Chapter 7: Market Structures

Chapter 7: Market Structures

Types of Market Structures
Perfect Competition Monopoly Monopolistic Competition Oligopoly

Perfect Competition A market structure in which a LARGE number of firms all produced the SAME product

Wheat, Milk, Orange Juice, Notebook Paper, Agriculture
Perfect Competition Examples Wheat, Milk, Orange Juice, Notebook Paper, Agriculture Number of Sellers Many Variety of goods None (Identical Products) Price Control (Consumers try to get the best deal) Entry into Market (easiest to enter)

Monopoly A market structure dominated by a single seller

Monopoly Examples Public Water, Post office Number of Sellers One
(Most are ILLEGAL) Number of Sellers One Variety of Goods None Price Control Complete (total control) Entry into Market Complete Barriers (most difficult to enter)

Monopolistic Competition
A market structure in which MANY companies sell products that are SIMILAR

Example Jeans, Books, Bagel shops, Gas stations, Retail clothing stores, Video rental stores, Fast food restaurants Number of Sellers Many Variety of Goods Some Price Control Little Entry into Market Low / Few

Oligopoly A market structure in which a FEW larger firms dominate the market

Oligopoly Examples Number of Sellers A few dominate Variety of Goods
Cars, Movie studios, breakfast cereals, household appliances, air travel, supermarkets, banks, steel, oil Number of Sellers A few dominate Variety of Goods Some Price Control Entry into Market High Barriers

Price Control (least to most)
Perfect Competition Monopolistic Competition Oligopoly Monopoly

Entry into Market— Barriers to Enter the Market (least to most)
Perfect Competition Monopolistic Competition Oligopoly Monopoly

Vocabulary Words

Barriers to entry Any factor that makes it difficult for a new firm to enter the market Like a brick wall…

Start-up Costs The expenses a firm must pay BEFORE it can begin to produce and sell goods

Perfect Competition

Perfect Competition A market structure in which a LARGE number of firms all produced the SAME product

Wheat, Milk, Orange Juice, Notebook Paper
Perfect Competition Examples Wheat, Milk, Orange Juice, Notebook Paper Number of Sellers Many Variety of goods None (Identical Products) Price Control (Consumers try to get the best deal) Entry into Market (easiest to enter)

Four (4) Conditions: Many buyers and sellers
Identical products (commodity) Well informed buyers and sellers No barriers to enter or exit the market

Perfectly competitive markets require everyone in the market MUST accept the market price given.

Perfect Competition What happens to the supply curve? Supply curve shifts to the Right What SPENT variable would this be? Number of Suppliers (Increases) What happens to the equilibrium price? Decreases

Commodity A product that is the SAME, no matter who produces it

Commodity Example “In countries where farmers make up a small fraction of the population, such as American and Europe, the government provides large subsidies for agriculture. But in countries where the farming population is relatively large, such as China and India, the subsidies go the other way. Farmers are forced to sell their crops below-market prices so that urban dwellers can get basic food items cheaply.”

Commodity Example “If the government has to support the price of milk, the real problem is that there are too many dairy farmers…Governments should not be in the business of providing incentives for people that would not otherwise make sense.” --Naked Economics, p

Imperfect Competition
A market structure that does NOT meet the conditions of perfect competition

How do Perfect Competitions keep prices low?
Use inputs (such as technology) to their best advantage (competition)

Monopoly

Why Are There Monopolies?
Q: What about a market causes there to be only one firm in operation? A: Several possible factors. First, a firm could control a key resource needed for the production of a good. For example, there can be only one dam at any point along a river, so whoever owns the dam will have a monopoly on the production of hydroelectric power there. Second, the government could mandate that only one firm will operate in a market. This is true with respect to mail delivery. Only the U.S. Postal Service (a government monopoly) can deliver mail into your mailbox. Other firms can deliver packages to your door, but not to your mailbox. Finally, economies of scale in production may dictate that one large firm is the most efficient way to provide a product. This situation is called natural monopoly.

