Markets are the most efficient way to allocate resources Experts or planner are not needed to make sure markets run efficiently—they do that on their own Yet for a market to remain efficient, a certain degree of competition is necessary › If there was a model of a market it would be called perfect competition
What would happen if a gas station raised its current price 20% higher tomorrow? Why? What would happen if the power company raised its price 20% higher tomorrow? Why
There are 2 types of markets: competitive and imperfectly competitive › Firms in competitive markets are referred to as price takers In competitive markets a firm’s size is small compared to the market—thus they have little influence on price › Or little market power
Competitive markets are sometimes called perfectly competitive › Also called PURE Perfectly competitive markets have a large number of small firms all producing the same product with the same technology No one single firm can influence price. http://www.youtube.com/watch?v=61GCogalzVc&feature=related
1. Many buyers and sellers participate in the market. 2. Goods offered are largely the same (identical) 3. Buyers and sellers are well informed about products. 4. Sellers are able to freely enter and exit the market.
Because there are lots of firms, no one firm has enough market share to influence the entire market. There are so many consumers that no one buyer can influence price, their purchases represent a small portion of output Supply and demand determine selling prices.
Very little difference in products sold by suppliers These products may be called commodities › Milk, notebook paper, bacon The buyer will not pay extra for one particular company’s goods. They will always choose the supplier with the lowest price. Thus prices are driven down lowering profits and the incentive to enter the market
Buyers know enough to get the best deal. Buyer has full information about features and price. Informed decisions are determined by tradeoff between time spent researching versus the amount of money saved.
Few if any barriers to entry Firms can enter the market to profit › Leave the market when they do not make money. Markets with more firms, have more competition and lower prices. › Thus less profit
Barrier can be any factor that keeps firms from entering the market to compete Examples of barriers: › Start up costs, technology, profit margins, patents, copyrights
Single supplier of a product with no close substitutes Main cause of monopolies is barriers to entry Economies of scale – characteristics that cause a producer’s average cost to drop as production rises. › Additional units cost LESS to produce, not more http://www.youtube.com/watch?v=9Hxy-TuX9fs&feature=related http://www.youtube.com/watch?v=8pU6WQXkiOU&feature=related
There are 3 main barriers to entry in a monopolistic market › A key resource may be owned by the firm › Government may provide the exclusive right to operate in a given market › The costs of production for a single seller may be more efficient than a large number of sellers http://www.youtube.com/watch?v=7UWgK ZsKZOc&feature=related
Many times the monopolist faces an occurrence called economies of scale A monopolist benefits as output increases and costs decrease Whereas a large number of firms see costs rise as they are able to produce less per firm as more firms enter the market
Natural monopoly – market that runs most efficiently when one large firm provides all of the output (public water) Government monopoly – government provides exclusive right to a market of good/service Technological monopoly – exclusive rights to sell a particular technology
FFranchises – contract issued by a local authority that gives a single firm the right to sell its goods within a market LLicense – government issues the right to operate a business (radio, tv) ›P›Professional sports leagues are great examples of licensing and franchises (Industrial Organizations)
Monopolists don’t have as much control over prices as we think Monopolists must choose either output or price to maximize profits. They must choose a level of output that yields the highest profits like other firms http://www.youtube.com/watch?v=7UWgKZsKZOc
Practice of charging different customers different amounts For a firm to price discriminate, it must have two things: › Ability to control prices somewhat (some market power) › Item is difficult to resell (hamburger, movie ticket) › Ability to separate customers by their willingness to pay Age, geography, income Examples include: airline tickets, movie tickets, manufacturer rebates, grocery store cards
Every firms has a monopoly over selling its similar product Many Firms Few barriers to entry (no patent on cola) Slight control over price › Most competition is over anything BUT price Differentiated products (not identical)
Trying not to compete based on price alone Instead: › Physical characteristics (texture, shape, color, taste) › Location (grocery stores, movie theatres) › Service Level (Chick-fil-A vs. McDonald’s) › Advertising, image, or status Celebrities endorsements, sponsorships
AGAIN, firms want to maximize profits Prices under monopolistic competition will be higher than in perfect competition, because firms have some market power. › Yet firms are not entirely dealing with inelasticity even though their products are different › You MAY be willing to pay 5$ more for an exotic meal, but not $15 or $30 more › Also, higher profit margins attract new firms into the market, increasing output and lowering prices
Dominated by a few large, firms (usually 2-4) Firms sell very similar products and control 70-80% of a market’s output Firms interact strategically They may cooperate or collude (acting like a monopolist) › agreeing to set prices or output levels ( price fixing ) Or they may compete ruthlessly Engaging in a price war competitors slash their prices very low to steal one another’s business http://www.pbs.org/wgbh/pages/frontline/shows/walmart/view/?ut m_campaign=viewpage&utm_medium=grid&utm_source=grid
Monopoly and oligopoly can be bad for consumers › Raising prices, creating shortages, lowering quality Firms can collude, merge, form a cartel, set prices or outputs to drive competitors away › Setting prices so low that they become a barrier to entry is called predatory pricing http://www.youtube.com/watch?v=lZfbZDK0hLw&feature=related
Federal government has a number of policies and agencies to police companies’ ability to control markets Regulation involves government intervention in a market › FTC, Justice Department’s Antitrust Division › Antitrust laws (Sherman and Clayton Antitrust Acts) › Oversees mergers (XM & Sirius Radio, Ticketmaster & Livenation)
Deregulation is the removal of market controls by government Can increase competition in industries stifled by powerful firms More competition is intended to lower prices and improve quality Deregulated industries include: › Airlines, trucking, banking, railroad, natural gas, TV, energy