Week 3:
Preparation: Chap 3: Industrial
Organization
A market is efficient (only) if market price = MC.
The higher the deviation the higher the loss of market’s welfare.
Market power: a firm ability to sell its products at a price above MC.
Most commonly measure of a firm’s market power: Lerner index (L):
L = (p – MC)/ p.
In a perfect competitive market, MC=p and L=0.
LCartels≈ 30%
It is not z theoretical possibility for firms to sustain substantial market
power.
To measure a market power in a market (rather than for a single firm): weighted
average of the Lerner indices.
mi = Ri/ R with mi = market shares of a firm i; Ri = firms i revenue; R = total
market revenue
n
The market’s Lerner index: L = ∑ mi Li
i=1
Economic ways of getting and maintaining market power: advertising, collusion,
mergers, acquisitions and predatory behavior.
Market power induces allocative inefficiency.
Market power can be beneficial because push developing of new products or
production technologies.
Market concentration: concentrated only if a handful of firms have a serious
combined market share.
Competition authorities tend to be less lenient toward mergers in more
concentrated markets.
Economic regulation is often only relevant for highly concentrated markets.
n
Measured by the Herfindahl-Hirschman index (H): H = ∑ m2i
i=1
In the case of n equally sized firms: H = 1/n
A market having a concentration H is as concentrated as a market with N = 1/H
equally sized firms.
Also: L = H/ where =– p (Q)/ p’(Q) Q = the elasticity of demand.
Monopolies: markets where only supplier is active, so that H=1.
Profit max quantity: MR = MC
A short-cut to a monopoly firm’s profit-maximizing price is ghe ‘inverse elasticity
rule’: L = 1/
Because R = p(Q)Q; MR= p’(Q)Q + p(Q); and MC = MR;
[p(Q) – MC]/ p(Q) = [p’(Q)Q]/ p(Q) rewritten as L = 1/
Special case of the formula because H = 1
One of the central questions of Industrial Organization: is there arole for
government intervention in the case of market power.
, The main goal of competition policy (or antitrust policy) is to promote
competition in the market in general. Three pillars: anti-cartel law, abuse of a
dominant position, merger control. A fourth one can also be state aid control.
While competition policy is relevant for markets in general, economic regulation
only applies to specific markets. Regulated markets are usually natural
monopolies; i.e. markets where the production by a single firm minimizes costs.
2 most commonly used types of economic regulations:
- Rate-of-return regulation: the regulator sets prices such that the firm is
exactly compensated for the costs it in curs, including a ‘fair’ rate-of-
return.
- Price-cap regulation: the regulator simply sets a maximum price, usually
for a long period of time, taking inflation and technological progress into
account
Ratchet effect: the regulator may be tempted to tighten the price cap when the
firm decreases costs because this would bring the price closer to MC.
Chap 6: Oligopoly
A market is an oligopoly if a handful of firms are active in this market. Lies
between monopoly (a market with only firm) and perfect competition (in which
case many firms compete).
The Bertrand game: each firm’s profit is its price-cost margin times the number
of cups its sell.
Unique Nash Equilibrium: pB = MC = 1.
The Outcome of the Bertrand game: while the market is quite concentrated, the
outcome s the same as in a perfectly competitive market.
The Bertrand paradox:
- 2 or more firms are active in the market.
- Each firm can serve the entire demand at any price (even if can be
unrealistic: if firms face a serious capacity constraint, they tend to choose
a price > MC).
- The firms’ strategic choice variable is the price.
- The firms interact only once.
- All firms have the same MC.
- All consumers buy at the firm(s) with the lowest price: not true if firms sell
differentiated goods, in case of search costs or switching costs (they could
tho get market power) .
Cournot Competition: firms in a market make independent decisions as to how
much quantity to produce and sell to the market. All firms sell their output at the
market clearing price, which depends only on the total quantity the firms offer
for sale. Firms generate higher producer surplus, lower consumer surplus and
lower welfare than in perfect competition; but firms generate lower producer
surplus, higher consumer surplus and higher welfare than in monopoly market.
In Cournot competition, the Nash Equilibrium is: L = H/
Lerner index (L)>0 except in perfect competition where H = 0 or -> ∞
Bertrand paradox can be resolved by assuming that firms compete in
quantities and production capacities rather than on prices.