Monopoly A market structure dominated by a single seller

Monopoly Examples Public Water, Post office Number of Sellers One
(Most are ILLEGAL) Number of Sellers One Variety of Goods None Price Control Complete (total control) Entry into Market Complete Barriers (most difficult to enter)

Monopoly Example 1: DMV “ Think about the Department of Motor Vehicles, which has a monopoly on the right to grant driver’s licenses. What is the point of being friendly, staying open longer, making customers comfortable, adding clerks to shorten lines, keeping the office clean, or interrupting a personal call when a customer comes to the window?” --Naked Economics, page 64

Monopoly Example 1: DMV “ None of these things will produce even one more customer! Every single person who needs a driver’s license already comes to the DMV and will continue to come no matter how unpleasant the experience. There are limits, of course. If service becomes bad enough, then voters may take action against the politician in charge. But,that is an indirect, cumbersome process.” --Naked Economics, page 64

Monopoly Example 1: DMV “ Compare that to your options in the private sector. If a rat scampered across the counter at your favorite Chinese take-out restaurant, you would (presumably) just stop ordering there. End of problem. The restaurant will get rid of the rats or go out of business.” --Naked Economics, page 64

Monopoly Example 1: DMV “ Meanwhile, if you stop going to the Department of Motor Vehicles, you may end up in jail.” --Naked Economics, page 64

Monopoly Example 2: Post Office
“ [S]everal weeks ago when a check I was expecting from Fidelity, the mutual fund company, failed to show up in the mail. (I needed the money to pay back my mother, who can be a fierce creditor.) Day after day went by—no check. Meanwhile, my mother was “checking in” with increasing frequency.” --Naked Economics, page 64

“ One of two parties was guilty, Fidelity or the U.S. Postal Service, and I was getting progressively more angry. Finally I called Fidelity to demand proof that the check had been mailed. I was prepared to move all of my (relatively meager) assets into Vanguard, Putnam, or some other mutual fund company (or at least make the threat). --Naked Economics, page 64-65

“ Instead, I spoke with a very friendly customer assistant who explained that the check had been mailed two weeks earlier but apologized profusely for my inconvenienced anyway. She canceled the check and issued another one in a matter of seconds. Then she apologized some more for a problem that, it was now apparent, her company did not cause.” --Naked Economics, page 65

“The culprit was the post office. So I got even angrier and then… I did nothing. What exactly was I supposed to do? The local postmaster does not accept complaints by phone. I did not want to waste time writing a letter (which might never arrive anyway). Nor would it help to complain to our letter carrier, who has never been consumed by the quality of his service.” --Naked Economics, page 65

“The point, carefully disguised in this diatribe, is that the U.S. Postal Service has a monopoly on the delivery of first-class mail. And it shows.” --Naked Economics, page 65

Monopoly Example 3: Miss Kroope
“One of the largest government monopolies remaining in the United States is public education.” --Naked Economics, page 66

Economies of Scale Factors that cause a producer’s average cost per unit to fall as output rises

Economies of Scale They occur because Start-up costs are high.
As production Increases, the firm becomes more efficient, even at a level of output high enough to supply the entire market. An example: Hydroelectric plant

Natural Monopolies A market that runs most efficiently when l large firm supplies ALL output

Natural Monopolies Result: Usually only ONE business remains
Examples: telecommunications, public water, electricity, mail delivery

Natural Monopolies Why does the government usually step in to allow these to happen for necessary services? Ensures we don’t waste resources building additional plants when only one is needed In return, the government controls prices.

There are 4 Types of Government Monopolies:
Patent Franchise License Industrial Organization

Patent A license that gives the inventor a new product the exclusive right to sell it during a certain period of time

Patent Patents encourage companies to research and develop new products Patents benefit society as a whole.

