ECON 696:
Managerial Economics and Strategy
Lecture Notes 6:
Competitors and Competition
Behaving strategically means knowing who your competitors are and how they will
respond to changes in your behavior.
This chapter discusses different types of markets,
how firms in them behave and the effects of this behavior on profitability.
The chapter starts with a discussion about the tricky processes of defining a market and
identifying competitors.
It also introduces the concept of market concentration.
The chapter then discusses the four standard market structures:
perfect competition,
monopoly, monopolistic competition and oligopoly.
Oligopoly includes two types of
competition: Cournot or quantity competition and Bertrand or price competition.
Finally, the relationship between market structure and profitability is examined.
Identifying Competitors and Defining Markets
1.
Identifying competitors
The text describes pretty clearly what a competitor is, or how you determine whether a
particular firm is a competitor.
There are two important definitions.
The first definition is mathematical and is derived from the formula for elasticity.
The
usual form for an elasticity calculation is the percentage change in quantity divided by the
percentage change in price, which may be written in a variety of ways:
1
2
1
2
1
2
1
2
P
P
P
P
Q
Q
Q
Q
P
P
Q
Q
P
%
Q
%
+

+

=
∆
∆
=
∆
∆
=
η
In determining whether or not goods are substitutes for each other, you might calculate
the percentage change in the quantity of one is divided by the percentage change in the
price of the other.
This version of elasticity is called the
cross price elasticity
.
If two goods, x and y, are being considered, the cross price elasticity of these may be
described either as
y
x
xy
P
%
Q
%
∆
∆
=
η
or as
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x
y
yx
P
%
Q
%
∆
∆
=
η
If two goods are substitutes, an increase in the price of one should be accompanied by an
increase in the quantity of the other, holding other things constant.
As a result, if two
goods are substitutes, their cross price elasticity will be positive.
The second definition is descriptive and focuses on the characteristics of the product
being sold.
The book discusses some specifics, but in practical terms, any option that a
reasonable consumer is likely to consider when making a purchase is a substitute.
This
will typically include goods which:
•
serve the same function
•
have similar characteristics (including price)
•
are available in the same general location.
The second definition of substitutes is more intuitive and perhaps more useful, but the
first is more precise.
You might agree that margarine and butter are substitutes, but what
about margarine and cooking oil or vegetable shortening?
Both may be used for frying,
but vegetable shortening is generally not used on toast.
If data could be obtained on the
prices and quantities sold of margarine and vegetable shortening, a definite answer could
be offered as to whether or not they are substitutes by calculating the cross price
elasticity.
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