Structure, Conduct and

Performance 1
HOW MARKET STRUCTURES INFLUENCE FIRMS’ COMPETITIVE
S T R AT E G I E S , A N D T H E R E B Y T H E I R P E R F O R M A N C E
 Students are aware of how a monopolist
makes decision.
Key concepts:

Learning ◦ Characteristics of monopoly

◦ Sources of barriers of entry
Objectives ◦ Uniform pricing
◦ Price discrimination
◦ Two-part tariff
◦ Tie-in sales
Frequently
asked
questions
Why some firms in an industry
have higher profit margins than
others?

Why some industries have low

profit margins compared to other
industries?

What strategies firms can use to

improve or maintain their profit
margins?
Market structure
determines strategy.
Strategy determines
performance.
STRUCTURE → CONDUCT → PERFORMANCE
Pure Monopolistic Oligopoly Pure
Competition Competition Monopoly

Market Structure Continuum

The four market models COMMON MARKET

ST R U C T U R E S
Let’s begin with
monopoly
MONO = ONE. ONE FIRM IN THE MARKET
 What is monopoly?
Monopoly is a market structure in which one firm makes up the
entire market/industry.

There are barriers to entry into the market prevent competition,

and there are no close substitutes for the monopolist’s product.

Firm has power to set price

Non-price competition – mostly PR or advertising the product

Some terminology
◦ Monopolistic firm = monopolist
◦ Monopolistic market = monopoly

Photo Credit: William Warby

Examples
Public utility companies
◦ Electric, water

Licensed companies
◦ King Power (duty-free retail)
◦ Krungsri Bank on campus

Near monopolies
◦ CP All (Thailand’s convenient store market)
◦ Gillette (70% of razor blade sales)
◦ De Beers (90% of diamonds in the late 1980s)

Professional sports teams in their respective geographical area

(e.g. in the town).
Monopolist’s
advertising
examples
Clip 1

Clip 2

Clip 3
 Pure/Perfect Monopolistic
Characteristic Competition Competition Oligopoly Monopoly
Number of firms A very large number Many Few One
Type of product Standardized Differentiated Standardized or Unique; no close
differentiated substitutes
Conditions of entry Very easy, no obstacles Relatively easy Significant obstacles Blocked
Control over price None Some, but within rather Limited by mutual inter- Considerable
narrow limits dependence;
considerable with
collusion
Nonprice Competition None Considerable emphasis Typically a great deal, Mostly public relation
on advertising, brand particularly with advertising
names, trademarks product differentiation
Examples Agriculture Retail trade, dresses, Steel, auto, farm Local utilities
shoes implements

Monopoly characteristics: Recap

Conduct or strategy is
all about maintaining
barriers to entry!
PREVENTING ENTRY TO MAINTAIN MONOPOLY POSITION
 Patents
Economies
Factors or of scale
and
licenses
strategies
to prevent Ownership
Other
entry of
essential
strategic
behaviors
resources
Economies of scale

One of the major barriers.

Occurs where the lowest unit costs (ATC) and, therefore, lowest unit prices for consumers depend
on the existence of a small number of large firms or, in the case of a pure monopoly, only one
firm.

Because a very large firm with a large market share is most efficient, new firms cannot afford to
start up in industries with economies of scale.
The fewer
number of firms, Average
the lower the Cost
average cost.

One firm producing Q1 has

average cost C1.

If two firms share the market, C1/3

each produces Q1/2 and has C1/2
average cost C1/2.
C1 ATC
If three firms share the
market, each produces Q1/3
Q1/3 Q1/2 Q1 Q
has average cost C1/3.
Natural monopoly is an industry in which a single firm can produce at a lower cost than can two or
more firms.
◦ As the number of firms in the industry increases, ATC of producing a fixed number of unit increases.

Public utilities are often natural monopolies because

◦ they have economies of scale in the extreme case
◦ one firm is most efficient in satisfying the entire demand.

Government usually gives one firm the right to operate a public utility industry (electricity, water,
natural gas, etc.) in exchange for government regulation of its power.