How Long Does a Patent Last?
Utility Patent - 20 years from the date of filing of the earliest application Design Patent - 14 years from the grant of the patent Plant Patent - 20 years from the date of filing of the earliest application

Patent Example “Don’t try to sell sildenafil citrate on a street corner or you may end up in jail. This is not a drug that you snort or shoot up, nor is it illegal.” --Naked Economics, page 14

Patent Example “It happens to be Viagra, and Pfizer holds the patent, which is a legal monopoly granted by the U.S. government.” --Naked Economics, page 14

Patent Example “Viagra cost pennies a pill, but because Pfizer has a patent on Viagra giving it a monopoly on the right to sell the product for twenty years, the company sells each pill for as much as $7. This huge markup, which is common with new HIV/AIDS drugs and other lifesaving products, is often described as some kind of social injustice perpetrated by…the ‘big drug companies.’” --Naked Economics, page 53

Patent Example “Indeed, when a drug comes off patent—the point at which generic substitutes become legal—the price usually falls by percent.” --Naked Economics, page 53

Patent Example “The average cost of bringing a new drug to market is somewhere in the area of $600 million. And for every successful drug, there are many expensive research forays that end in failure” --Naked Economics, page 53

Patent Example “Yes, the government could buy the patent when a new drug is invented. The government would pay a firm up front a sum equal to what the firm would have earned over the course of its twenty-year patent….That’s an expensive solution that comes with some problems of its own. For example, which drug patents would the government buy?” --Naked Economics, page 53

Franchise Right to sell a good or service within an exclusive market
Example: Dominos, Dunkin Donuts

License Government issued right to operate a business

Industrial Organizations
Allows, but can restrict number of firms in the market Example: National Football League (NFL)

What is a problem with industrial organizations? Team owners may charge high prices for tickets

For example, if there is limited number of suppliers, which usually does not change, and there are an increasing number of demanders.

Price Demand 1 Demand 2 Supply 25 100 200 50 80 175 75 60 150 40 125 20

Why is the supply curve vertical? It is a stadium—where there is a constant number of seats! 2) What happens to equilibrium price when there is more demand? Equilibrium price INCREASES

Output Decisions 1. A monopolist faces a limited choice—it can choose either output or price. A monopolist looks at the big picture and tries to maximize profits. This usually means monopolists will produce fewer goods at a higher price.

Output Decisions 2. To maximize profits, a seller should set its marginal revenue, or the amount it earns from the last unit sold, equal to its marginal cost, or the extra cost from producing that unit. 3. When a firm has some control over price--and can cut price to sell more--marginal revenue is less than price.

Output Decisions 4. What happens to the supply curve?
What SPENT variable would this be? What happens to the equilibrium price?

Output Decisions 4. What happens to the supply curve?
SHIFTS TO THE LEFT What SPENT variable would this be? N- Number of Suppliers What happens to the equilibrium price? INCREASES

Price Discrimination Division of customers into groups based on how much they pay for a good Examples in Oligopoly (Airplanes and grocery stores)

Price Discrimination Example 1 for Oligopolies
“Grocery stores appear to be the model of one price for all. But even today, they post one price, charge another to shoppers willing to clip coupons and a third to those with frequent-shopper cards that allow stores to collect detailed data on buying habits.” --Naked Economics, page 17

“A firm can attempt to sell the same item to different people at different prices. The next time you are on an airplane, try this experiment: Ask the person next to you how much he or she paid for the ticket. It’s probably not what you paid; it may not even be close.” --Naked Economics, page 16

“You are sitting on the same plane, traveling to the same destination, eating the same bad food—yet the prices you and your row mate paid for your tickets may not even have the same number of digits.” --Naked Economics, page 16

“[T]he airline industry is to separate business travelers, who are wiling to pay a great deal for a ticket, from pleasure travelers who are on a tighter budget.” --Naked Economics, page 16

Price Discrimination 1. Based on the idea that each customer has his/her own maximum price s/he will pay for a good. 2. If a monopolist sets a low price, the monopolist will gain a lot of customers but the monopolist will lose the profits it could have made from the customers who bought at the low price but were willing to pay more

Price Discrimination 3. Price discrimination can be practices by any company with market power. However, some companies enjoy market power without holding a monopoly.