Chap 9: Market entry and product positioning
Preparation: Chap 3: Industrial
Organization
A market is efficient (only) if market price = MC.
The higher the deviation the higher the loss of market’s welfare.
Market power: a firm ability to sell its products at a price above MC.
Most commonly measure of a firm’s market power: Lerner index (L):
L = (p – MC)/ p.
In a perfect competitive market, MC=p and L=0.
LCartels≈ 30%
It is not z theoretical possibility for firms to sustain substantial market
power.
To measure a market power in a market (rather than for a single firm): weighted
average of the Lerner indices.
mi = Ri/ R with mi = market shares of a firm i; Ri = firms i revenue; R = total
market revenue
n
The market’s Lerner index: L = ∑ mi Li
i=1
Economic ways of getting and maintaining market power: advertising, collusion,
mergers, acquisitions and predatory behavior.
Market power induces allocative inefficiency.
Market power can be beneficial because push developing of new products or
production technologies.
Market concentration: concentrated only if a handful of firms have a serious
combined market share.
Competition authorities tend to be less lenient toward mergers in more
concentrated markets.
Economic regulation is often only relevant for highly concentrated markets.
n
Measured by the Herfindahl-Hirschman index (H): H = ∑ m2i
i=1
In the case of n equally sized firms: H = 1/n
A market having a concentration H is as concentrated as a market with N = 1/H
equally sized firms.
Also: L = H/ where =– p (Q)/ p’(Q) Q = the elasticity of demand.
Monopolies: markets where only supplier is active, so that H=1.
Profit max quantity: MR = MC
A short-cut to a monopoly firm’s profit-maximizing price is ghe ‘inverse elasticity
rule’: L = 1/
Because R = p(Q)Q; MR= p’(Q)Q + p(Q); and MC = MR;
[p(Q) – MC]/ p(Q) = [p’(Q)Q]/ p(Q) rewritten as L = 1/
Special case of the formula because H = 1
One of the central questions of Industrial Organization: is there arole for
government intervention in the case of market power.
, The main goal of competition policy (or antitrust policy) is to promote
competition in the market in general. Three pillars: anti-cartel law, abuse of a
dominant position, merger control. A fourth one can also be state aid control.
While competition policy is relevant for markets in general, economic regulation
only applies to specific markets. Regulated markets are usually natural
monopolies; i.e. markets where the production by a single firm minimizes costs.
2 most commonly used types of economic regulations:
- Rate-of-return regulation: the regulator sets prices such that the firm is
exactly compensated for the costs it in curs, including a ‘fair’ rate-of-
return.
- Price-cap regulation: the regulator simply sets a maximum price, usually
for a long period of time, taking inflation and technological progress into
account
Ratchet effect: the regulator may be tempted to tighten the price cap when the
firm decreases costs because this would bring the price closer to MC.
Chap 6: Oligopoly
A market is an oligopoly if a handful of firms are active in this market. Lies
between monopoly (a market with only firm) and perfect competition (in which
case many firms compete).
The Bertrand game: each firm’s profit is its price-cost margin times the number
of cups its sell.
Unique Nash Equilibrium: pB = MC = 1.
The Outcome of the Bertrand game: while the market is quite concentrated, the
outcome s the same as in a perfectly competitive market.
The Bertrand paradox:
- 2 or more firms are active in the market.
- Each firm can serve the entire demand at any price (even if can be
unrealistic: if firms face a serious capacity constraint, they tend to choose
a price > MC).
- The firms’ strategic choice variable is the price.
- The firms interact only once.
- All firms have the same MC.
- All consumers buy at the firm(s) with the lowest price: not true if firms sell
differentiated goods, in case of search costs or switching costs (they could
tho get market power) .
Cournot Competition: firms in a market make independent decisions as to how
much quantity to produce and sell to the market. All firms sell their output at the
market clearing price, which depends only on the total quantity the firms offer
for sale. Firms generate higher producer surplus, lower consumer surplus and
lower welfare than in perfect competition; but firms generate lower producer
surplus, higher consumer surplus and higher welfare than in monopoly market.
In Cournot competition, the Nash Equilibrium is: L = H/
Lerner index (L)>0 except in perfect competition where H = 0 or -> ∞
Bertrand paradox can be resolved by assuming that firms compete in
quantities and production capacities rather than on prices.
Chap 9: Market entry and product positioning
