ECO 501- 22-3- 09- Markets- Introduction (1).pptx
- 1. ECO 501.1; ECO 501.2 MANAGERIAL ECONOMICS Fall Semester, 2022 BRAC University Week 9: Introduction to Markets
- 2. WEEK 9: Markets- Introduction • Topic 1: What is a market? • Topic 2: Perfect Competition • Topic 3: Assumptions: Homogenous Good • Topic 4: Assumptions: Information Sets • Topic 5: Assumptions: Independent Decisions • Topic 6: Assumptions: Entrance and Exit. • Topic 7: Some Types of Markets • Reference: McGuigan. Chap 10
- 3. Topic 1: What is a market? • A market is a meeting place where a single buyer and a single seller meet for transaction • Market analysis economics looks at ALL the transactions in the industry (all the firms and consumers). • It is important to distinguish the two before further analysis. • How are markets defined? • 1: No of sellers: Product markets Monopoly- Duopoly- Oligopoly- Monopolistic Competition • 2: No of buyers: Factor markets Monopsony- duopsony- oligopsony. • Economics analyses markets by no of sellers. Group 1 above
- 4. Topic 1: What is a market? • A firm’s decision has two influences. 1: Does a firm’s decision to produce more or less influence itself and other firms? 2: What impact does that have on the industry? • Our analysis will then be based on the above two questions • Market analysis starts with Perfect Competition, or Pure Competition. • Perfect Competition (PC) is used as a benchmark to compare other real world market scenarios. It is a benchmark like the body temperature of 98.4 degree Fahrenheit or BP of 80/120.
- 5. Topic 2: Perfect Competition • PERFECT (PURE) COMPETITION: • Assumptions 1. Many buyers and many sellers 2. Homogenous, identical product in the eyes of the consumer 3. Independent decisions 4. Symmetric information 5. Easy entrance and exit • IMPLICATION OF PERFECT (PURE) COMPETITION • 1. A commodity market 2. Each unit identical to all buyers & sellers 3. each unit sells at same price. 4. No buyers or no sellers can influence market price or quality 5. Market forces (dd and ss) determine outcome
- 6. Topic 2: Perfect Competition • PC does not exist in reality. The assumptions of PC gives an insight to how firms in different contexts may or may not be able to exercise market power. • Market power: Can a firm through its output decision influence the price at which a good will sell at? • By producing less or more, if a firm can influence price, the firm has market power. • By charging a higher or lower price, a firm can exercise market power. • There are other ways of gaining market power. We will discuss these later.
- 7. Topic 2: Perfect Competition • What is competition? • Market-share is defined as a firm’s percentage of the total demand in a market (industry). • Let a market sell 10,000 units per time period. • If there are many firms, where no single firm’s market-share can influence the outcome, then that market is competitive. • Perfect competition: This arises when there is competition as defined above, plus the market- share of each firm is insignificant. No firm can influence other firms or the industry by selling more or less.
- 8. Topic 2: Perfect Competition • Price-taking behaviour • Sellers try to charge a price as high as possible if they can. Or else, they accept the market price to be given. Buyers try to offer a price a low as possible if they can. Or else, they accept the market price to be given. They are then known as price- takers. • When sellers and buyers are price-takers, they have no market power.
- 9. Topic 3: Assumptions: Homogenous Goods • Homogenous Goods Buyer’s Perspective: 1: Homogenous good: identical in the eyes of consumers. 2: If two goods sold by two sellers are identical in your eyes, you will offer the same price to both sellers. 3: If not, then you would offer a higher price to the one you prefer more. • Seller’s Perspective: 1: If the seller knows buyers offer the same price for the same good, sellers cannot charge a higher price. Charging a lower price is not rational. • When goods are homogenous, they sell at a competitive price. This does not depend on the number of sellers.
- 10. Topic 3: Assumptions: Homogenous Goods • Example of Homogenous Goods 1: Crude oil. The crude oil that Bangladesh buys is the same crude oil sold by different petroleum exporting countries. Because of competition, it sells at the same price. 2: Prices of Bananas. The same breed of bananas sell at the same price. • Paradox of Homogenous Goods 1: Homogenous goods selling at same price is not related to the number of sellers. 2: Two sellers (or many sellers) in a region selling a homogenous good is expected to be sold at a competitive price. 3: When goods are viewed identically, they will command the same price
- 11. Topic 3: Assumptions: Homogenous Goods • Eggs in Dhaka City 1: There are 22 million+ people in Dhaka. If 50% of the people of Dhaka eats one egg daily, the daily demand is 11 million+. • There are many sellers and buyers. No seller (or groups) can exercise control over market price. • Eggs sell at a competitive price • 2: If tomorrow, there is a strike, the total no of eggs available in Dhaka city will fall. This will raise prices. Opposite will happen if there is a sudden increase in Dhaka city.
- 12. Topic 4: Assumptions: Information Sets • Information Set: What information set do the buyer and seller have about a: quality of the product? b: performance of the product? • First the quality of the product. • Symmetric Information: When the buyer and the seller have same set of information about the quality of the product. • Whatever the buyer knows about the actual quality, the seller knows the same. • Implication: 1. Good quality products sell at a high price and low quality at a low price. 2. Both good and low quality will be available. There will be product choice on the market.