Classic example is natural monopoly

Incumbent $
has advantage
over new firm $NF
LRATC for
Currently, only one firm (M) is M and NF
supplying electricity to 12
million people in Bangkok. $M
Suppose a new firm (NF)
offers services to 2 million
people.

$NF - $M will be the pricing QNF for QM for Q

advantage of incumbent firm. 2M people 12M people
Patents and licenses

Legal barriers to entry

Patents
◦ Grant the inventor the exclusive right to produce or license a product for twenty years
◦ This exclusive right can earn profits for future research, which results in more patents and monopoly profits.
◦ Similar legal instruments: copyrights

Licenses
◦ Examples: Radio and TV stations and taxi companies, and of course, “King Power.”
◦ Only one or a few firms are allowed to offer the service.
Ownership of essential resources

Can prevent other firms to enter.

Examples
◦ International Nickel Co. of Canada (now called Inco) used to control about 90 percent of the world’s nickel
reserves
◦ DeBeers of South Africa controls most of the world’s “white diamond” supply (about 70%)
◦ Professional sports leagues control player contracts and leases on major city stadiums.
Other strategic behaviors

Aggressive price cutting, increased advertising, and other actions can make it difficult for an entering
firm to succeed. But such a behavior is often under the government’s watchful eyes.
Example: Microsoft
◦ Microsoft denied its computer code from software firms wanting to produce Windows-based applications that
would compete with its products.
◦ In 2004 the European Commission ruled this action illegal.

Other actions that arise from more positive circumstances that can make it difficult for new entrants to
survive such as
◦ Well-established clientele, e.g. airline milage clubs
◦ Favorable financing to long-term customers.
What about pricing
and output decision
that maximizes profit?
HOW MUCH TO PRODUCE AND AT WHAT PRICE
Model assumptions

The monopoly is secured by patents, economies of scale, or resource ownership.

The firm is not regulated by any unit of government.

Two pricing options

Different prices
Single price for
for different
all customers
customers
Suppose the firm
uses unform
pricing
SINGLE-PRICE MONOPOLIST CHARGES THE SAME PRICE FOR ALL
UNITS OF OUTPUT
P

Marginal revenue and

the demand curve
MR D
Q The monopolist is the industry.
A B C
◦ Firm demand curve is the market demand curve.
◦ Downward sloping demand curve (as usual)

MR is below D
◦ Given a downward sloping demand curve, marginal
revenue (MR) for each additional unit falls faster than the
P price as quantity is increased.
◦ With a straight-line demand curve, MR will always
intersect the x-axis (Q) at half the distance of where the
demand line intersects the x-axis.

D
Q
The monopolist must lower the price to sell the additional unit.
The lower price is applied to all of the units being produced, not just the last unit, thereby causing
marginal revenue to be less than price.
The added revenue will be the price of the last unit less the sum of the price cuts which must be
taken on all prior units of output.
Intuition is from the relationship between average and marginal values.
◦ Suppose your current GPA is 3.5 and you get a B = 3 from the course.
◦ After the semester is over, your GPA (which is equivalent to AR) will be lower, but it won’t be 3 (which is
equivalent to MR).

Why MR is below D, and hence the price (P > MR)

To maximize
profit, choose P
Q and then P MC
Find output where
D at Qprofit max MC = MR, this is the profit
Monopolist is a price maker, and hence profit
maximization is a two-step approach.
maximizing Q

Step 1: Pick the level of output (Q) that

P= Find how much consumers
maximizes the profit.
$24
will pay where the profit
◦ The last unit of output where marginal
benefit (additional/marginal revenue) from max Q intersects demand,
producing that unit still exceeds marginal MC = MR this is the monopolist price
cost, i.e. MR > MC
D
◦ Or, where MR = MC and MC is rising MR
Q
Step 2: Pick the price (P) from the demand at 4 = Qprofit max
that level of output to be able to sell all units
produced.
 Possible Making profit: P > ATC

short-run
Break even: P = ATC

Continue with loss: ATC > P > AVC

Shutdown: P < AVC

outcomes
Making
profit
P = AR > ATC

Unit profit = (P – ATC).

