Week 5: The Supply

Side: Alternative
Market Structures
UMUC HMGT 435

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Key Learning Objectives Week 5
• Understand different market structures and impact on price and
quantity decisions for suppliers
• Perfect Competition (last week)
• Monopoly
• Monopolistic Competition
• Oligopoly
• Understand when a firm can price discriminate

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Implications of Market Structure on Price and Quantity
• Market Structure is determined by:
• Number of firms competing
• Type of product sold
• Firm Specific demand curve (market power)
• Entry conditions (ability of other firms to enter the market)
• Four Market Structures:
• Perfect Competition (discussed last week)
• Monopolistic Competition
• Oligopoly
• Monopoly

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The Market Structure Continuum

Perfect
Competition Oligopoly

Monopolistic Monopoly
Competition

Many Firms A few firms One Firm

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Last Week We Looked at Perfectly Competitive Firms
• Characteristics of a perfectly competitive market:
• Many sellers (large number of firms) and buyers
• Homogeneous product (identical and no branding)
• No barriers to entry
• Price Charged:
• Firms in Perfectly Competitive Market cannot control the price they charge,
must charge whatever the market determines
• Long-Run Economic Profit = 0 as new firms enter
• Examples in Healthcare: medical supplies

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Perfectly Competitive Markets Are Efficient

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 Characteristics of a Monopoly
• In contrast to perfect competition, a monopoly
market has the following features:
• ONE seller
• Homogeneous or differentiated product
• Complete barriers to entry (e.g. patents, copyrights,
geography etc.)
• Because there is only one firm, that firm faces the
market demand curve, which is downward sloping
• In other words, the firm is the market and
determines price

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 What Price and Quantity
Does A Monopolist Choose
• What is the profit-maximizing price and quantity
for a monopolist?
• Recall that all firms will maximize profits
where MR=MC
• We have already seen that the marginal cost
curve for a firm depends on its production
function and input prices
• What does the firm’s MR curve look like?

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 Dollars Marginal Revenue For A Monopolist
per unit

MR Demand

Quantity

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 Monopoly Model (cont.)
• We are now ready to find the profit-maximizing
output for a monopolist
• The monopolist sets output at a level where
MR=MC
• On a graph, find the level of Q where the MR and MC
curves intersect
• To determine the price the monopolist will charge,
locate the price on the demand curve at this same
output level

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 Monopoly Model (cont.)
Dollars
per unit
MC

P*

MR Demand

Q* Quantity

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 Monopoly Model (cont.)

• The monopolist’s level of profits can then be

determined by adding its average total cost curve to
the graph

• Profits will be the difference between P* and ATC,

multiplied by Q*

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 Monopoly Model (cont.)
Dollars
per unit
MC

P*
ATC
Profits
ATC*

MR Demand

Q* Quantity

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 Contrast to Perfect Competition
Dollars Under perfect competition,
per unit the market equilibrium would
MC instead be where P=MC

ATC
PC

MR Demand

QC Quantity
The higher price and lower output in a monopolized market is why economists claim that
competition is better for social welfare
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 Barriers to Entry in Monopoly
• A monopoly only maintains its status if there are no
substitutes for the product it sells
• There must be barriers to entry, so that other
firms cannot enter the market to compete
• The two most common barriers to entry:
• Economies of scale (think Costco)
• Legal restrictions (patents, copyrights)

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 Economies of Scale
• Economies of scale
• If a monopoly is producing output at a level where long
run average costs are declining, then new firms cannot
compete on a cost basis
• Example: A monopoly hospital in a small town may
have substantial economies of scale if it can meet
demand with only 40-50 beds
• Unless a new hospital could take away a substantial
share of the existing hospital’s patients, it could not
match the existing hospital in costs (and therefore
profits as well)

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 Legal Restrictions Creating A Monopoly or Market Power
• Legal restrictions
• Physicians require a license to practice
medicine
• Many states require that providers obtain
a Certificate of Need to offer a new
service
• Drug companies obtain patents for new
pharmaceutical products

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Distortions in Monopoly Market
• The quantity (Q) produced by a
monopolist is less than socially
optimal
• Creates a deadweight loss (see
graph to the right)
• A higher Q (closer to a perfectly
competitive market) would be
more efficient

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 The Market Structure Continuum
• We have talked about 2 extremes of the
market structure continuum
• Perfect Competition
• Pure Monopoly
• Along this continuum, there are 2 more
levels of competitiveness that we will
encounter in the health care sector
• Monopolistic Competition
• Oligopoly

