Chapter 7: Market Structures

Chapter 7:

Types of Market Structures

1) Perfect Competition 2) Monopoly

3) Monopolistic Competition

Perfect Competition

A market structure in which a LARGE

Perfect Competition

Examples Wheat, Milk, Orange Juice, Notebook Paper, Agriculture

Number of Sellers Many

Variety of goods None

(Identical Products)

Price Control None

(Consumers try to get the best deal)

Entry into Market None

Monopoly

Monopoly

Examples Public Water, Post office

(Most are ILLEGAL)

Number of Sellers One

Variety of Goods None

Price Control Complete

(total control)

Entry into Market Complete Barriers

Monopolistic Competition

A market structure in which MANY

Monopolistic Competition

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

Oligopoly

Oligopoly

Examples 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 Some

Price Control

(least to most)

1. Perfect Competition

2. Monopolistic Competition

Entry into Market—

Barriers to Enter the Market

(least to most)

1. Perfect Competition

2. Monopolistic Competition

Barriers to entry

Any factor that makes it difficult for a new firm to enter the market

Start-up Costs

Types of Market Structures

1) Perfect Competition 2) Monopoly

3) Monopolistic Competition

Perfect Competition

A market structure in which a LARGE

Perfect Competition

Examples Wheat, Milk, Orange Juice, Notebook Paper

Number of Sellers Many

Variety of goods None

(Identical Products)

Price Control None

(Consumers try to get the best deal)

Entry into Market None

Four (4) Conditions:

1) Many buyers and sellers

2) Identical products (commodity)

3) Well informed buyers and sellers

Perfectly competitive markets

require everyone in the market

MUST

accept the market

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

Commodity

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

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.”

Imperfect Competition

How do Perfect Competitions

keep prices low?

Types of Market Structures

1) Perfect Competition 2) Monopoly

3) Monopolistic Competition

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

Monopoly

Monopoly

Examples Public Water, Post office

(Most are ILLEGAL)

Number of Sellers One

Variety of Goods None

Price Control Complete

(total control)

Entry into Market Complete Barriers

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?”

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.”

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.”

Monopoly Example 1:

DMV

“ Meanwhile, if you stop going to the Department of Motor Vehicles, you may end up in jail.”

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.”

Monopoly Example 2:

Post Office

“ 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).

Monopoly Example 2:

Post Office

“ 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.”

Monopoly Example 2:

Post Office

“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.”

Monopoly Example 2:

Post Office

“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.”

Monopoly Example 3:

Miss Kroope

“One of the largest government monopolies remaining in the United States is public education.”

Economies of Scale

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

Natural Monopolies

Natural Monopolies

• Result: Usually only ONE business remains

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

There are 4 Types of

Government Monopolies:

A) Patent

B) Franchise

C) License

Patent

• A license that gives the inventor a new

Patent

• Patents encourage companies to research and develop new products

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

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.”

Patent Example

“It happens to be Viagra, and Pfizer holds the patent, which is a legal monopoly granted by the U.S. government.”

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.’”

Patent Example

“Indeed, when a drug comes off patent—the point at which generic

substitutes become legal—the price usually falls by 80-90 percent.”

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”

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?”

Franchise

• Right to sell a good or service within an exclusive market

License

Industrial Organizations

• Allows, but can restrict number of firms in the market

Industrial Organizations

• What is a problem with industrial organizations?

Industrial Organizations

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

Industrial Organizations

25 100 200 100

50 80 175 100

75 60 150 100

100 40 125 100

Industrial Organizations

25 100 200 100

50 80 175 100

75 60 150 100

100 40 125 100

Industrial Organizations

1) 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?

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

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

Output Decisions

4. What happens to the supply curve?

What SPENT variable would this be?

Output Decisions

4. What happens to the supply curve?

SHIFTS TO THE LEFT

What SPENT variable would this be?

N- Number of Suppliers

Price Discrimination

• Division of customers into groups based on how much they pay for a good

• Examples in Oligopoly

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.”

Price Discrimination

Example

2

for

Oligopolies

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.”

Price Discrimination

Example

2

for

Oligopolies

“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.”

Price Discrimination

Example

2

for

Oligopolies

“[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.”

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 Discrimination

3. Price discrimination can be practices by any company with market power.

Market Power

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.

Price Discrimination

4. List 4 EXAMPLES of price discrimination (targeted discounts)

a) Discounted airline fares

b) Manufacturers’ rebate offers

c) Senior citizen or student discounts

Price Discrimination

5. List 3 LIMITS on price discrimination

a) Some market power

(is rare in highly competitive markets)

b) Distinct customer groups

(based on sensitivity to price)

c) Difficult resale

Monopolistic Competition

A market structure in which MANY

Monopolistic Competition

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

Monopolistic Competition

• What is the main difference between a perfect competition and a monopolistic competition?

PC – Identical products (commodity)

Monopolistic Competition

• List the 4 Conditions of a Monopolistic Competition:

• 1. Many firms

• 2. Few artificial barriers to entry

• 3. Slight control over prices

Differentiation

Nonprice Competition

• A way to attract customers through other means EXCEPT price.

FOUR (4) forms of Nonprice

Competition

:

1. Physical Characteristics (ex: shape, size, color, texture, taste)

2. Location (where sold?)

3. Service level

4. Advertising

Monopolistic Competition

• 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

Monopolistic Competition

If monopolistically competitive firms started to earn

profits well above their costs, market trends would work to take them away.

1. 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

Oligopoly

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

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 Some

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.”

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

Oligopoly

• List 4 reasons there can be high barriers to enter an Oligopoly:

a) Licenses

b) Patents

c) High start-up costs

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

Price War

• Series of competitive price cuts that lowers the market BELOW the cost of production

Who are price wars harmful to? Producers

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

Collusion

• Agreement among firms to divide the market, set prices, or limit production

Collusion Example

• When selling secretly do this, it is

ILLEGAL and carries heavy penalties (fine and prison)

Price Fixing

• An agreement among firms to charge ONE price for the SAME good

Cartel

• A formal organization of producers that agree to coordinate prices and production

• a. In the United States, cartels are Illegal

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

Cartel

• Do cartels typically last very long?

Results of an

Oligopoly

• As the number of sellers in an oligopoly grow larger, an oligopolistic market looks more like:

a) Monopoly

b) Monopolistic Competition c) Perfect Competition

Market Power

How do firms try to increase its Market Power by controlling prices and output?

A. Form a cartel

Predatory Pricing:

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.

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a

d

d

i

t

i

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breaking monopolistic companies, the

Antitrust Laws:

• Laws that encourage competition in the marketplace

(forbids companies from conspiring together in ways that erase the benefits of

Antitrust Laws (Question)

The purpose of antitrust laws is to:

a) Regulate the prices charged by a monopoly

b) Increase competition in an industry by preventing mergers and breaking up large firms.

c) Increase merger activity to reduce costs and raise efficiency

Antitrust Laws

Rationalization:

If a business does NOT allow competition, we believe that it goes against our

country’s fundamental belief of

Trust

Sherman Antitrust Act (1890)

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

Types of Corporate

Combinations

Deregulation

Deregulation

While deregulation weakens government control, antitrust laws strengthen it.

The government uses BOTH of these

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,

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)

Standards