Total profit = (P – ATC) x Q

Breaking
even
P = AR = ATC
Continuing Find output where
Determining Profits Graphically:
MC = MR, this is the profit A Firm with Losses

with loss
maximizing Q
P
Find how much consumers ATC at Qprofit max MC
will pay where the profit ATC
ATC > P = AR > AVC max Q intersects demand,
this is the monopolist price AVC
ATC
FC = (ATC – AVC) x Q Losses D at Qprofit max
P
Find profit per unit where AVC
Pay both FC and VC and earn the profit max Q
revenue. This gives a loss of intersects ATC
MC = MR
(ATC – P) x Q. D
Since AVC<P<ATC at the MR
profit maximizing quantity, Q
Qprofit max
this firm continues to Additional loss
if shutdown
operate with losses
 P
Shutdown ATC at Qif operaters MC
ATC
ATC AVC
Losses
P = AR < AVC Since AVC > P where AVC
D at Qif operates
MR = MC, P
FC = (ATC – AVC) x Q this firm shuts down
Pay only FC, but earn no
MC = MR
revenue. This gives a loss of
D
FC = (ATC – AVC) x Q. MR
Q
In the short-run, fixed costs Qif operates
Additional loss
are sunk costs. The firm has if operates

to pay fixed cost regardless of

whether or not it produces.
What if the firm
uses non-uniform
pricing?
CHARGING DIFFERENT PRICES TO DIFFERENT CUSTOMERS
 Price Two-part
Non- discrimination tariffs

uniform
pricing
strategies Tie-in sales Auctions
What is price discrimination?

Charge different buyers different prices.

◦ Consumers with less elastic demands are charged higher prices
◦ Consumers with more elastic demands are charged lower prices

Price differences are not based on cost differences.

◦ 3% cash discount or 3% credit card surcharge is transaction fee
Not all firms can price discriminate.
They can only do it when…

Have some market power: Firm demand is downward sloping, and hence can charge P > MC
Market segregation: The firm must be able to identify different buyers and can separate its market
based on their willingness to pay.
◦ Seniors and children demand is more elastic than adults (e.g. movie tickets).
◦ People buying from Makro (large volume) and people buying from 7-11 (small volume)
◦ People living in Beverly Hills demand is more inelastic than people living in downtown LA.

No resale (or no arbitrage): A low price buyer is prevented from buying at the low price and reselling the
good to a high price buyer.
◦ Services and warranties are often not transferable.
Types of price discrimination
First-degree: Second-degree: Third-degree:
Perfect Self-selection Segmented-market
•Charge each consumer the •Know something about the •Can observe some signal
maximum they are willing distribution of willingness that is correlated with
to pay. to pay. consumers’ willingness to
•Require full information on •Consumer self-select from pay, e.g. zip code, age,
willingness to pay a price menu gender, student or not.
•Rather hypothetical. •Quantity/volume discount, •Charge different prices to
Closest is auction. e.g. cheaper by dozens different consumers based
•Different prices for on the identity of the
different sections of consumers
seating in a sport stadium •Discount coupons
$
Profit under perfect
price discrimination

PM Perfect price
MR
c = MC = ATC

Demand
discrimination
QM QPD Q
Charge each consumer the maximum they are
willing to pay.

Total profit is larger than it would be with no

discrimination and a single price.
$
Profit under single
price monopoly

PM

c = MC = ATC

MR Demand
QM QPD Q
Segmenting
markets P Economic
P
profit Economic
Pa
profit
Movie tickets

Higher price for adults as they MC = ATC Ps

MC = ATC
have inelastic demand
Ds
Lower price for students as Qa Qs
MRa Da MRs
they have elastic demand
(a) Adults (b) Students
$

P*
c’
Two prices give
higher profit
c”
c = MC = ATC
Combined Combined
D2 MR1 MR D1 Demand
Q
Q*

Single price Total profit is larger than it would be with no

discrimination and a single price.