- 13. Topic 4: Assumptions: Information Sets • Symmetric Information If both buyer and seller can identify different quality mobile phones credibly there will not be fraudulent behavior. 1: Buyer cannot offer lower price for either product– seller cannot charge higher price either. 2: Low quality and high quality sell at their competitive prices • Asymmetric Information Seller knows more: In used car markets, sellers know more about the true quality of a car. Sellers will have an incentive to hide true quality from buyers. Buyer knows more: In a life insurance market, the buyer of insurance will have an incentive to hide information of their true health.
- 14. Topic 4: Assumptions: Information Sets • Asymmetric Info: Used Car Market. Seller knows more 1. A good car sells at Tk 200; and a bad car at Tk 100. 2. Buyers cannot credibly distinguish quality. 3. Good and bad cars are randomly distributed. 4. The probability of getting a good and bad car is 50:50. • 5. As a buyer, what price would you offer? With the above information, you would offer 6. ½(200+100)= Tk 150. 7. What will happen if the average price persists in the presence of info asymmetry? 8. Good quality cars will sell less. Only bad cars will be sold. The market will have only one product.
- 15. Topic 4: Assumptions: Information Sets • Asymmetric Info: Insurance Market. Buyer knows more 1. The buyer of a health insurance knows if they are healthy (good) or sick (bad). 2. Using same info as used cars market: healthy & sick patients are randomly distributed with a probability of 50:50 selecting any of the two types. • 5. As a seller of insurance, what premium would you offer? 6. If you offer avg premium, sick patients will buy more health insurance. 7. If only sick patients buy health insurance, this could lead to NO INSURANCE if situation persists for too long.
- 16. Topic 4: Assumptions: Information Sets • Is Asymmetric Information a Sustainable Outcome? With asymmetric information, fraudulent behavior prevails. Some sellers or buyers can make gains. • This will not be sustainable. Once others start to know of this fraudulent behavior, markets will correct themselves. • Asymmetric information on quality is also known as: Adverse selection; Hidden characteristics; Hidden preferences. • We shall discuss these later on
- 17. Topic 4: Assumptions: Information Sets • Asymmetric Information About Performance: Once a good is sold, and once adverse selection has been addressed then comes the que: 1: How well will the good perform? 2: What is life-span of the good? • Before a transaction these cannot be determined credibly • After hiring a worker, que: 1: How well will the worker perform? 2: Will the worker shirk? • These are known as: Moral hazard- hidden actions. • We shall discuss these later on, if time allows.
- 18. Topic 5: Assumptions: Independent Decisions • Independent Decisions: • When my decision to produce more or less DOES NOT AFFECT your decision to do so • AND • Your decision to produce more or less DOES NOT AFFECT my decision to do so • Both have to hold at same time • If I cannot influence your decisions in a market with my decisions, and you cannot also do the same, Then • I will try to do the best I can– AND You will do the same • The Eggs Example: You and I try to sell as many eggs as we can.
- 19. Topic 5: Assumptions: Independent Decisions • Inter-dependent Decisions: • My decision depends on WHAT You are doing • AND • Your decision depends on WHAT I am doing. • When decisions are inter- dependent, we will use game theory. • We will discuss inter-dependent equilibrium later. • We will discuss it under game theory, and the concept of the Nash equilibrium
- 20. Topic 6: Assumptions: Entrance and Exit • Two determinants that influence a firm's decision to enter a market: First: 1. What is the avg profitability of firms in the industry? 2. Is the market exhausted? • If 1 and 2 above are favourable, then a firm may be interested to enter a market. • Second: 1. How costly is it to enter? This cost is determined by fixed costs. • Rule of Thumb: 1. If FC to enter a market is low, then exit decision is easy. 2. If FC to enter a market is high, then exit decision is difficult.
- 21. Topic 6: Assumptions: Entrance and Exit • Rule of Thumb: • 3. The FC to enter a monopoly market will be the highest. As the number of firms that operate in an industry increases, the FC of entrance will tend to fall. 4. Geographical and other constraints also determine the ease or difficulty of entrance. • Fixed Cost is a Sunk Cost 1. Once a decision to enter a market has been made and the fixed cost has been paid, it becomes a Sunk Cost. 2. Only when the Sunk Cost has been recovered, and the firm can no longer recover operating costs, can the firm think of exiting from the market
- 22. Topic 7: Some Markets • Commodity Markets: buyers & sellers meet to transact a standardized good. • Buyers & Sellers do not need to know each other, i.e., do not need to match • Examples: Think • Matching Markets: Buyers & sellers meet certain conditions for a transaction. • Examples: Think • Markets defined by sellers– not by buyers. Monopoly; Duopoly; Oligopoly etc
- 23. Topic 7: Some Markets Relevant Market: Group of firms belonging to the same strategic group of Consumers. Example: The grocery in your neighbourhood has market power in the neighbourhood. Think due to what factors? • Concentrated Market: A relevant market with majority of total sales occurring in the largest four firms. • Example: There are many groceries in Dhanmondi, but the relevant market is dominated by few large superstores. Think due to what factors?
- 24. Topic 7: Some Markets • Fragmented Market: A relevant market whose market shares are small. • Example: Groceries in Dhanmondi. Fragmented into few large groceries, and many small corner shops. Think due to what factors? • Consolidated Market: A relevant market whose number of firms has declined over time through acquisition, merger, and buy outs. • Example: Telecom carriers; Cigarette and tobacco. Think due to what factors?