IO Chapter 9 (I suggest you skim 9.2 and skip 9.3.)

Is it true that increased market power is linked to increased market concentration?

In other words, is there more monopoly power in industries where there are fewer firms?

Certainly the Cournot model suggests this is the case, as the solution (in terms of both p and q) was between the perfect competition and monopoly models.

Or put another way, HOW MANY firms does it take to reach perfect competition?

What other factors do we have to take into consideration other than number of firms?

What did the dominant firm and the Cournot model have in common?

One was the more general case of the other.

In fact what is the most general case? How is the price determined under perfect competition? Think of the graph. What is true of the supply curve?

p(q) = 1000 - (q₁+q₂+q₃+q₄+q₅+q₆+...) =1000 - S(q_i)

So what is the monopolist? A special case where only q₁>0 What is the duopolist? A special case where q₂ >0 also. The dominant firm is the case where q₂ to q_n sum to K.

From this we can also derive Figure 9.1 and Figure 9.2 (which are basically the same graphs, but with different emphases.)

We can actually solve the Cournot model for multiple firms, to see how quickly it approaches perfect competition. As it turns out, when we reach about 15 (identical) firms we are pretty close to the perfectly competitive case. (This is of course assuming there are no other violations of the basic assumption - ie homogeneous products, etc.) Also, the firms have to be identical, in terms of their cost functions, technology, market share.

What if we have 14 firms with 1% of the market each, and 1 firm with 86% of the market? Is that likely to approach perfect competition? What might it look like instead?

It turns out there are ways to measure market power empirically.

Ex:

Lerner Index:

L = S_i[s_i(p - MC_i)/p]

s_i is market share of the ith firm (a number between 0 and 1 - so 10% of market will be s=.1)

What will the value of L be in the case of perfect competition? How about if MC = 0?

The higher the L value, the more market power there is in a particular industry.

There are also formulas we can use to look at concentration, including

1. the concentration index and

2. the Herfindahl (or Herfindahl-Hirshman Index (HHI) index.

C_m = S_ms_i where m is a small number like 1 to 4 and where a C value close to 1 again suggests more concentration, since under perfect competition the top 4 firms should only have a small percent, thus leading to a small C.

HHI = S_is_i²

What will this number be under perfect competition? It also approaches 0. Economists often multiply H by 10,000 and report it as a number between 0 and 10,000.

Suppose you have the following data:

s p MC

.10 10 8

.30 15 8

.10 10 10

.50 15 9

What are L, C (for m=2 and 4), and H in this case?

L= .36

C₂= .8, C₄=1

H=.36 or 3600

We can also examine L and H together.

For instance, in the case of the Cournot model

L = H/e

So now we have talked about a number of factors which contribute to our understanding of market power.

What are these?

Think about monopolistic competition, dominant firm, duopoly, cartel, monopoly.

All assumed that demand was upward sloping (ie the elasticity of demand is an important factor).

Two required some kind of game theory, which means we made certain assumptions about firm behavior.

Most assumed a small number of firms.

Thus, the conduct or behavior of firms is an important factor to consider.

In addition, the elasticity of demand is important.

Finally, the structure of the market and the amount of market concentration, is also important.

Basically economists who actually analyze market structure using real data have to look at all three of these. What does the empirical study of market concentration look like?

The SCP or structure-conduct-performance paradigm summarizes the approach most economists take.

Structure --------> Conduct -----> Performance

Concentration -> Behavior ----> Market power ----> profit and loss of welfare

collusion? p>MC

Economists generally believe that higher market concentration will lead to more market power.

Ie more concentration (fewer firms) leads to more market power and thus to higher profits.

How would you set this up econometrically?

L = a + bH with b > 0

Unfortunately, testing this empirically is difficult for two reasons:

1) Data are limited. Economists have often used profit data instead of L.

2) The causality may run in the reverse direction between conduct and structure.

For example, a firm may price aggressively (low), in order to force a competitor out of the market.

conduct -------> structure ---------> performance