12. Firms and Market Structures

Diseconomies of Scale

• A firm experiencing diseconomies of scale should decrease its plant size.
• Decreasing plant size leads to its efficient scale, minimizing long-run average total cost.
• Plant size can be adjusted in the long run only.

Monopolistic Competition Characteristics

• A market is characterized as monopolistic competition when there are numerous independent sellers and differentiated products
• There are low barriers to entry with downward-sloping demand curves, and highly elastic demand.
• Monopolies and oligopolies have high barriers to entry, with a single seller (monopoly) or few interdependent sellers (oligopoly).

Law of Diminishing Returns

• The law of diminishing returns states that with fixed quantities of other resources, output increases at a decreasing rate as more of one resource (e.g., labor) is added.
• Output increases at a decreasing rate as adding more workers results in inefficiencies.

Demand Curves in Monopolistic Competition

• Demand for monopolistic competitors products is elastic due to availability of many close substitutes.
• Firms raising product prices cause customers to move to substitute products.

Price Takers

• Firms that operate as price takers produce the quantity where marginal cost equals marginal revenue (MC = MR).
• Production levels maximize profit but without maximizing revenue.
• Price takers will make zero economic profit in the long run.

Monopolistic Competition: Short Run vs. Long Run

• In the short run, firms in monopolistic competition can earn positive economic profit because price exceeds average total cost.
• In the long run, with low barriers to entry and resulting entrant competition, demand for individual firms falls.
• Prices get driven down to average total costs, reducing economic profits to zero.

Diminishing Returns & Marginal Costs

• In the short run, with increasing output quantity, marginal costs of production eventually rise at an increasing rate.
• Output will increase at a decreasing rate as more resources are added to production processes.

Oligopoly Characteristics

• An oligopoly is least likely characterized by a large number of sellers
• Oligopolies has a few sellers, and tend to have barriers to entry and significant economies of scale.

Venture Capitalist Expectations in Monopolistic Competition

• Venture capitalists can expect low costs to enter a monopolistically competitive market.
• Products will be differentiated, not homogeneous.
• Firms will compete more on feature differences and quality rather than price.

Diminishing Returns Example

• When output increases with labor but at a decreasing rate, this is an example of diminishing returns to labor
• Diminishing returns states at some point, output increases at a decreasing rate as more of a resource (e.g., labor) is devoted to productions while holding other inputs constant.

Assessing Market Structure Impact after Merger

• To assess the impact of a potential merger on market structure, calculate the Herfindahl-Hirschman Index.
• Herfindahl-Hirschman Index is more sensitive to mergers than the n-firm concentration ratio.

Diminishing Marginal Returns and Costs

• At production levels that are consistent with decreasing marginal returns, costs will increase at an increasing rate as production rises.

Monopolistic Competition: Key Characteristic

• Differentiated products are a key characteristic of monopolistic competition, producers generally have downward sloping demand curves.

Oligopoly Pricing

• Within an oligopoly, prices tend to fall somewhere between the price where all participants would maximize profits and a price that would result from perfect competition.
• Given options of $30, $20, and $25, and perfect competition valued at $18 and maximized profits at $25, a firm is most likely to charge $20.

Economic Market for Differentiated Products

• If a market is economic featuring a large number of competitors offering differentiated products it will be a monopolistic competition.
• Firms produce identical products under perfect competition
• Oligopolies have a small number of firms.

Common Feature Across Market Types

• Extensive advertising is least likely to be a feature between monopolistic competition and perfect competition
• Advertising differentiates the products of monopolistic competition while a key feature of perfect competition involves identical products.

Distinguishing Features of Monopolistic Competition

• A single seller is the least likely characteristic to describe monopolistic competition.
• There are many sellers or producers who sell differentiated products that permit firms to attract customers without reducing price.
• There are low barriers to entry.

Optimal Pricing Strategy

• Optimal pricing in an oligopoly market depend on the expected responses of how competitors will respond.
• Interdependence of firms is an oligopoly characteristic.

Perfectly Competitive Market Conditions

• Sellers making economic profits is the least likely condition in a perfectly competitive market
• Sellers do not make economic profit after taking into account their opportunity costs in competitive markets.
• Sellers in competitive markets face elastic demand and have indistinguishable products.

Long-Run Average Total Cost Curve

• The upward sloping segment of a long-run average total cost curve represents the existence of diseconomies of scale.
• Diseconomies of scale occur along the upward sloping segment costs rise as output increases.

Monopolistic Competition Characteristic

• Each producer offers a differentiated product
• Horizontal demand curves facing producers are a feature of perfect competition
• Interdependence is a characteristic of oligopoly markets.

Oligopolistic Industry Trait

• Interdependence among firms characterizes oligopolistic industries.
• One firm's pricing or advertising impacts other firms' demand curves.
• These industries have few sellers and barriers to entry.

