Chapter 7 Market Structures Aww, Snap!

Perfect Competition Perfect Competition – a market where a large number of firms are all producing essentially the same product

Perfect Competition Four Conditions for Perfect Market: Many buyers and sellers participate Sellers offer identical products Products that are the same no matter who makes or sells them are commodities

Perfect Competition Four Conditions for Perfect Market: Buyers and sellers are well informed about products Sellers are able to enter and exit the market freely

Barriers to Entry Barriers – factors that make it difficult for new firms to enter a market Barriers lead to imperfect competition

Examples of Barriers Start-Up Costs – The expenses a new business must pay before it can enter the market High Start-Up Costs prevent new firms from entering

Examples of Barriers Technology – how much training does it take to enter the market?

Examples of Barriers Government – may require licensing, certification, approval, etc.

Price and Output A perfectly competitive market produces the lowest sustainable prices possible With many firms competing, each firm lowers its prices to the point of just covering their costs

Monopoly Monopoly – Barriers prevent firms from entering a market that has a single supplier

Factors that Create a Monopoly 1. Economies of Scale – average cost of production always drops, never increases 2. Natural Monopoly – market runs most effectively when one large firm provides all output

Factors that Create a Monopoly Natural Monopolies are usually given special status by the government, but the government is allowed to control their prices New technologies can destroy a natural monopoly

Government Monopolies Government Monopoly – a monopoly created by the government

Typical High School Boy Questions? Wait… what’s a government monopoly?

Government Monopolies Government Monopoly – a monopoly created by the government There are 3 types of government monopolies, each with a different reason for being formed

Three Kinds of Government Monopoly Technological Monopoly – government issues a patent Patent – exclusive rights to sell a good or service for a specific period of time

Three Kinds of Government Monopoly Franchises and Licenses Franchises – government allows company to create an exclusive market for their brand name and products

Three Kinds of Government Monopoly Franchises and Licenses Licenses – government grants a firm the right to operate a business

Three Kinds of Government Monopoly Industrial Organizations – government allows companies in an industry to restrict the number of firms in the market

Output Decisions Do you emphasize price or output? Price-Takers – in a competitive market, businesses have no control over their own prices Price-Setters – in a non-competitive market, business can choose what price to charge

Falling Marginal Revenue MR = price in perfect competition, and does not change In a monopoly, however, MR begins falling at a point Therefore, monopolies set production where MR = MC, but charge a higher price

Falling Marginal Revenue Price Qd TR Change MR $12 8,000 $96,000 - $11 9,000 $99,000 +$3,000 $3 $10 10,000 $100,000 +$1,000 $1 $9 11,000 -$1,000 -$1 8 12,000 -$3,000 -$3

Price Discrimination Do you think monopolies usually charge the same price to all of their customers?

Price Discrimination NO!!

Price Discrimination Price Discrimination – dividing consumers into different groups and charging different prices to each group

Price Discrimination Monopolies are not the only companies that do this Any company with market power, the ability to control prices and output, can use discrimination

Price Discrimination The easiest way to maximize profit for a monopoly is to identify consumers who will not pay full price, and offer them a “discount” These are called targeted discounts – think of airline fares, manufacturers rebates, student discounts

Limits to Price Discrimination I am the limit to price discriminicization.

Limits to Price Discrimination 1. Firm must have some market power 2. There must be distinct consumer groups 3. It must be difficult for consumers to resell the product

Monopolistic Competition and Oligopoly Presidenting is my anti-drug.

Monopolistic Competition Monopolistic Competition – many companies compete in an open market, but sell products that are slightly different from one another

Example

4 Characteristics of Monopolistic Competition 1. Many Firms 2. Few Artificial Barriers to Entry 3. Slight Control Over Prices 4. Differentiated Products

Other Means of Competition In a Monopolistic Competition, firms compete in a variety of ways other than prices Physical Characteristics Location Service Level/Quality Advertising and Image

Monopolistic Competition Economists contend that price, output, and profits in a monopolistic competition are very similar to a perfect competition

Oligopoly Oligopoly – a market dominated by a few large, profitable firms If 4 of the largest firms can claim 70% or more of the market share, it is an oligopoly

Example

Example

Characteristics of Oligopoly 1. Many Barriers to Entry 2. Cooperation and Collusion Price Leadership – market leader raises prices, other firms follow suit (can also cause price war, though)

Characteristics of Oligopoly 1. Many Barriers to Entry 2. Cooperation and Collusion Collusion – an agreement among members of an oligopoly to set prices and production levels

Characteristics of Oligopoly 1. Many Barriers to Entry 2. Cooperation and Collusion Collusion causes price fixing, where firms agree to sell at the same or similar prices It’s illegal, by the way

Characteristics of Oligopoly 1. Many Barriers to Entry 2. Cooperation and Collusion Cartels – an agreement by producers to coordinate prices and production Legal in some countries, not here

Regulation and Deregulation What might a firm do to increase its market power? Form a cartel Merge with competitors Predatory Pricing - Temporarily lower prices to put others out of business

Regulation and Deregulation Government has Antitrust Laws in place to prevent such practices Trust – a business combination similar to a cartel Began with Sherman Antitrust Act in 1890

Fair or Unfair? Nike is one of the world’s largest and most popular shoe manufacturers Once Nike introduced clothing, it forced companies that wanted to buy its shoes to buy its clothes as well

Fair or Unfair? Disney, ABC, AOL, and Time-Warner have merged together They now control the Disney Channel, Cartoon Network, and the WB, which is a basic monopoly on children's programming

Regulation and Deregulation Government can step in and break up monopolies based on the Sherman Antitrust Act Famous examples: John D. Rockefeller’s Standard Oil (1911), AT&T (1982)

Regulation and Deregulation Government can also block mergers from happening Merger – when one company joins with another Government uses research to see whether the merger will help or hurt consumers

Regulation and Deregulation The Republican Party has typically supported deregulation – when the government stops making decisions about what businesses can and cannot do Government uses regulation and deregulation for the same purpose – to promote competition