MARKET STRUCTURE AND POWER Chapter 13.1 Market Structure ¨ Market structure: establishes the overall environment within which each firm operates. ¤ Number and size distribution of buyers and sellers ¤ Type of product for sale n Whether firms in the same industry produce standardized products or differentiated products n Differentiated products are less substitutable ¤ Barriers to entry n These reflect any increased costs that new firms must incur relative to existing firms when entering a particular market n High costs deter entry ¤ Whether any asymmetry of information exists between buyer and sellers Market Structure vs Market Power ¨ Market structure affects market power ¤ Market power refers to the firms ability to restrict output (or quality and thereby raise the price) n will dictate to some extent how firms behave Market Structure vs. Market Power Degree of Market Power 0% ……………………………………..100% Perfect Monopolistic Oligopoly Monopoly Competition Competition No. sellers Many Many Few One Individual firm Tiny Small Large 100% mkt. share Type of product H D H or D H Barriers to entry None None Substantial Complete Consumer info. Perfect Slight Perfect or Perfect or Imperfect Imperfect Imperfect H=Homogenous D=Differentiated Measuring Market Concentration ¨ Market concentration: reflects the number and size distribution of firms in an industry ¤ E.g. perfect competition has a large number of firms with small market shares ¤ Want to capture this structure with a statistics ¨ Two measures of market concentration ¤ Concentration ratio ¤ Herfindahl-Hirschman Index Measuring Market Concentration ¨ Concentration ratio ¤ % of industry output produced by the largest firms in the industry n Industry output measured in terms of sales or volume of output n Four-Firm Concentration Ratio (CR4) n % of industry output produced by 4 larges firms n 60% indicates that the four large firms account for 60 percent of industry output n <40% competitive n 40-60% monopolistic competition n 60+ oligopoly Measuring Market Concentration ¤ Limitations n Only considers number and size distribution of firms when determining market structure n Does consider barriers to entry n Does not consider the distribution of output among the largest firms n Firms more likely to be price competitive when similarly sized compared to when one firm dominates the industry and others are much smaller Measuring Market Concentration ¨ Herfindahl-Hirschman Index (HHI) ¤ Takes into account the relative size of the largest firms in the concentration ratio N HHi==+++ S222 S S...... S 2 åi =1 iN12 Si is the % of market share or % industry output produced by the ith firm. N is the total number of firms in the industry 010,000<HHI £ (100)2 0 many firms, 10,000 one firm Measuring Market Concentration ¤ Market structure and HHI n No specific cut offs that reflect structure of the market using HHI n Department of justice has some guidelines concerning when the level of HHI triggers concern about the potential exploitation of market power n HHI<1000: reasonably competitive n 1000>HHI<1800: mildly concentrated n HHI>1800: highly concentrated market.