a dominant firm with a competitive fringe(6) The profit-maximizing price p* can then be read from the residual demand curve, and the fringe supply can be obtained from the fringe supply curve. The total amount supplied by the dominant firm plus the fringe intersects the market demand curve at p If the dominant firm is considerably more efficient than the fringe firms, however, it may be able to ignore the fringe. This will be the case if the dominant firm's monopoly price is less than po. because the fringe cannot profitably produce, the dominant firm can ignore it and produce the monopoly output. This would be the case in figure if the dominant firms marginal cost curve intersected its marginal revenue curve to the right of the downward jump for example, if the dominant firms marginal cost was MO°1
A dominant firm with a competitive fringe (6) • The profit-maximizing price p* can then be read from the residual demand curve, and the fringe supply can be obtained from the fringe supply curve. The total amount supplied by the dominant firm plus the fringe intersects the market demand curve at p*. • If the dominant firm is considerably more efficient than the fringe firms, however, it may be able to ignore the fringe. This will be the case if the dominant firm’s monopoly price is less than p0 . because the fringe cannot profitably produce, the dominant firm can ignore it and produce the monopoly output. This would be the case in figure if the dominant firm’s marginal cost curve intersected its marginal revenue curve to the right of the downward jump: for example, if the dominant firm’s marginal cost was MCD 1
The effect of entry (1) In the dominant-firm model, the size of the fringe the number of fringe firms-is assumed to be fixed However, if there is a profitable entry opportunity we would expect over time that entry would be reduced Although we can think of this problem purely in terms of the incentives to enter a homogeneous product market, in reality this problem occurs more often where there is an innovator who has an early lead, but is followed by a succession of imitative entrants producing slightly differentiated products. In many industries the observed market structure corresponds to a dominant firm whose position is slowly eroded-and sometimes is eliminated-by entry
The effect of entry (1) • In the dominant-firm model, the size of the fringethe number of fringe firms-is assumed to be fixed. However, if there is a profitable entry opportunity we would expect over time that entry would be reduced. • Although we can think of this problem purely in terms of the incentives to enter a homogeneous product market, in reality this problem occurs more often where there is an innovator who has an early lead, but is followed by a succession of imitative entrants producing slightly differentiated products. In many industries the observed market structure corresponds to a dominant firm whose position is slowly eroded-and sometimes is eliminated-by entry
The effect of entry(2) In a classic paper Gaskins (1971) studied the evolution of a market of this type. The dominant firm, through its choice of prices over time, is able to determine the profitability, and hence the rate of entry Since the choice of price is assumed to limit entry, a dynamic industry structure ot this kind is often referred to as dynamic limit pricing Gaskins assumes that entry is an increasing function of the margin an entrant would expect-the difference between price and the entrants average cost. Moreover, the rate of entry is exogenously restricted The essential trade-off for the dominant firm is between current and future profits; whether to make hay while the sun shines and extract as fut much economic surplus from the market while the firm has a virtual monopoly-but thereby encourage more entry-or husband the surplus and price more modestly, encouraging a lower rate of entry, and hence a longer reign of dominance As entry progresses, the market power of the dominant firm will be much diminished, and even its static profit-maximizing price will be much lower Eventually, given symmetric costs, the dominant firm will actually be forced to concede the entire market, which is equivalent really to the ma harket becoming perfectly competitive and the dominant firm just reverting to one of the competitive firms if the dominant firm is able to sustain a cost advantage, then in the final steady state it may be able to maintain a significant market share
The effect of entry (2) • In a classic paper Gaskins (1971) studied the evolution of a market of this type. The dominant firm, through its choice of prices over time, is able to determine the profitability, and hence the rate of entry. Since the choice of price is assumed to limit entry, a dynamic industry structure of this kind is often referred to as dynamic limit pricing. • Gaskins assumes that entry is an increasing function of the margin an entrant would expect-the difference between price and the entrant’s average cost. Moreover, the rate of entry is exogenously restricted. • The essential trade-off for the dominant firm is between current and future profits; whether to make hay while the sun shines and extract as much economic surplus from the market while the firm has a virtual monopoly-but thereby encourage more entry-or husband the surplus and price more modestly, encouraging a lower rate of entry, and hence a longer reign of dominance. • As entry progresses, the market power of the dominant firm will be much diminished, and even its static profit-maximizing price will be much lower. Eventually, given symmetric costs, the dominant firm will actually be forced to concede the entire market, which is equivalent really to the market becoming perfectly competitive and the dominant firm just reverting to one of the competitive firms. If the dominant firm is able to sustain a cost advantage, then in the final steady state it may be able to maintain a significant market share
The effect of entry 3) The factors affecting the optimal price trajectory are The rate of interest. The higher the rate of interest, the more the leading firm will discount future profits and prefer to charge high prices now, irrespective of its effect on entr The relative cost position of the dominant firm and the entrants. The better placed is the dominant firm for making long-run profit by sustaining long-run market share, the more it will want to price conservatively and husband its position The response of fringe entry to higher prices charged by the dominant firm If the effect on entry is small, then the dominant firm will have no qualms about extracting monopoly rents now, but if a flood of entry can be expected in response to high current prices then it will want to conserve its position
The effect of entry (3) • The factors affecting the optimal price trajectory are: • The rate of interest. The higher the rate of interest, the more the leading firm will discount future profits and prefer to charge high prices now, irrespective of its effect on entry. • The relative cost position of the dominant firm and the entrants. The better placed is the dominant firm for making long-run profit by sustaining long-run market share, the more it will want to price conservatively and husband its position. • The response of fringe entry to higher prices charged by the dominant firm. If the effect on entry is small, then the dominant firm will have no qualms about extracting monopoly rents now, but if a flood of entry can be expected in response to high current prices then it will want to conserve its position
The effect of entry (4 Gaskins model has been criticized on 2 important grounds. 1. Entrants have myopic expectation The model incorporates an ad hoc assumption that the rate of entry depends only on the current market price Rational entrants would base their entry decision not onl on the price today, but also on their expectation of future prices 2. There is an implicit assumption that the dominant firm is able to commit to its price path However, since nothing links its price decisions over time, the profit-maximizing price at every instance is simply the short-run profit-maximizing price. This means that the price path in the Gaskins model is not incentive compatible: at time t it is not profit maximizing to charge the price specified by the price path determined in period
The effect of entry (4) • Gaskins’ model has been criticized on 2 important grounds: • 1. Entrants have myopic expectation. • The model incorporates an ad hoc assumption that the rate of entry depends only on the current market price. Rational entrants would base their entry decision not only on the price today, but also on their expectation of future prices. • 2. There is an implicit assumption that the dominant firm is able to commit to its price path. • However, since nothing links its price decisions over time, the profit-maximizing price at every instance is simply the short-run profit-maximizing price. This means that the price path in the Gaskins model is not incentive compatible: at time t it is not profit maximizing to charge the price specified by the price path determined in period 1