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Explorations in Economics

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1 Explorations in Economics
Alan B. Krueger & David A. Anderson

2 Chapter 8: Exploring Economics
Module 23: Monopoly Module 24: Oligopoly and Monopolistic Competition Module 25: Regulating Market Power

A monopoly is a market with just one firm that can earn continual profit if competitors have difficulty entering the market. OBJECTIVES: To explain the concept of market structure. To describe the characteristics of a monopoly. To explain the effects of price discrimination. Note that laws set up the rules for some monopolies to form like the public utilities. Some firms do have some of the characteristics of monopoly but still have competition.

4 MARKET STRUCTURE Market structure describes the nature of competition within a market. Point out the spectrum of firms in terms of competition. Discuss some examples of the different structures.

5 MARKET STRUCTURE The product market for a good includes all those products that consumers consider to be close substitutes for that good. Lead a discussion of Super Bowl advertisers. Students will see that most are oligopolists.

6 MARKET STRUCTURE Imperfect competition arises when there is not enough competition among firms to prevent individual firms from raising their price above the equilibrium level determined by supply and demand. What factors influence the size of the competition in a market? Close substitutes, the distance served or geography of the market.

7 WHAT IS A MONOPOLY? Market power is the ability of a firm to change the market price of a good or service. Monopoly is a product market served by only one firm. The one supplier in a monopoly is called a monopolist. Challenge students to evaluate the choices available to see the same movie. What makes one theater better or worse than the other?

8 WHAT IS A MONOPOLY? Barriers to entry are obstacles that prevent firms from entering particular markets. A natural monopoly is a market in which high startup costs make it prohibitively expensive for more than one firm to operate. Ask the students if they created a movie would the local theater play it? Why or why not? Where do most of the movies come from? Does the government allow for some natural monopolies to operate? Why?

9 WHAT IS A MONOPOLY? The average cost is the total cost of production divided by the quantity of output. Economies of scale exist if, in the long run, an increase in output results in a decrease in average cost. Recall the term price takers as extensive competition forces the market price to be assumed by all firms. Introduce the term price makers as no competition allows the one firm to set the market price. Lead a discussion of what lessons were learned from the board game Monopoly. Did the game teach equality or the consolidation of power?

10 WHAT IS A MONOPOLY? The Four Main Sources of Market Power:
High Start- Up Costs Exclusive Access to a Critical Input Government Protection Unfair Practices Have students discuss firms that they see as dominant and then list their competitors. iPods are a good example. Are there high start-up costs for the production of iPods? Research and development costs and specialized equipment are high cost business expenses Do they have exclusive access to a critical input? No Is there government protection? Patents and trademark protection are in place for these products Are there unfair practices? Some might say.

11 WHAT IS A MONOPOLY? Threats to a Monopolist:
The major threat is introduction of competition. Others include: Technological change The entry of international firms The end of government protection Discuss the recent trend of competition in the tablet market. First iPad and now many other tablets like Kindle, Nook and others Why don’t all monopolies upgrade to the latest technology? Does globalization hurt or help domestic markets? Why does the government protect some firms?

12 WHAT DO MONOPOLISTS DO? Monopolists as Price Makers Maximizing Profit (MR=MC) Explain how monopolists have price control. They are price makers, recognizing the demand for the entire market demand. Here MonopolE lowers the price to the point where profit is maximized. The quantity of 4 units at $6 where MR=MC earns the greatest profit of $7. Monopolies do not maximize revenues; If they drop to $5 per unit, ,then revenue incerases to $25, greater than at $6. But, the profit drops to $5.

Find the output where MR = MC on the graph for the profit maximizing output. You should spend a considerable amount of time on the MR=MC output rule. It applies to all the market structures. Here the data from the table in the previous slide shows that the MR=MC product maximizing level of output is at 4 units of output. The revenue falls with the 5th unit.. Recall that in perfect competition, the MC above the AVC curve would be the supply curve of the firm. But, in monopoly, we cannot use that idea. The quantity supplied depends on more than price—it also depends of the demand curve.

A consumer’s reservation price for a product is the highest price he or she is willing to pay to own one more unit of the product. Reservation price is synonymous with the idea of willingness to pay. Who would buy the software in this table and graph? Adrian, Brie, Cody and Deshawn Why not the others? Evan would buy but the monopolist would not sell at $5. If he sold at $5, he would lose a dollar less from the others, so the marginal revenue would only be $1 for Evan. It is better to keep the price at $6 rather than paying the MC of $3 to gain $1.

15 PRICE DISCRIMINATION Price discrimination is the practice of charging different customers different prices for the same good. 1. Some customers must have higher reservation prices than others for the same good. 2. The firm must be able to distinguish between customers with higher and lower reservation prices. 3. It cannot be possible for customers to resell the good. 4. The firm must have market power. Under perfect competition, competitors would enter and drive the price down to the marginal cost of production. Price discrimination sounds illegal but it is actually an efficient way to have people pay what they are willing to pay. Some people will pay higher prices but others that would have not have been able to afford the single price can now join the market.