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 Monopolistic Competition
• Many sellers
• Differentiated product (due to branding)
• No barriers to entry

• Examples
• Breakfast cereals
• Ibuprofen (Advil, Motrin, etc.)
• Cigarettes
• Do not confuse this with “perfect competition” or
“monopoly,” this market structure is in-between
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 Monopolistic Competition (cont.)
• Because products are differentiated across firms,
each seller has some ability to control price
• Each seller faces a slightly downward sloping demand
curve

• Sellers have an incentive to “differentiate” their

product from competitors through “branding”
• Doing so is likely to raise demand for their product

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 Monopolistic Competition (cont.)
Dollars
per Unit
Demand under
monopolistic competition

Demand under
perfect competition

2 potential demand curves for an Output

individual firm
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 Monopolistic Competition (cont.)
• How do sellers differentiate their product?
• Advertising (creating a brand)

• Is advertising bad for consumers?

• Creates imaginary or artificial wants
• Persuasive, not informative
• Business stealing, w/ no benefits to consumer
• Habit buying is a barrier to entry

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 Monopolistic Competition (cont.)
• Benefits of advertising
• May convey important info on value of a good or
service
• People benefit from real diversity & choice
• Cheap info to customers to distinguish b/w products
• May promote quality competition
• Firms willing to invest in creating a brand name reputation
will work to keep it
• May inform the consumer of good or service they
weren’t aware of
• Shifts the D curve toward the right

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 Oligopoly
• Few, dominant sellers
• Homogeneous or differentiated product
• Substantial barriers to entry

• Examples
• Tertiary services at teaching hospitals
• Many prescription drugs
• Cable Internet Services

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 Oligopoly

• Because there are only a few dominant sellers,

actions of any one firm can change the overall
market price

• Like monopoly, oligopoly will lead to lower output

and higher prices than would be observed under
perfect competition
Regulators are concerned about consumer welfare in
oligopolistic markets

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Measures of Oligopoly
• Measures of Market Concentration Using Market Share
• Market share shows a firm’s sales relative to industry sales, higher market
share means that a firm has more influence in a market
• Herfindahl-Hirshman Index (HHI) – Take market share of each firm and
square them and add up across firms
• Low HHI: market is competitive
• High HHI: market is an oligopoly
• Concentration Ratios – The more market share is dominated by a few firms
the higher the concentration ratio.
• Example: If the four-firm concentration ratio is 80%, than the four largest firms have
80% of the market

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Oligopoly Pricing Based on Game Theory
• Game Theory: Looks at the Prisoner A
outcomes of decisions made when Prisoner CONFESS KEEP QUIET
those decisions depends upon the B
choices of others
• Prisoner’s Dilemma – when acting CONFESS Both go to jail for Prisoner B
separately two entities choose less 10 years gets life
imprison,
optimal result (e.g confess) which is Prisoner A
called the “dominant strategy” goes free
• But if they could collude they can get a
better outcome
• If firms can act over time, they can KEEP Prisoner A gets life Both go to
eventually reach an optimal price through QUIET imprison, Prisoner jail for one
“tacit collusion” B goes free year

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Game Theory (continued)
Nash Equilibrium
• a player has no incentive to independently change his course of action in a
game.
• Each firm makes the best decision for themselves based on what they think
others will do
• No firm can do better by changing their strategy
• Each firm sets its P=MC and both firms earn profit = 0
• Bertrand Competition: even with just two firms predicted outcome that P=MC

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Price Discrimination
• Firms with some market power can “price discriminate” and charge
different customers different prices for the same good or service.
• Example: Happy Hour in a Bar: Charge lower prices during off-peak hours
before dinner to generate demand.
• Conditions Necessary to Be Able to Price Discriminate:
1. Some market power
2. Consumers cannot resell the product
3. Must be able to segment market into different groups of consumers

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Summary of Market Structures
Market Structure Number of Type of Product Firm Specific Entry Conditions Examples in
Firms Demand Curve Healthcare

Perfect Many Homogeneous Perfectly Elastic No Barriers Medical supplies

Competition (e.g. latex gloves)
Monopolistic Many Differentiated by Elastic but not No Barriers Pharmaceuticals
Competition Advertising/ perfectly elastic (e.g. Prilosex vs.
Branding competitor)
Oligopoly Few Homogeneous or Less Elastic Large Barriers Health insurance
Differentiated from Economies of industry in local
Scale or markets
government
policies

Monopoly One Unique Market demand Large barriers Patented drugs

curve from economies of and local hospitals
scale or
government
policies

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