Company Behavior in Monopolistic Competition

• Companies will focus on average market price rather than individual competitor prices.
• Price fixing is not be possible, and no one company can assert meaningful power over pricing, due to a a large number of independent sellers who will each have small market shares

Impact of Competitor Decisions on Market Structure

• The production and pricing alternatives of a firm are most impacted by competitors' decisions in an oligopoly.
• Oligopolies consist of a few firms producing similar or differentiated products.
• There is a high interdependence degree among competitors in the oligopoly market

Long-Term Profits in Monopolistic Competition

• For profitable firms with monopolistic competition, positive economic profits will tend to decrease over a long period, even if accounting profits remain positive
• Economic profit, unlike accounting profit, factors in implicit (or opportunity) costs.

Common Characteristics of Market Types

• Monopolistic competition and pure competition do not have in common a perfectly elastic demand curve.
• Price searchers face are present and face downward sloping demand curves.
• Producers face a perfectly elastic demand curve under pure competition.

Law of Diminishing Returns - Example

• Doubling the number of salespeople will result in the increase of total sales, reducing the average sales per salesperson
• Output will eventually decrease as more of a resource is added while holding constant other resource use
• More salespeople will generate more sales at a decreasing rate, and total sales increase and will reduce the average sales per salesperson.

Atypical Characteristics of Monopolistic Competition

• A small number of independent sellers is least likely to be featured in a market with monopolistic competition, as there exists a large number of independent sellers
• There are sellers that produce a differentiated product
• There will be low barriers to entry

Oligopoly Characteristics, Least Likely

• Relatively small economies of scale is least likely a feature of an oligopoly, which have large economies of scale and interdependence among competitors.
• Oligopolies include differentiated or similar products, and there are few sellers

Accurately Describing Monopoly Markets

• A market with a single seller of a product that has no good substitutes is accurately described by a monopoly.
• Monopolies has one seller, a specific and well-defined product without substitutes, and high barriers to entry.

Limitations of the N-Firm Approach

• A key limitation of the N-firm and Herfindahl-Hirschman concentration measures assessing market power is that they do not explicitly include the effects of potential competition.
• New entrants is not considered in industry concentration measurements, and pricing ability may be low when top firm market shares are large.

Monopolistic Competition - Accurate Aspects

• Monopoly competition has a large number of independent sellers, low barriers to entry, and an elastic downward sloping demand curve.
• Each firm produces a differentiated product.

Conditions and Revenue

• Firms acting under perfect competition will be least able to impact revenue by decreasing price
• Any firm lowers its output below market will hurt revenues
• Firms operating in monopolistic competition our oligopoly are price seachers, decreasing the price will increase their sales, but may lead to revenue loss, or income.

Company Outcomes for Competition Types

• When the market price is greater than its average variable cost (AVC) but lower than its average total cost (ATC), the firm should continue to produce and sell its product in the short run but not in the long run, unless the price increases. Firm's losses are minimized when the firm continues to produce,
• The should exit it's market if the price can't increase.

Free Entry & Exit plus Product Differentiation

• Monopolistic competition is known for free entry and exit, for differentiated products, and for price searcher behavior.

Marginal Returns

• As the quantity produced rises, costs begin to rise at an increasing rate, as this accurately defines decreasing marginal returns.

Cournot Duopoly Models

• In the long run, two firms with identical marginal cost curves in a Cournot duopoly model will sell the same quantity with equivalent market shares at an equilibrium price above the price in a perfectly competitive market.

Product Innovation & Competition

• Firms that produce new and innovative products face less elastic demand curves that allow them to increase prices and economic profits.
• Firms must persistently innovate product features as close substitutes erode profit.

Use of Concentration

• Concentration measures are used to identify the market structure of an industry and do not affect the elaticity.

Differences in Oligopoly Pricing

• Sequential pricing is a key difference in oligopoly price setting. The leader chosses the price first, which is different than the simultaneous pricing by market participants approach

Market Competition

• Monopolistic competition features low barriers to entry and monopolists do not.
• Each producer faces a downward sloping curve.

Scaling Factors

• Economies of scale occur as long-run unit costs fall as outputs increase.

Market Characteristics

• Perfect competition is most likely present with a small and homogenous market with low price control.

Industry Aspects

• Identifying a factor least likely to be included in an oligopoly reveals that it contains identical products

Market Entry

• One clear differentiation between monopolistic competition than pure monopoly highlights that barrier to entry is in fact quite low.

Firm Analysis

• A purely competitive market has smaller firms earn no economic profit for any significant period.

Market Structure

• Firms making the same product, would indicate the presence of a perfect competition, where any seller is small relative to the total market.

Market Conditions

• Barrier of entry are not a factor for perfect competition, in an industry with many sellers.

Monopolistic Competition

• Monopolistic competition does not feature each firm facing perfectly elastic demand