Market Power Ability of a company to change prices and output

Market Power If you do NOT have another choice—you can either accept the item at the price it is being offered at or do NOT accept the item at all. Business know if there product is good enough and there is no other option—people will buy their product!

Price Discrimination 4. List 4 EXAMPLES of price discrimination (targeted discounts) Discounted airline fares Manufacturers’ rebate offers Senior citizen or student discounts Children fly or stay free promotion

Price Discrimination 5. List 3 LIMITS on price discrimination
Some market power (is rare in highly competitive markets) b) Distinct customer groups (based on sensitivity to price) c) Difficult resale (ex: airline tickets)

A market structure in which MANY companies sell products that are SIMILAR

Example Jeans, Books, Bagel shops, Gas stations, Retail clothing stores, Video rental stores, Fast food restaurants Number of Sellers Many Variety of Goods Some Price Control Little Entry into Market Low / Few

What is the main difference between a perfect competition and a monopolistic competition? PC – Identical products (commodity) MC – Not identical; a fact of everyday life

List the 4 Conditions of a Monopolistic Competition: 1. Many firms 2. Few artificial barriers to entry 3. Slight control over prices 4. Differentiated price

Differentiation Making a product different from other similar products

X Nonprice Competition
A way to attract customers through other means EXCEPT price. X

FOUR (4) forms of Nonprice Competition:
Physical Characteristics (ex: shape, size, color, texture, taste) Location (where sold?) Service level Advertising (anything, EXCEPT PRICE!!!)

Prices under Monopolistic competition will be higher than they would be in a perfect competition, because firms have some power to raise prices. However, the number of firms and ease of entry prevent companies from raising prices as high as they would if they were a true monopoly. If a monopolistically competitive firm raised prices too high, most customers would ignore any differences and buy the cheaper product.

If monopolistically competitive firms started to earn profits well above their costs, market trends would work to take them away. Fierce competition would encourage rivals to think of new ways to differentiate their products and lure customers back. 2. New firms will enter the market with slightly different products that cost a lot less than the market leaders. If the original good costs too much consumers will switch to these substitutes.

Oligopoly

Oligopoly A market structure in which a FEW larger firms dominate the market (4 Largest firms produce at least 70-80% of the output.)

Oligopoly Examples Cars, Movie studios, breakfast cereals, household appliances, air travel, supermarkets, banks Number of Sellers A few dominate Variety of Goods Some Price Control Entry into Market High Barriers

Oligopoly Example “The airline industry is far less competitive than it appears to be. You and some… friends could start a new airline relatively easily; the problem is that you wouldn’t be able to land your planes anywhere. There are a limited number of gate spaces available at most airports, and they tend to be controlled by the big guys.” --Naked Economics, page 14

Oligopoly A. The FOUR largest firms produce at least 70 to 80% of the output B. The biggest firms in an oligopoly may well set prices higher and output lower than in a perfectly competitive market C. Oligopolies can form high barriers to enter the market to keep new companies from entering the market and to compete with existing firms.

Oligopoly List 4 reasons there can be high barriers to enter an Oligopoly: Licenses Patents High start-up costs Economics of scale

Oligopoly E. When determined oligopolists work together illegally to set prices and bar competing firms from the market, they can become as damaging to the consumer as a monopoly. F. There are 3 practices that concern government the most because they represent ways that firms in an oligopoly can try to control a market. These practices don’t always work.

