maximising
Non-profit-maximising
competition.
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.
D Some profit should be earned
MR anyway

Profit Sales
maximising maximising
52 decision decision
 Competition,
Competition,market
marketstructures
structuresand
andbusiness
businessdecisions
decisions
Non-profit-maximising
Non-profit-maximising
competition.
competition.

P, Cost MC

AC

D
MR

Profit
maximising
53 decision
 Competition,
Competition,market
marketstructures
structuresand
andbusiness
businessdecisions
decisions
Non-profit-maximising
Non-profit-maximising
competition.
competition.

P, Cost MC
Old sales maximising decision is a profit
maximising decision at a new level
of average cost
AC

D
MR

Old profit New profit

maximisin maximisin
54
g g
decision decision
 Competition,
Competition,market
marketstructures
structuresand
andbusiness
businessdecisions
decisions
Measurement
Measurementofofmarket
marketstructures
structures
Seller
Sellerconcentration
concentration

Seller
Seller concentration
concentration
refers
refersto
tothe
thedegree
degreeto
towhich
whichproduction
productionforforaa
particular
particularmarket
marketor
oror
orin
inaaparticular
particularindustry
industry
is
isconcentrated
concentrated in
inthe
thehand
handofoffew
fewlarge
largefirms
firms

Measurement of concentration

• number of firms in the market

• size distribution of firms in the market
55
 Competition,
Competition,market
marketstructures
structuresand
andbusiness
businessdecisions
decisions
Measurement
Measurementofofmarket
marketstructures
structures
Seller
Sellerconcentration
concentration

The Australian
Bureau of
8140.0.55.001 Industry
Statistics Concentration Statistics

56
 Competition,
Competition,market
marketstructures
structuresand
andbusiness
businessdecisions
decisions
Measurement
Measurementofofmarket
marketstructures
structures
Seller
Sellerconcentration
concentration

C2542 - Paint Manufacturing in Australia

KEY COMPETITORS (www.ibisworld.com.au/static/iwabout/SamIndPart.asp)
MAJOR PLAYERS

Table: Market Share

Major Player Market Share Range
Orica Limited 22.00% - 25.00% (2004)
Wattyl Limited 17.00% - 19.00% (2004)
Barloworld Australia Pty Limited 9.00% - 11.00% (2004)
Akzo Nobel Industries Limited 7.00% - 9.00% (2003)

57
 Competition,
Competition,market
marketstructures
structuresand
andbusiness
businessdecisions
decisions
Measurement
Measurementofofmarket
marketstructures
structures
Seller
Sellerconcentration
concentration

Measurement of
concentration

T
hefirmsintheind
ustry aresorte
d
a
ccordin
gtothesiz
eo fthe iro
utput.
X i -theo
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58 1 X
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 Census Measures of Market Concentration

 Concentration Ratios
– Group market share data are called concentration ratios.
– CRi = ∑ Xi, where Xi is market share of the ith leading firm.
– CRi = 100 for monopoly.
– CRi ≈ 0 for a perfectly competitive industry.
 Herfindahl-Hirschmann Index
– Calculated in percentage terms, the HHI is the sum of squared market
shares for all competitors.
– HHI = ∑ Xi2, where Xi2 is squared market share of the ith firm.
– HHI = 10,000 for monopoly.
– HHI ≈ 0 for a perfectly competitive industry.
 Limitations of Census Information
– Slow reports hinder usefulness.
– National statistics obscure local markets.

59
 Competition,
Competition,market
marketstructures
structuresand
andbusiness
businessdecisions
decisions
Measurement
Measurementofofmarket
marketstructures
structures
Seller
Sellerconcentration
concentration

Measurement of concentration

Diagrammatic
approach
100%
The curve of real (not
Cumulative % of output

equal distribution

The curve of equal

distribution of shares
of the market among
firms
This distance measures
concentration
N
No of firms cumulated from the largest
60
 Competition,
Competition,market
marketstructures
structuresand
andbusiness
businessdecisions
decisions
Multinational
Multinationalcompanies.
companies.Vertical
Verticaland
andhorizontal
horizontalcoordination.
coordination.

Diversification
Diversification

Vertical
Verticalcoordination
coordination

Multinational
Multinationalcompany
company

61
 Competition,
Competition,market
marketstructures
structuresand
andbusiness
businessdecisions
decisions
Multinational
Multinationalcompanies.
companies.Vertical
Verticaland
andhorizontal
horizontalcoordination.
coordination.
Diversification
Diversification

Invest in production
Buys shares of
facilities to produce
A firm X a firm Y producing
a product D
producing a good B
a good A

Invents a new
product C

62
 Competition,
Competition,market
marketstructures
structuresand
andbusiness
businessdecisions
decisions
Multinational
Multinationalcompanies.
companies.Vertical
Verticaland
andhorizontal
horizontalcoordination.
coordination.
Vertical
Verticalcoordination
coordination

A firm X
producing
a good A

63
 Competition,
Competition,market
marketstructures
structuresand
andbusiness
businessdecisions
decisions
Multinational
Multinationalcompanies.
companies.Vertical
Verticaland
andhorizontal
horizontalcoordination.
coordination.
Vertical
Verticalcoordination
coordination

A firm X
producing
a good A

Invest in production
facilities or buys shares
of or coordinate activities
with a firm producing an
input D
64
 Competition,
Competition,market
marketstructures
structuresand
andbusiness
businessdecisions
decisions
Multinational
Multinationalcompanies.
companies.Vertical
Verticaland
andhorizontal
horizontalcoordination.
coordination.
Vertical
Verticalcoordination
coordination

A firm X
producing
a good A

Invest in production Invest in facilities or

facilities or buys shares buys shares of or
of or coordinate activities coordinate activities
with a firm producing an with a firm providing
input D professional training
65 for employees
 Competition,
Competition,market
marketstructures
structuresand
andbusiness
businessdecisions
decisions
Multinational
Multinationalcompanies.
companies.Vertical
Verticaland
andhorizontal
horizontalcoordination.
coordination.
Vertical
Verticalcoordination
coordination

Invest in production
facilities or buys shares
of or coordinate
activities with a firm using
A as an input

A firm X
producing
a good A

Invest in production Invest in facilities or

facilities or buys shares buys shares of or
of or coordinate activities coordinate activities
with a firm producing an with a firm providing
input D professional training
66 for employees
 Competition,
Competition,market
marketstructures
structuresand
andbusiness
businessdecisions
decisions
Multinational
Multinationalcompanies.
companies.Vertical
Verticaland
andhorizontal
horizontalcoordination.
coordination.
Vertical
Verticalcoordination
coordination

Invest in production
facilities or buys shares
of or coordinate Invest in or buys shares
activities with a firm using of or coordinate activities
A as an input with a firm specialising in
the selling of product A
A firm X
producing
a good A

Invest in production Invest in facilities or

facilities or buys shares buys shares of or
of or coordinate activities coordinate activities
with a firm producing an with a firm providing
input D professional training
67 for employees
 Competition,
Competition,market
marketstructures
structuresand
andbusiness
businessdecisions
decisions
Multinational
Multinationalcompanies.
companies.Vertical
Verticaland
andhorizontal
horizontalcoordination.
coordination.
Multinational
Multinationalcompany
company

Undertake
vertical Establishes
coordination branches in other
measures abroad countries
A firm producing
a good A in a
home country
Buys share of
Conduct
analogous firms
diversification
in other countries
practices abroad

68