Chapter 7: Market Structures

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Chapter 7 Market Structures
2
Types of Market Structures

1. Perfect Competition
2. Monopoly
3. Monopolistic Competition
4. Oligopoly

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Perfect Competition

• A market structure in which a LARGE number of
  firms all produced the SAME product

4
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 (easiest to enter)
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Monopoly

• A market structure dominated by a single seller

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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 (most difficult to enter)
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Monopolistic Competition

• A market structure in which MANY companies sell
  products that are SIMILAR

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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
Entry into Market Low / Few
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Oligopoly

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

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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
Entry into Market High Barriers
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Price Control(least to most)

1. Perfect Competition
2. Monopolistic Competition
3. Oligopoly
4. Monopoly

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Entry into MarketBarriers to Enter the
Market(least to most)

1. Perfect Competition
2. Monopolistic Competition
3. Oligopoly
4. Monopoly

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Vocabulary Words
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Barriers to entry

• Any factor that makes it difficult for a new firm
  to enter the market
• Like a brick wall

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Start-up Costs

• The expenses a firm must pay BEFORE it can begin
  to produce and sell goods

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Types of Market Structures

1. Perfect Competition
2. Monopoly
3. Monopolistic Competition
4. Oligopoly

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Perfect Competition
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Perfect Competition

• A market structure in which a LARGE number of
  firms all produced the SAME product

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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 (easiest to enter)
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Four (4) Conditions

1. Many buyers and sellers
2. Identical products (commodity)
3. Well informed buyers and sellers
4. No barriers to enter or exit the market

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• Perfectly competitive markets require everyone
  in the market MUST accept the market price given.

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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 equilibrium price? Decreases

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Commodity

• A product that is the SAME, no matter who
  produces it

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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
  below-market prices so that urban dwellers can
  get basic food items cheaply.

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Commodity Example

• If the government has to support the price of
  milk, the real problem is that there are too many
  dairy farmersGovernments should not be in the
  business of providing incentives for people that
  would not otherwise make sense.
• --Naked Economics, p. 141-142

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Imperfect Competition

• A market structure that does NOT meet the
  conditions of perfect competition

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How do Perfect Competitions keep prices low?

• Use inputs (such as technology) to their best
  advantage (competition)

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Monopoly
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Types of Market Structures

1. Perfect Competition
2. Monopoly
3. Monopolistic Competition
4. Oligopoly

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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 operate in
  a market. This is true with respect to mail
  delivery. Only the U.S. Postal Service (a
  government monopoly) can deliver mail into your
  mailbox. Other firms can deliver packages to your
  door, but not to your mailbox. Finally, economies
  of scale in production may dictate that one large
  firm is the most efficient way to provide a
  product. This situation is called natural
  monopoly.

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Monopoly

• A market structure dominated by a single seller

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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 (most difficult to enter)
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Monopoly Example 1 DMV

• Think about the Department of Motor Vehicles,
  which has a monopoly on the right to grant
  drivers 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?
• --Naked Economics, page 64

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Monopoly Example 1 DMV

• None of these things will produce even one more
  customer! Every single person who needs a
  drivers 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.
• --Naked Economics, page 64

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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.
• --Naked Economics, page 64

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Monopoly Example 1 DMV

• Meanwhile, if you stop going to the Department
  of Motor Vehicles, you may end up in jail.
• --Naked Economics, page 64

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Monopoly Example 2 Post Office

• Several 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 byno check.
  Meanwhile, my mother was checking in with
  increasing frequency.
• --Naked Economics, page 64

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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).
• --Naked Economics, page 64-65

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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.
• --Naked Economics, page 65

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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.
• --Naked Economics, page 65

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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.
• --Naked Economics, page 65

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Monopoly Example 3Miss Kroope

• One of the largest government monopolies
  remaining in the United States is public
  education.
• --Naked Economics, page 66

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Economies of Scale

• Factors that cause a producers average cost per
  unit to fall as output rises

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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 high enough
  to supply the entire market. An example
  Hydroelectric plant

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Natural Monopolies

• A market that runs most efficiently when l large
  firm supplies ALL output

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Natural Monopolies

• Result Usually only ONE business remains
• Examples telecommunications, public water,
  electricity, mail delivery

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Natural Monopolies

• Why does the government usually step in to allow
  these to happen for necessary services?
• Ensures we dont waste resources building
  additional plants when only one is needed 
• In return, the government controls prices.

