EC3099 Units D and E: Competition, Market Structure, and
Market Power
Contents
1. Unit D: Competition, Market Structure, and Welfare 2
What is Industrial Organization (IO)? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
Core Goals of Industrial Organization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
Market Structure Characteristics . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
Firm Behavior Shaping Market Structure . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
Market Outcomes Measurement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
The Rationale for Regulation and Competition Policy . . . . . . . . . . . . . . . . . . . . 3
Competition Policy Definition and Objectives . . . . . . . . . . . . . . . . . . . . . . . . . 3
Structure-Conduct-Performance (SCP) Paradigm . . . . . . . . . . . . . . . . . . . . . . . 5
Three Types of Economic Efficiency . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
Perfect Competition: The Welfare Benchmark . . . . . . . . . . . . . . . . . . . . . . . . . 5
Contestable Market Theory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
2. Unit E: Market Power and Efficiency 8
Monopoly: The Opposite Extreme . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
Monopoly Profit Maximization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
The Lerner Index of Market Power . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
Monopoly vs Perfect Competition: Welfare Analysis . . . . . . . . . . . . . . . . . . . . . 10
Productive and Dynamic Efficiency . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
Glossary 13
Notation and Symbols 14
Economic Models Reference Sheet 15
1
,EC3099: Competition, Market Structure, and Market Power Units D and E: Page 2
1. Unit D: Competition, Market Structure, and Welfare
What is Industrial Organization (IO)?
Industrial Organization is the study of the operation and performance of imperfectly competitive
markets and the behavior of firms in these markets. It provides the theoretical foundation for
understanding how market structure affects firm behavior and market outcomes.
Core Goals of Industrial Organization
Research Question Focus Area
Market Structure Analysis Why do different markets have different structures? How
does market structure affect firms’ behavior?
Firm Behavior Impact How does firms’ behavior affect market structure?
Outcome Assessment Understanding market outcomes and their welfare implica-
tions
Market Structure Characteristics
Market structures differ across four key dimensions:
Dimension Description Examples
From monopoly to per- Google (monopoly), Airlines
Number of Firms fect competition (oligopoly), Restaurants (many
firms)
Organization of sequen- Apple (controls hardware + soft-
Vertical Integration tial production process ware), Traditional manufacturers
within a firm (outsource)
Horizontal: Different Coke vs Pepsi, Ford vs Honda
characteristics for dif-
Product Differentiation ferent tastes
Vertical: Different qual- iPhone vs budget smartphones
ity levels
How easy is it for new Patents, brand loyalty, high startup
Barriers to Entry firms to enter the mar- costs
ket?
,EC3099: Competition, Market Structure, and Market Power Units D and E: Page 3
Firm Behavior Shaping Market Structure
Firms actively influence market structure through strategic decisions:
• Non-price competition: Research and development investments create technological advan-
tages and entry barriers
• Entry and exit decisions: Strategic market entry/exit affects competitive dynamics
• Strategic investment: Infrastructure investments (e.g., Amazon’s warehouses) can deter com-
petition
• Merger decisions: Consolidation directly reduces the number of competitors
Market Outcomes Measurement
Economic performance is evaluated through multiple metrics:
• Prices and quantities produced in the market
• Consumer surplus (CS) - benefit consumers receive above what they pay
• Producer surplus (PS) - profit and economic rent earned by firms
• Total welfare: 𝑊 = 𝐶𝑆 + 𝑃 𝑆
Perfect competition serves as the benchmark for welfare maximization.
The Rationale for Regulation and Competition Policy
Market Reality Policy Need
Perfect competition paradigm rarely exists Real markets often dominated by small number of large firms
Market failures occur Collusion, predation, and entry barriers harm consumers
Examples of abuse Microsoft (2007), Intel (2009), Google (ongoing DOJ cases)
Historical Antitrust Cases
• Microsoft (2007): €500 million fine for tying Windows Media Player to operating system
• Intel (2009): €1.06 billion fine for abusing dominance in computer chips market
• Google (ongoing): Investigations by European authorities and DOJ over search dominance
• NVIDIA-Arm (2021): CMA investigation of anticipated acquisition
Competition Policy Definition and Objectives
Competition Policy aims at ensuring that competition in the marketplace is not restricted in a
way that is detrimental to society. It sets rules for competition among firms to achieve improved
market efficiency.