16 PRICE DISCRIMINATION Perfect Price Discrimination and Efficiency Removes the inefficiency in single pricing models. Price Discrimination in Practice Examples: Movie ticket prices based on time, lunch versus dinner specials at restaurants; golf course prices on weekends versus weekdays Create a list on the board of the different types of price discrimination in the area. Movie theaters are the easiest to begin with. Discuss how some sellers like real estate agents and car dealers can determine buyer’s reservation price without asking.

Innovative new products improve our standard of living and promote economic growth. High profits can support innovation. Some profits strengthen barriers to entry. Challenge students to think of innovative products that have changed our lives in the past 25 years. Why do some monopolists use profits to strengthen barriers to entry?

18 MODULE 23 REVIEW What is… A. Imperfect competition?
B. Market structure? C. Product market? D. Monopoly? E. Monopolist? F. Market power? G. Barriers to entry? H. Natural monopoly? I. Average cost? J. Economies of scale? K. Reservation price? L. Price discrimination?

KEY IDEA: When there are many firms in a market, they can gain market power if they can differentiate their products. When there are only a few firms in a market, they might be able to work together to reduce output below the perfectly competitive level, charge a relatively high price, and raise their profits. OBJECTIVES: To describe what characterizes oligopolies and how they operate. To explain why it is difficult for a small number of firms to enforce an agreement that restricts output. To analyze how firms in markets characterized by monopolistic competition behave with regard to pricing, advertising, product development, and quality of service. Challenge students to think of firms that see differentiated products? Retail clothing, cars and trucks, breakfast cereal and snack bars, tires.

An oligopoly is a market with a small number of firms. An oligopolist is a firm in an oligopoly industry. Focus on the fact that when we see national advertising the company is typically an oligopoly. They are trying to persuade buyers that their product is different from the competition. They do this so they can maintain a higher price. See if the students recognize the top four companies in each category. Stress that when a small number of firms account for a large proportion of the sales, we say that an industry is highly concentrated.

Collusion among oligopolists exists as they work together. A cartel is a group of firms that agree to work together and act like a monopoly. Discuss OPEC as an foreign entity. What is the goal of OPEC? OPEC is the group of foreign countries who can control the price of oil by acting jointly to impose quotas. This allows for higher oil prices and greater profit. How do they avoid breaking the law against the formation of cartels? They do not maintain an office or other presence in the US. They are countries not firms so they can avoid the laws.

In a market characterized by monopolistic competition, many firms supply similar but not identical goods. Differentiated products are goods and services that differ somewhat from other competitive products. Building Brand Loyalty gives customers reasons to buy a specific firm’s product Free Entry means that short run profits draws in new competition List the ways that cars and trucks can be differentiated? What about prom dresses? What about soft drinks? What slogans and ad characters do you think are effective in building brand loyalty? Do discount cards or loyalty cards build brand loyalty? What about frequent flyer programs? Discuss the phrase “Beating the Competition”.

Monopolistic Competition versus Perfect Competition and Monopoly This is a summary table to show how three of the market structures are different. Oligopoly is more like monopolistic competition when firms do not collude. Then they act like monopolists.

Pros Cons offering a wider range of products competition for the service offered profits in the short run for firm higher price than perfectly competition markets Inefficiently low quantity of output profits fall as advertising budgets rise A summary of the pro’s and con’s of Monopolistic Competition

25 MODULE 24 REVIEW What is… A. Oligopoly? B. Oligopolist? C. Cartel?
D. Monopolistic competition? E. Highly concentrated? F. Collusion? G. Differentiated products? H. Quotas? I. Chiseling?

KEY IDEA: Antitrust regulations are designed to limit the inefficiencies brought about by imperfectly competitive markets. OBJECTIVES: To analyze the effects of market structure on efficiency. To discuss the pros and cons of price controls. To explain the purpose of antitrust policy and how it is enforced. Often abuses by firms in the marketplace will result in laws to curb their market power.

Perfect Competition Perfect Competition results in the efficient level of production. Monopoly Price will be higher and the quantity of output lower with increased market power. Monopolistic Competition, Oligopoly, and Efficiency Non-price competition (advertising and branding) create non-competitive practices. Explain the correlation between market power, price and output.

Price controls are policies by which the government sets the prices in an industry. The goal is to bring about efficient quantity of good. Public utility rates set where MR=MC but many firms would not operate due to high start-up costs. So, regulated price is where price equals average total cost. Difficult to set pricing policy as markets and consumer preferences change. Review price ceilings from Chapter 4. Discuss examples of price controls. The energy crisis of the ‘70’s and the 2013 debate with minimum wage are examples.

29 ANTITRUST POLICY Antitrust policy is a set of laws designed to promote competition in the marketplace. Anti-trust laws passed to: limit non-competitive actions limit price-fixing prohibit predatory acts The Enforcement of Antitrust Policy The Department of Justice and the Federal Trade Commission regulate some business practices and examine proposed mergers. Students should be able to recall Teddy Roosevelt and the Trust Busting from US History. Challenge students to recall the Sherman and Clayton Anti-trust Acts.

30 MODULE 25 REVIEW What is… A. Price controls? B. Trust? C. Tying?
D. Antitrust policy? E. Interlocking directorates? F. Predatory acts?

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