Industry Structure & Public Policy “I don’t think it’s right that only one company gets to make the game Monopoly.” Steven Wright Comedian EIGHT

In this chapter: Industry Structure & Public Policy Meaning of ‘industry structure” Characteristics of the four structures Market power Why firms behave the way the do

Makeup of an industry as defined by certain factors: Industry Structure Industry Structure Makeup of an industry as defined by certain factors: Number and size distribution of sellers Nature of the product Barriers (or lack of barriers) to entry and exit These factors determine whether a firm has market power, ability to set price.

Industry Structure (Four Types) Pure Competition Monopolistic Competition Oligopoly Monopoly Number Sellers Many, many, many sellers – small relative to industry (too small to matter) Many sellers – small relative to industry Few sellers (usually 3to4) – large relative to industry One seller Nature of Product Barriers to Entry/Exit Examples

Industry Structure (Four Types) Pure Competition Monopolistic Competition Oligopoly Monopoly Number Sellers Many, many, many sellers – small relative to industry (too small to matter) Many sellers – small relative to industry Few sellers (usually 3to4) – large relative to industry One seller Nature of Product Homogeneous (identical) Heterogeneous (differentiated) Could be homogeneous or heterogeneous Unique, no close substitutes Barriers to Entry/Exit Examples

Industry Structure (Four Types) Pure Competition Monopolistic Competition Oligopoly Monopoly Number Sellers Many, many, many sellers – small relative to industry (too small to matter) Many sellers – small relative to industry Few sellers (usually 3to4) – large relative to industry One seller Nature of Product Homogeneous (identical) Heterogeneous (differentiated) Could be homogeneous or heterogeneous Unique, no close substitutes Barriers to Entry/Exit None None to Low Medium to High High Examples

Industry Structure (Four Types) Pure Competition Monopolistic Competition Oligopoly Monopoly Number Sellers Many, many, many sellers – small relative to industry (too small to matter) Many sellers – small relative to industry Few sellers (usually 3to4) – large relative to industry One seller Nature of Product Homogeneous (identical) Heterogeneous (differentiated) Could be homogeneous or heterogeneous Unique, no close substitutes Barriers to Entry/Exit None None to Low Medium to High High Examples Agriculture, stock market Restaurants, gas stations, hair salons Cigarettes, soft drinks, airlines Duke Power, Time Warner Cable, Charlotte Observer Which do you suppose has most market power? Ability to set price? WHY?

Market power (and ability to set price) is highest when: Number of sellers is smaller With many sellers, setting price too high will drive consumers away from you to lower priced rivals. Product is differentiated If products are close substitutes, consumers are more likely to be driven away because you aren’t the only game in town. Barriers to entry/exit are high If barriers are low, profits will attract more firms into the industry, lowering profits and driving price down.

Firm Behavior Due to Industry Structure Monopolistic Competition Examples: Restaurants, convenience stores, gas stations, nail shops, hair salons. Part “monopoly”, part “competition”: Monopoly because it is selling a unique product. Competition because there are lots of close substitutes. Considered inefficient by economists because of “excess capacity” The Thai restaurant on WT Harris usually has more tables than they need. But at peak times they can fill every seat. Most of the time they have excess capacity. Economists don’t mind the inefficiency in this case because it provides variety of consumption, increases social welfare. Imagine what would happen if there was no excess capacity in restaurant market . . .

Firm Behavior Due to Industry Structure Oligopoly Examples: Soft drinks, airlines, athletic shoes, beer, cigarettes, satellite TV. High market power, but not free to change price: Oligopolists have high market share because there are so few firms in the industry (Coke, Pepsi and Cadbury Schweppes have 90% of market) A big player cannot change their price without first considering what their rivals will do in response: What will they do if I raise price? What if I lower my price? Olgipolies are characterized by non-price rivalry: Tend to see oligopolists advertise without mentioning price – usually quality, convenience, taste-tests, sex appeal . . .

Firm Behavior Due to Industry Structure Monopoly Examples: Charlotte Observer, Duke Power, Pharmaceutical companies over certain drugs, the only dry cleaner in a small town. Firms can be natural monopolies: If one firm can produce a very large quantity of a good at a lower average cost per unit than several firms, the government may allow them to be a monopoly and erect high barriers to keep rivals out. Example: Duke Power, Pharmaceuticals

Industry Structure & Public Policy Key Terms: Barriers to entry Collusion Heterogeneous Homogeneous Industry structure Monopolistic competition Monopoly Natural monopoly Oligopoly Perfect competition