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There are 4 Types of Government Monopolies

1. Patent
2. Franchise
3. License
4. Industrial Organization

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Patent

• A license that gives the inventor a new product
  the exclusive right to sell it during a certain
  period of time

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Patent

• Patents encourage companies to research and
  develop new products
• Patents benefit society as a whole.

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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
• Plant Patent - 20 years from the date of filing
  of the earliest application

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Patent Example

• Dont 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.
• --Naked Economics, page 14

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Patent Example

• It happens to be Viagra, and Pfizer holds the
  patent, which is a legal monopoly granted by the
  U.S. government.
• --Naked Economics, page 14

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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 bythe big drug companies.
• --Naked Economics, page 53

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Patent Example

• Indeed, when a drug comes off patentthe point
  at which generic substitutes become legalthe
  price usually falls by 80-90 percent.
• --Naked Economics, page 53

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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
• --Naked Economics, page 53

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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.Thats an expensive solution that comes
  with some problems of its own. For example,
  which drug patents would the government buy?
• --Naked Economics, page 53

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Franchise

• Right to sell a good or service within an
  exclusive market
• Example Dominos, Dunkin Donuts

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License

• Government issued right to operate a business

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Industrial Organizations

• Allows, but can restrict number of firms in the
  market
• Example National Football League (NFL)

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Industrial Organizations

• What is a problem with industrial organizations?
• Team owners may charge high prices for tickets

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Industrial Organizations

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

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Industrial Organizations
Price Demand 1 Demand 2 Supply
25 100 200 100
50 80 175 100
75 60 150 100
100 40 125 100
125 20 100 100
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Industrial Organizations
Price Demand 1 Demand 2 Supply
25 100 200 100
50 80 175 100
75 60 150 100
100 40 125 100
125 20 100 100
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Industrial Organizations

• Why is the supply curve vertical?
• It is a stadiumwhere there is
• a constant number of seats!
• 2) What happens to equilibrium price when there
  is more demand?
• Equilibrium price INCREASES

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Output Decisions

• 1. A monopolist faces a limited choiceit 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 higher price.

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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 than price.

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Output Decisions

• 4. What happens to the supply curve?
• What SPENT variable would this be?
• What happens to the equilibrium price?

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Output Decisions

• 4. What happens to the supply curve?
• SHIFTS TO THE LEFT
• What SPENT variable would this be?
• N- Number of Suppliers
• What happens to the equilibrium price?
• INCREASES

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Price Discrimination

• Division of customers into groups based on how
  much they pay for a good
• Examples in Oligopoly
• (Airplanes and grocery stores)

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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.
• --Naked Economics, page 17

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Price Discrimination Example 2 for Oligopolies

• A firm can attempt to sell the same item to
  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. Its probably not what you
  paid it may not even be close.
• --Naked Economics, page 16

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Price Discrimination Example 2 for Oligopolies

• You are sitting on the same plane, traveling to
  the same destination, eating the same bad
  foodyet the prices you and your row mate paid
  for your tickets may not even have the same
  number of digits.
• --Naked Economics, page 16

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Price Discrimination Example 2 for Oligopolies

• The 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.
• --Naked Economics, page 16

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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 but were willing to pay more

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Price Discrimination

• 3. Price discrimination can be practices by any
  company with market power.
• However, some companies enjoy market power
  without holding a monopoly.

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Market Power

• Ability of a company to change prices and output

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Market Power

• If you do NOT have another choiceyou can either
  accept the item at the price it is being offered
  at or do NOT accept the item at all.
• Business know if there product is good enough and
  there is no other optionpeople will buy their
  product!

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Price Discrimination

• 4. List 4 EXAMPLES of price discrimination
  (targeted discounts)
• Discounted airline fares
• Manufacturers rebate offers
• Senior citizen or student discounts
• Children fly or stay free promotion

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Price Discrimination

• 5. List 3 LIMITS on price discrimination
• Some market power
• (is rare in highly competitive markets)
• b) Distinct customer groups
• (based on sensitivity to price)
• c) Difficult resale
• (ex airline tickets)

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Monopolistic Competition
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Monopolistic Competition

• A market structure in which MANY companies sell
  products that are SIMILAR

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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
Entry into Market Low / Few
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Monopolistic Competition

• What is the main difference between a perfect
  competition and a monopolistic competition?
• PC Identical products (commodity)
• MC Not identical a fact of everyday life

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Monopolistic Competition

• List the 4 Conditions of a Monopolistic
  Competition
• 1. Many firms
• 2. Few artificial barriers to entry
• 3. Slight control over prices
• 4. Differentiated price

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Differentiation

• Making a product different from other similar
  products

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Nonprice Competition

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

X
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FOUR (4) forms of Nonprice Competition

• Physical Characteristics (ex shape, size, color,
  texture, taste)
• Location (where sold?)
• Service level
• Advertising
• (anything, EXCEPT PRICE!!!)