Note: Two possible solutions (Q*) if MC is

between c’ and c”
$

Profit 2 Profit 1
P1
P2
c = MC = ATC

D2 MR2 MR1 D1
Q
Q2 Q1

Two prices
What is a two-part tariff?

Charges a consumer
◦ a lump-sum fee (the first tariff) for the right to buy as many units of the goods as the consumer wants
◦ at a specified price (the second tariff).

Because of the lump-sum fee, consumers pay more per unit if they buy a small number of goods
than if they buy a larger number.

Example
◦ To get telephone or cell phone service, pay a monthly connection fee and a price per minute of use.
◦ To buy goods at Costco, pay an annual fee to get the right to go to Costco stores.
Two-part tariff
examples
Costco

Tops Club

Sizzler
If identical $

consumers
Lump sum
payment

Same individual demand

PM
Maximum profit would be equal
to that of perfect price
discrimination by:
◦ charge the unit price PTPT c = MC = ATC
PTPT = MC
MR Demand
◦ ask for the lump sum
payment equal to the area QM QTPT Q
under the demand curve
above MC.
 $

T2 T2

Two types of consumers

D2 MR2
P
MR1
c = MC = ATC

D1
but one price menu
Q1 Q
Q2

Type-1 buy more units at any price P than type-2

But cannot tell who is type-1 and who is type-2
◦ know the distribution, but not the identity
◦ Consumers have to self-select

Choose between the two menus

$ ◦ Menu 1: Charge T1 as lumpsum and unit price P = MC, type-2
will not buy. Profit = T1
T1 ◦ Menu 2: Charge T2 as lumpsum and unit price P = MC, both
types will buy. Profit = 2 x T2

c = MC = ATC
P
D2 MR2 MR1 D1
Q1 Q
Two types of
consumers
with two price
menus $

Make type-1 to dislike the price T2 T1

menu for type-2 (and vice
versa) by charging T1 > T2 and Additional earning
P1 = MC < P2 P2
from P > ATC
Type-1 consumers (who buy in c = MC = ATC
large volume) enjoy from the P1
lower unit price P1. D2 MR2 MR1 D1
Q
Higher T1 will discourage type-2 Q2 Q1
(who buy in small volume) to
switch to the high-volume price
menu even though they are
paying more at P2.
What is a tie-in sale?

Consumers have to buy one product together with another one.

Bundling
Requirement tie-in sale
(Package tie-in sale)
• Two or more products are sold together in a • Consumers who purchase one product from
fixed proportion the firm are required to make all their purchase
• An Apple computer and an iPod combo offered of another product (at any quantity that varies
to student purchase and by consumers)
• MS Office Suite (with one of each different • Polaroid camera and film
types of software – Word, Excel, PowerPoint, • iPhone and its APP store
and so on)
Tie-in sales are
business strategy
beyond pricing
UNLIKE PRICE DISCRIMINATION AND T WO -PART TARIFF THAT ARE
PRICING STRATEGIES TO EARN MORE PROFIT
Benefits of tie-in sales
Create or maintain market power
Avoid price control Ensure quality and efficiency
of other products
• Suppose monopoly power is • Sometimes the government • To ensure quality control of the
with product A, but not with B. sets a price control on certain products or reduce search cost
• Offering A and B together, can products. for customers
reduce the size of market • Can require customers to buy • Kodak films and development.
available to competitors for B. one product at the controlled Non-Kodak developer cannot
• Can earn more profit from B price along with another develop the film with the same
through price discrimination product at a price well beyond quality as Kodak.
and/or lower cost from equilibrium pricing to make up • iPhone and its APP store.
economies of scale for the loss of profits due to Purchasing from the iPhone
• Example: MS Windows and price control. APP store, iPhone users would
Internet Explorer bundle. not have compatibility issue
and even more selection of
APPs than any other
competitors.
What is an auction?

