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market efficiency

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Industry structure is often measured by computing the Four-Firm Concentration Ratio. Suppose you have an industry with 20 firms and the CR is 30%. How would you describe this industry? Suppose the demand for the product rises and pushes up the price for the good. What long-run adjustments would you expect following this change in demand? What does your adjustment process imply about the CR for the industry?

Now consider that the industry has 20 firms but the CR for the industry is 80% instead of 30%. How would you describe this industry? What are some reasons why this industry has a high CR while the other industry had a low CR? Is it possible for smaller firms to thrive and profit in such an industry? How? Contrast the effects on market efficiency if the dominating firms use a price leadership model versus a contestable markets model. Be sure to show your work.

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Solution Preview

Concentration ratio is a measure of the proportion of total output in an industry that is produced by a given number of the largest firms in the industry.
The four-firm concentration ratio is the proportion of total output produced by the four largest firms in the industry. It is commonly used to indicate the degree to which an industry is oligopolistic and the extent of market control of the largest firms in the industry.

Concentration ratios are calculated based on the market shares of the largest firms in the industry.

An industry with 20 firms and the CR = 30% is called "Low Concentration", for a concentration ratio of 0 to 50 percent is commonly interpreted as low concentration. The industry is monopolistically competitive and that the four largest firms have very moderate market control.

When the demand for the product rises and pushes up the price for the good. Then in the short run, the existing 20 firms will make positive profit and become better off. The short-run equilibrium will be reached where marginal cost equals marginal revenue, i.e. profit maximizing.

However, In the long-run firms are able to change the scale of product and enter or leave the industry. New firms will also enter the industry to take advantage of the profit, and the total supply will be increased, which will press the market price down to the long-run equilibrium price (= the minimum LR average cost).

On the other hand, since this industry is monopolistically competitive, each firm has some power of price setting. They will compete for market share by charging a price lower ...

Solution Summary

Contrast the effects on market efficiency if the dominating firms use a price leadership model versus a contestable markets model. Be sure to show your work.

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