Price War Series of competitive price cuts that lowers the market BELOW the cost of production Who are price wars harmful to? Producers Who do price wars benefits? Consumers

Price War Example Initially benefit consumers by lowering prices
Some sellers can be severely hurt by price wars—some can lose money and/or go out of business. When the price war ends, prices tend to rise again If one or more sellers have gone out of business prices may rise even higher than before the war because there is less competition

Collusion Agreement among firms to divide the market, set prices, or limit production a. One outcome of collusion is: Price fixing

Collusion Example When selling secretly do this, it is ILLEGAL and carries heavy penalties (fine and prison) Raises prices higher than they would be under competitive forces

Price Fixing An agreement among firms to charge ONE price for the SAME good a. In the United States, collusion is Illegal

Cartel A formal organization of producers that agree to coordinate prices and production a. In the United States, cartels are Illegal b. In other countries and international organizations, cartels are Legal

Cartel Cartels can only survive if every member keeps to its agreed output levels and NO more! Otherwise, prices will fall and firms will lose profits. However, each member has a strong incentive to cheat and produce more than its quota. If every member cheats, too much product reaches the market, and prices fall Cartels can also collapse if some producers are left out of the group and decide to lower their prices below the cartel’s levels.

Cartel Do cartels typically last very long? NO

Results of an Oligopoly
As the number of sellers in an oligopoly grow larger, an oligopolistic market looks more like: Monopoly Monopolistic Competition Perfect Competition Collusion as a solution

Market Power How do firms try to increase its Market Power by controlling prices and output? A. Form a cartel B. Combine with one another C. Predatory Pricing

Predatory Pricing: Selling a product below cost to drive competitors out of the market

Regulation The federal government has a number of policies that keep firms from controlling the price and supply of important goods. If a firm controls a large share of a market, the Federal Trade Commission (FTC) and the Department of Justice’s Antitrust Division will watch that firm closely to ensure that it does not unfairly force out its competitors. In addition to breaking monopolistic companies, the government has the power to prevent the rise of monopolies

Antitrust Laws: Laws that encourage competition in the marketplace
(forbids companies from conspiring together in ways that erase the benefits of competition –Naked Economics, p. 56)

Antitrust Laws (Question)
The purpose of antitrust laws is to: Regulate the prices charged by a monopoly Increase competition in an industry by preventing mergers and breaking up large firms. Increase merger activity to reduce costs and raise efficiency Create public ownership of natural monopolies Do all of the above

Antitrust Laws Rationalization:
If a business does NOT allow competition, we believe that it goes against our country’s fundamental belief of encouraging competition—and therefore, we do NOT allow it.

Trust An illegal grouping of companies that discourages competition

Sherman Antitrust Act (1890)
Outlawed mergers and monopolies that limit trade between states

Merger Combination of two or more companies into a single firm
There are 3 types of Corporate Combination. Each corporate combination can lead to larger, more Efficient firms. Often, larger firms can produce and sell their products at LOWER prices. However, their size can also give some of these combinations more Monopoly Power.

Types of Corporate Combinations
Add info here!!!

Deregulation The removal of some government controls over a market

Deregulation While deregulation weakens government control, antitrust laws strengthen it. The government uses BOTH of these tools– deregulation and anti-trust laws for the same purpose: to promote competition.

Federal Agencies

Federal Agencies What do they do? Food and Drug Administration (FDA) Regulates food and drugs consumed by individuals Federal Trade Commission (FTC) Regulates trade between states Federal Communications Commission (FCC) Regulates television, phone, radio, and other communication products Federal Aviation Administration (FAA) Regulates airplanes, helicopters, and other aviation devices

Federal Agencies What do they do? Equal Employment Opportunity Commission (EEOC) Regulates the hiring and firing practices of employers to ensure equal opportunity Environmental Protection Agency (EPA) Regulates environmental concerns Occupational Safety and Health Administration (OSHA) Regulates safety and health in businesses Consumer Product Safety Commission (CPSC) Reports and requests recalls for consumer products

Standards H A

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