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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 and
  ease of entry prevent companies from raising
  prices as high as they would if they were a true
  monopoly. If a monopolistically competitive firm
  raised prices too high, most customers would
  ignore any differences and buy the cheaper
  product.

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Monopolistic Competition

• If monopolistically competitive firms started to
  earn profits well above their costs, market
  trends would work to take them away.
• 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 consumers will switch to these substitutes.

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Oligopoly
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Oligopoly

• A market structure in which a FEW larger firms
  dominate the market
• (4 Largest firms produce at least 70-80 of the
  output.)

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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
Entry into Market High Barriers
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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 wouldnt 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.
• --Naked Economics, page 14

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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 entering
  the market and to compete with existing firms.

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Oligopoly

• List 4 reasons there can be high barriers to
  enter an Oligopoly
• Licenses
• Patents
• High start-up costs
• Economics of scale

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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 oligopoly can try to control a market.
  These practices dont always work.

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Price War

• Series of competitive price cuts that lowers the
  market BELOW the cost of production
• Who are price wars harmful to? Producers
• Who do price wars benefits? Consumers

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Price War Example

• Initially benefit consumers by lowering prices
• Some sellers can be severely hurt by price
  warssome can lose money and/or go out of
  business.
• When the price war ends, prices tend to rise
  again
• If one or more sellers have gone out of business
  prices may rise even higher than before the war
  because there is less competition

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Collusion

• Agreement among firms to divide the market, set
  prices, or limit production
• a. One outcome of collusion is Price fixing

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Collusion Example

• When selling secretly do this, it is ILLEGAL and
  carries heavy penalties (fine and prison)
• Raises prices higher than they would be under
  competitive forces

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Price Fixing

• An agreement among firms to charge ONE price for
  the SAME good
• a. In the United States, collusion is Illegal

103
Cartel

• A formal organization of producers that agree to
  coordinate prices and production
• a. In the United States, cartels are Illegal
• b. In other countries and international
  organizations, cartels are Legal

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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 producers are left out of
  the group and decide to lower their prices below
  the cartels levels.

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Cartel

• Do cartels typically last very long? NO

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Results of an Oligopoly

• As the number of sellers in an oligopoly grow
  larger, an oligopolistic market looks more like
• Monopoly
• Monopolistic Competition
• Perfect Competition
• Collusion as a solution

107
Market Power

• How do firms try to increase its Market Power by
  controlling prices and output?
• A. Form a cartel
• B. Combine with one another
• C. Predatory Pricing

108
Predatory Pricing

• Selling a product below cost to drive competitors
  out of the market

109
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 Justices
  Antitrust Division will watch that firm closely
  to ensure that it does not unfairly force out its
  competitors.
•  
• In addition to breaking monopolistic companies,
  the government has the power to prevent the rise
  of monopolies

110
Antitrust Laws

• Laws that encourage competition in the
  marketplace
• (forbids companies from conspiring together in
  ways that erase the benefits of competition
  Naked Economics, p. 56)

111
Antitrust Laws (Question)

• The purpose of antitrust laws is to
• Regulate the prices charged by a monopoly
• Increase competition in an industry by preventing
  mergers and breaking up large firms.
• Increase merger activity to reduce costs and
  raise efficiency
• Create public ownership of natural monopolies
• Do all of the above

112
Antitrust Laws

• Rationalization
• If a business does NOT allow competition, we
  believe that it goes against our countrys
  fundamental belief of encouraging competitionand
  therefore, we do NOT allow it.

113
Trust

• An illegal grouping of companies that discourages
  competition

114
Sherman Antitrust Act (1890)

• Outlawed mergers and monopolies that limit trade
  between states

115
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 prices.
  However, their size can also give some of these
  combinations more Monopoly Power.

116
Types of Corporate Combinations

• Add info here!!!

117
(No Transcript)
118
Deregulation

• The removal of some government controls over a
  market

119
Deregulation

• While deregulation weakens government control,
  antitrust laws strengthen it.
•  
• The government uses BOTH of these tools
  deregulation and anti-trust laws for the same
  purpose to promote competition.
•  
•  

120
Federal Agencies
121
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, helicopters, and other aviation devices
122
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) Reports and requests recalls for consumer products
123
Standards

• 6.2.12 H
• 6.4.12 A