Pricing mechanism that induces the consumer with the highest willingness to pay to bid the
highest price to maximize the profit.

Can be interpreted as a kind of price discrimination.

Types of auctions
Sealed-bid first-price Sealed-bid second-price
English auction Dutch auction
auction auction
•Open ascending price. •Descending price. •Bided price is not •Bidders submit bids in
•Bidder and price are •An auctioneer calls out known to other bidders. sealed envelopes.
known. a price high enough so •Bidders submit bids in •The person submitting
•An auctioneer calls out that presumably no sealed envelopes. the highest bid wins the
a low price and raises it. bidder is interested in •The person submitting object but pays not what
•The auction stops when buying the object at that the highest bid wins the he bid, but the second
there is only one price. This price is object and pays what highest bid.
interested bidder. gradually lowered until he/she bid
some bidder indicates
•Sotherby’s
their interest.
•Tulip market

Sellers earn same expected revenue

Strategically equivalent
when values to bidders are independent

Yield same outcome when values to bidders are private

Single-price monopolist does not charge the highest possible price
◦ The monopolist can’t sell much output at that price and profits are too low.
◦ Exception: perfectly price discriminating monopolist because it can charge different prices to different
consumers.

Monopolist maximizes total profit, not per unit profit

◦ Monopolist selects the quantity that maximizes total economic profits rather than the difference between AR and
ATC, or the per unit profit.
◦ Look at previous example to see that total economic profits are highest where MR = MC.

The monopolist is most likely to earn economic profits in the long-run, but it is not correct to assume
that a monopolist always earns economic profits in the short run.

Some observations about monopoly

Structure: Monopoly (one firm with unique products and considerable barriers to entry)

Conduct:
◦ Choose quantity and then price to maximize profit
◦ Non-uniform pricing (price discrimination, two-part tariff, tie-in sales) can bring in more profit
◦ Maintain market power through barriers of entry such as economies of scale, intellectual property,
ownership of essential resources, or other strategic behaviors

Performance: Likely earn economic profit, if not earn normal profit, in the long-run.

SCP on Monopoly: Recap

Cases
A P P LY I N G T H E C O N C E P T S
I N B U S I N E S S S I T UAT I O N S
Pricing in gasoline
market
From Shepard (1991)

Question: Is the price difference between full-service and self-service gas, at

station that offers both types of service and in markets where there are
multiple firms, due to price discrimination?

Key points:
◦ Second-degree (self-select) price discrimination.
◦ Multi-firm setting. Different gas stations are horizontally differentiated,
whereas different service types are vertically differentiated
◦ Assumption on MC. No data on cost differences between different
qualities of service (full vs. self). So, assume that after controlling for
observable station characteristics, costs depend on level of service not
type of station.
Pricing in
gasoline P full
market
(continued) full df
Prediction: Price difference between full-
and self-service will be higher at multi-
product stations as compared to at
DSP DMP
single-product stations

Intuition:
◦ Demand of one product affects
another in multi-product stations.
self ds
◦ The station can raise revenue from
full-service by increase the price a
self
little bit.
◦ The marginal customers who drop
out will switch to self-service instead,
not go to another station. SP MP
More on price
discrimination

Photo credits: Coconuts Bangkok

 Photo credits: 2PriceThailand

Farang loves Thailand AREN’T THEY?

Thailand has just
woken up on curbing
monopoly power!
COMPETITION LAW CHANGES IN RECENT YEARS
Cases on BDMS
and CP
News article in 2016

Editorial opinion in 2020

News article in 2020

Keep in mind though
that monopoly power
may erode overtime
THERE IS A LIMIT TO BARRIERS TO ENTRY
De Beers
Once controlled over 70% of the world’s diamond market

But monopoly position eroded over time

◦ New diamond discoveries
◦ Nearly perfect artificial diamonds
◦ Unfavorable media attention (African Civil War dirty money)

Now focus on increasing demand for diamonds rather than

controlling supply

See p. 316 of McConnell, Brue, Flynn for more details.