Revision presentation for A2 Micro economics

1. Market Structure Conduct
and Performance
Revising for A2 Economics Questions on Markets

2. What is market structure?
• Organisational characteristics of a market
• We usually focus on those characteristics of a
market which affect the degree of competition
between firms + their pricing decisions
• Traditionally we emphasise:
1. The number and size distribution of buyers and sellers
2. The existence or absence of barriers to entry and exit

3. Structural characteristics of a market
• Ownership structure (e.g. state or private sector)
• Market share of largest businesses (concentration ratio)
• Nature of costs in the short & long run
• Degree of vertical integration along the supply chain
• Extent of product differentiation / product branding
• Price (Ped) and cross (Xed) price elasticity of demand
• Number and size of buyers of the industry’s product
• Turnover of customers from one seller to another (called
“market churn”) – affected by brand loyalty and advertising
and marketing

4. Q3Q2Q1
Cost & Price
Output (Q)
Costs and contestability in different industries
Low MES, limited scale
economies, contestable market
LRAC
Q1 Output (Q)
High MES, falling LRAC, barriers to
contestability
Extensive internal
economies of scale
leading to lower LRAC
Extensive internal
economies of scale
leading to lower LRAC
LRAC
Minimum
efficient
scale (MES)
Minimum
efficient
scale (MES)
Q4

5. Average
Cost per
Unit (£)
Quantity of output (Q)
Long Run Average Cost for a Natural Monopoly
Average cost falls across
a large range of output –
due to increasing returns
to scale
Average cost falls across
a large range of output –
due to increasing returns
to scale
Long run marginal cost of
production is often low
and stable as output
changes
Long run marginal cost of
production is often low
and stable as output
changes
LRACLRMC
AC1
AC2
AC3
Q1 Q2 Q3

6. Importance of defining the market
• Market and the industry often used inter-changeably
• But……………………………
– If we define a market in a narrow sense, it is likely that there
will be fewer producers
• E.g. the market for air travel to Aberdeen
– A broader definition of the market often gives us more choice
• E.g. the air transport industry (low cost airlines)
• The market for sportswear
– Defining the market is important when we measure the
concentration ratio and the extent to which a market is
dominated by one or a few large producers

7. Market Share and Market Power
Market share is not
the same as market
power!
First-Mover Advantages for Apple?

8. The Nature of Costs in an Industry
• Entry costs into a market
– Capital costs will vary from industry to industry
– E.g. a natural monopoly such as energy and power networks
• Sunk costs / exit costs
– These are costs that are not recoverable if a business leaves
• E.g. advertising and marketing
• Depreciation of capital equipment
– High sunk costs makes a market less contestable
• Natural cost advantages
– Location advantages e.g. close to ports, access to cheaper labour
– Ownership of important raw materials
– Control of the supply chain through vertical integration

9. Product differentiation
• Homogeneous goods
– Essentially the same physical characteristics
– Associated with perfect competition
– Different grades e.g. steel, cement, coal, fresh fruit
• Non-homogeneous goods
– Products differentiated from their competitors
– Branding, packaging and marketing are key here
• Strong product differentiation and brand loyalty allows firms to
charge higher premium prices
– Demand become less price elastic
– Reduction in the cross-price elasticity of demand
– Higher profit margins for a given unit cost

10. Conduct / Behaviour of Firms
• How does market structure affect pricing, output and other decisions of
businesses within the market
• Are there dominant firms?
• Is there evidence of anti-competitive behaviour?
– Collusive pricing agreements
– Control over the supply chain?
• How important is non-price competition in the market?
• Is there interdependence between firms?
• Do businesses behave strategically to retain profits by deterring the
entry of new competitors in the long run?
• Be aware that the market structure will affect the behaviour of firms

11. Some Key Performance Indicators
• Trends in real price levels for consumers over time
• Size of business profits – evidence of excess (monopoly) profits?
• How much spending on research and development and innovation
• Trend changes in labour productivity (output per worker employed)
• Environmental indicators e.g. Progress in reducing carbon intensity
• Does the conduct of firms give rise to efficient outcomes?
1. Allocative efficiency (prices relative to marginal cost)
2. Productive efficiency (unit costs in short and long run)
3. Dynamic efficiency (pace of innovation, quality of product)
4. Social efficiency (accounting for externalities)

12. Economic Efficiency Matters!

13. Cost & Price
Output (Q)
Allocative Efficiency – Competition / Pure Monopoly
Cost & Price
Output (Q)
Perfectly Competitive Market Pure Monopoly Market
S1
D1
P1
P2
Entry of
new firms
drives
price
lower
Entry of
new firms
drives
price
lower
AC
MC
AC
MC
Monopoly
demand
(AR)MR
P1 P1
Q1 Q2
P2
C2
Monopoly Profit
P>MC
Loss of allocative
efficiency
Monopoly Profit
P>MC
Loss of allocative
efficiency
S2

14. The usual causal view
Market
structure
Market
structure
Conduct of
Firms
Conduct of
Firms
PerformancePerformance

15. Conduct and market structure
The conduct of firms in a market
can affect market structure – e.g.
merger and takeover activity
Market
structure
Market
structure
Conduct of
Firms
Conduct of
Firms
PerformancePerformance

16. Performance and changing markets
The actual performance of firms in the market affects market structure –
e.g. rising dominance of best performing businesses – examples:
pharmaceuticals, food retailing
Market
structure
Market
structure
Conduct of
Firms
Conduct of
Firms
PerformancePerformance

17. Performance can affect market structure
• Performance can affect structure
– Top performing firms will gain market share at expense of rivals
– This gives them more market power
– Fine line between market dominance and economic efficiency
• Market conduct affects structure
– E.g. decisions about research and development and marketing
• Strategic behaviour of firms especially in oligopoly makes it
difficult to rely on the structure conduct performance model
• The theory of contestable markets stresses the dynamic
nature of competition especially when a market is open

18. Market power is
often self-
reinforcing
Innovative
businesses can
disrupt dominance

19. Tutor2u
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