,EC3099: Competition, Market Structure, and Market Power Units D and E: Page 4
Competition Policy Objectives (Order of Importance)
Priority Objective Description
Primary Economic welfare (total 𝑊 = 𝐶𝑆 + 𝑃 𝑆 - maximize total welfare,
surplus) size of economic pie
Primary Consumer surplus Increase benefits to consumers, protect
consumer interests
Secondary Defense of smaller firms Protect small businesses from large firm
dominance
Secondary Market integration Promote unified European market
(EU)
Secondary Economic freedom pro- Preserve competitive market conditions
tection
Secondary Fighting inflation Use competition policy to control price
levels
Secondary Fairness and equity Ensure fair distribution of economic ben-
efits
Secondary Environmental consid- Include environmental factors in competi-
erations tion decisions
Secondary Political stability Consider broader political and social sta-
bility
Why Competition Policy is Needed
Firms may engage in harmful behavior when unmonitored:
• Collusion - coordinating prices or output
• Anti-competitive mergers - reducing competition through consolidation
• Predatory behavior - pricing below cost to eliminate rivals
• Exclusionary behavior - preventing competitors from accessing markets
Dominant positions may persist due to:
• Sunk cost industries - large irreversible investments
• Lock-in effects and switching costs - customer inertia
• Network effects - value increases with number of users
, EC3099: Competition, Market Structure, and Market Power Units D and E: Page 5
Structure-Conduct-Performance (SCP) Paradigm
The SCP paradigm provides an economic roadmap for understanding market dynamics:
Component Description
Structure Market concentration, number of firms, entry conditions,
product differentiation
Conduct Pricing strategies, advertising, R&D behavior, competitive
tactics
Performance Profits, efficiency, innovation, overall welfare outcomes
Note: Feedback loops exist between components - conduct influences structure through mergers,
and performance affects future strategic choices.
Three Types of Economic Efficiency
Efficiency Type Definition and Implications
Allocative Efficiency Achieved when 𝑃 = 𝑀 𝐶 - optimal allocation of resources
to maximize total welfare
Productive Efficiency Using best technology and management to minimize costs
at any output level
Dynamic Efficiency Long-run innovation, R&D adoption, and technological
progress
Competition policy faces trade-offs among these different efficiency goals.
Perfect Competition: The Welfare Benchmark
Assumptions of Perfect Competition
Assumption Implication
Homogeneous goods No product differentiation - perfect substitutes
Full information All market participants have complete information
Small economies of scale Average costs increase rapidly with firm size
Market Power
Contents
1. Unit D: Competition, Market Structure, and Welfare 2
What is Industrial Organization (IO)? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
Core Goals of Industrial Organization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
Market Structure Characteristics . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
Firm Behavior Shaping Market Structure . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
Market Outcomes Measurement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
The Rationale for Regulation and Competition Policy . . . . . . . . . . . . . . . . . . . . 3
Competition Policy Definition and Objectives . . . . . . . . . . . . . . . . . . . . . . . . . 3
Structure-Conduct-Performance (SCP) Paradigm . . . . . . . . . . . . . . . . . . . . . . . 5
Three Types of Economic Efficiency . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
Perfect Competition: The Welfare Benchmark . . . . . . . . . . . . . . . . . . . . . . . . . 5
Contestable Market Theory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
2. Unit E: Market Power and Efficiency 8
Monopoly: The Opposite Extreme . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
Monopoly Profit Maximization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
The Lerner Index of Market Power . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
Monopoly vs Perfect Competition: Welfare Analysis . . . . . . . . . . . . . . . . . . . . . 10
Productive and Dynamic Efficiency . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
Glossary 13
Notation and Symbols 14
Economic Models Reference Sheet 15
1
,EC3099: Competition, Market Structure, and Market Power Units D and E: Page 2
1. Unit D: Competition, Market Structure, and Welfare
What is Industrial Organization (IO)?
Industrial Organization is the study of the operation and performance of imperfectly competitive
markets and the behavior of firms in these markets. It provides the theoretical foundation for
understanding how market structure affects firm behavior and market outcomes.
Core Goals of Industrial Organization
Research Question Focus Area
Market Structure Analysis Why do different markets have different structures? How
does market structure affect firms’ behavior?
Firm Behavior Impact How does firms’ behavior affect market structure?
Outcome Assessment Understanding market outcomes and their welfare implica-
tions
Market Structure Characteristics
Market structures differ across four key dimensions:
Dimension Description Examples
From monopoly to per- Google (monopoly), Airlines
Number of Firms fect competition (oligopoly), Restaurants (many
firms)
Organization of sequen- Apple (controls hardware + soft-
Vertical Integration tial production process ware), Traditional manufacturers
within a firm (outsource)
Horizontal: Different Coke vs Pepsi, Ford vs Honda
characteristics for dif-
Product Differentiation ferent tastes
Vertical: Different qual- iPhone vs budget smartphones
ity levels
How easy is it for new Patents, brand loyalty, high startup
Barriers to Entry firms to enter the mar- costs
ket?
,EC3099: Competition, Market Structure, and Market Power Units D and E: Page 3
Firm Behavior Shaping Market Structure
Firms actively influence market structure through strategic decisions:
• Non-price competition: Research and development investments create technological advan-
tages and entry barriers
• Entry and exit decisions: Strategic market entry/exit affects competitive dynamics
• Strategic investment: Infrastructure investments (e.g., Amazon’s warehouses) can deter com-
petition
• Merger decisions: Consolidation directly reduces the number of competitors
Market Outcomes Measurement
Economic performance is evaluated through multiple metrics:
• Prices and quantities produced in the market
• Consumer surplus (CS) - benefit consumers receive above what they pay
• Producer surplus (PS) - profit and economic rent earned by firms
• Total welfare: 𝑊 = 𝐶𝑆 + 𝑃 𝑆
Perfect competition serves as the benchmark for welfare maximization.
The Rationale for Regulation and Competition Policy
Market Reality Policy Need
Perfect competition paradigm rarely exists Real markets often dominated by small number of large firms
Market failures occur Collusion, predation, and entry barriers harm consumers
Examples of abuse Microsoft (2007), Intel (2009), Google (ongoing DOJ cases)
Historical Antitrust Cases
• Microsoft (2007): €500 million fine for tying Windows Media Player to operating system
• Intel (2009): €1.06 billion fine for abusing dominance in computer chips market
• Google (ongoing): Investigations by European authorities and DOJ over search dominance
• NVIDIA-Arm (2021): CMA investigation of anticipated acquisition
Competition Policy Definition and Objectives
Competition Policy aims at ensuring that competition in the marketplace is not restricted in a
way that is detrimental to society. It sets rules for competition among firms to achieve improved
market efficiency.
,EC3099: Competition, Market Structure, and Market Power Units D and E: Page 4
Competition Policy Objectives (Order of Importance)
Priority Objective Description
Primary Economic welfare (total 𝑊 = 𝐶𝑆 + 𝑃 𝑆 - maximize total welfare,
surplus) size of economic pie
Primary Consumer surplus Increase benefits to consumers, protect
consumer interests
Secondary Defense of smaller firms Protect small businesses from large firm
dominance
Secondary Market integration Promote unified European market
(EU)
Secondary Economic freedom pro- Preserve competitive market conditions
tection
Secondary Fighting inflation Use competition policy to control price
levels
Secondary Fairness and equity Ensure fair distribution of economic ben-
efits
Secondary Environmental consid- Include environmental factors in competi-
erations tion decisions
Secondary Political stability Consider broader political and social sta-
bility
Why Competition Policy is Needed
Firms may engage in harmful behavior when unmonitored:
• Collusion - coordinating prices or output
• Anti-competitive mergers - reducing competition through consolidation
• Predatory behavior - pricing below cost to eliminate rivals
• Exclusionary behavior - preventing competitors from accessing markets
Dominant positions may persist due to:
• Sunk cost industries - large irreversible investments
• Lock-in effects and switching costs - customer inertia
• Network effects - value increases with number of users
, EC3099: Competition, Market Structure, and Market Power Units D and E: Page 5
Structure-Conduct-Performance (SCP) Paradigm
The SCP paradigm provides an economic roadmap for understanding market dynamics:
Component Description
Structure Market concentration, number of firms, entry conditions,
product differentiation
Conduct Pricing strategies, advertising, R&D behavior, competitive
tactics
Performance Profits, efficiency, innovation, overall welfare outcomes
Note: Feedback loops exist between components - conduct influences structure through mergers,
and performance affects future strategic choices.
Three Types of Economic Efficiency
Efficiency Type Definition and Implications
Allocative Efficiency Achieved when 𝑃 = 𝑀 𝐶 - optimal allocation of resources
to maximize total welfare
Productive Efficiency Using best technology and management to minimize costs
at any output level
Dynamic Efficiency Long-run innovation, R&D adoption, and technological
progress
Competition policy faces trade-offs among these different efficiency goals.
Perfect Competition: The Welfare Benchmark
Assumptions of Perfect Competition
Assumption Implication
Homogeneous goods No product differentiation - perfect substitutes
Full information All market participants have complete information
Small economies of scale Average costs increase rapidly with firm size
