Chapter 7 MARKET STRUCTURES Monopoly

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Chapter 7 MARKET STRUCTURES Monopoly Oligopoly
ITS MISTER SMITH TO YOU, Moneybags!!!
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Market Structures

• Economists classify a firms market structure
  based upon its producing and selling environment.
• Four market structures
• Perfect competition
• Monopoly
• Monopolistic competition
• Oligopoly

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Perfect Competition/Pure Competition

• Perfect competition is a market with a large
  number of firms all producing essentially the
  same product.
• Perfect competition assumes that the market is in
  equilibrium and that all firms sell the same
  product for the same price.
• Firms choose how much to supply.
• Examples Farm Products, NYSE

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Conditions for Perfect Competition

1. Many buyers and sellers participate in the
   market.
2. Sellers offer identical products.
3. Buyers and sellers are well informed about
   products.
4. Sellers are able to enter and exit the market
   freely.

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Conditions for Perfect Competition

• 1. Many buyers and sellers participate in the
  market.
• --No one can influence the price. The market
  itself determines price and output.
  (supply/demand)

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Conditions for Perfect Competition

• 2. Sellers offer identical products.
• -- Commodities Products that are considered the
  same regardless of who makes or sells them.
• Examples milk, notebooks

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Conditions for Perfect Competition

• 3. Buyers and sellers are well informed about
  products.
• --Buyers and sellers know enough about the
  market to find the best deal.

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Conditions for Perfect Competition

• 4. Sellers are able to enter and exit the market
  freely.
• --Firms must be able to enter a market when they
  can make money and leave the market when they are
  not.

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Barriers to Entry

• Factors that make it difficult for new firms to
  enter the market.
• Barriers to entry can lead to imperfect
  competition.
• Imperfect competition is a market structure that
  does not meet the conditions of perfect
  competition.

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Barriers to Entry, cont.

• Two barriers
• Start- up costs Expenses that a new business
  must pay before the first product reaches the
  customer.
• Example Pizzeria need an oven, cheese, boxes,
  dough machine
• Technology High skills and scientific knowledge
  needed to enter the market.
• Example Pizzeria need to know how to run a
  computer, carpentry, make pizza

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Price and Output

• Prices in a perfectly competitive market are the
  lowest sustainable prices possible because
  competition drives prices down to the point where
  prices just cover the cost of production.

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Section 2 Monopoly

• A monopoly is a market structure in which only
  one seller sells a product for which there are no
  close substitutes.
• The supplier is a price-maker ? the business does
  not have to consider competition
• Monopolies are illegal in the US

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Examples of Monopolies
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• Miner and buyer of 70-90 of worlds diamonds
• Price-maker
• Created barriers to entry to other companies
• Marketed as proof of LOVE the diamond
  engagement ring is basically a DeBeers invention!

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Forming a Monopoly

• 1. Economies of Scale Factors that cause a
  producers average cost to drop as production
  rises.
• Characteristics
• High start-up costs (factory, machinery, etc.)
• Cost (average per unit) drops as output rises
• Example Dam
• Industries with economies of scale can easily
  become a natural monopoly.

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ECONOMIES OF SCALE

• Nuclear power plant
• cost of producing power in the first couple of
  hours is much greater than the cost of producing
  additional power

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Forming a Monopoly, cont.

• 2. Natural Monopolies A market that runs most
  efficiently when one large firm provides all of
  the output.
• Allowed and regulated by the government
• If a competitor enters the market, one or both of
  the firms would go out of business.
• price charged would go down, but so would
  quantity sold, so costs would be greater for both
  companies.
• Example Public water / electric company (digging
  reservoirs, overlapping piping, pumping stations)

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Forming a Monopoly, cont.

• Technology can replace natural monopolies.
• Example Telephone
• Expensive copper wires did not allow for
  competition (in the old days)
• Now, radio waves- modern cellular phones allow
  people to choose

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Government Monopolies

• Government monopolies are created when the
  government makes barriers to entry in markets.
• Patents (Government-issued) give companies
  exclusive rights to sell a new good or service
  for a specific amount of time.
• Guarantee companies can profit from their own
  research without competition.
• Patents give companies MARKET POWER

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EXAMPLES

• Subway system
• Public water supply
• Mail
• Electricity

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Government Monopolies, cont.

• Franchise the right to sell a good or service
  within an exclusive market.
• Examples National Park Service- food vendor.
• License a government-issued right to operate a
  business.
• Examples Radio/T.V. broadcasts (limited
  frequencies, land, etc.)

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Industrial Organizations

• The government allows the companies in an
  industry to restrict the number of firms in a
  market.
• RARE
• Example MLB allowed to choose which cities
  have baseball teams (otherwise all cities would
  want teams and that would mess everything up)

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Monopolies and Price

• Monopolies cannot charge any price it wants.
• Price does determine demand for almost all goods
  or services.

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Price Discrimination

• Price Discrimination is the practice of dividing
  customers into two or more groups based on how
  much they will pay for a good.
• Each group has a different maximum price they
  will pay.
• Targeted discounts Identify those customers not
  willing to pay regular price and offer discounts.
• Example Senior citizen discounts on movie
  tickets.

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Section 3 Monopolistic Competition Oligopoly

• Most markets are NOT monopolies or perfect
  competition types.
• The most popular market structures fall under TWO
  categories
• Monopolistic Competition, and
• Oligopoly.

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Monopolistic Competition

• Monopolistic Competition is a market structure in
  which many companies sell products that are
  similar but not identical.
• Example JEANS All jeans are considered denim
  pants but consumers have choices of brands,
  color, styles, and sizes.
• Other examples gas, bagels, ice cream.

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Monopolistic Competition, cont.

• The FOUR Conditions of Monopolistic Competition
• Many firms
• Few artificial barriers to entry
• Slight control over price
• Differentiated products

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The Four Conditions of Monopolistic Competition

• MANY FIRMS
• Low start- up costs allow firms to spring up
  quickly to join the market quickly.
• FEW ARTICIFICAL BARRIERS TO ENTRY
• No patents- either because they are expired or
  because the product is distinct enough.

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The Four Conditions of Monopolistic Competition,
cont.

• SLIGHT CONTROL OVER PRICE
• Firms can have a little control over price
  because each firms products are a little
  different and people are willing to pay more for
  that difference.
• If a firm charges too much, the consumer will
  substitute a rivals product.
• Example Coke/Pepsi vs. store brand

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The Four Conditions of Monopolistic Competition,
cont.

• DIFFERENTIATED PRODUCTS
• Firms can distinguish themselves and their goods
  from the other products.
• Example Name brand Nike, Puma, Adidas

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Nonprice Competition

• Nonprice Competition is a way to attract
  customers through style, service or location, but
  not a lower price.
• Nonprice Competition takes many different forms
• Physical Characteristics
• Location
• Service Level
• Advertising, image, or status

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Nonprice Competition, cont.

• 1. Physical Characteristics
• Offer new size, color, shape, texture, taste
• Example sneakers, pens, cars
• 2. Location
• Determines how much a firm can charge
• Example Desert gas station

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Nonprice Competition, cont.

• 3. Service Level
• Firms can charge more because of the services
  they offer.
• 4. Advertising, Image, Status
• Firms can differentiate their products from
  others through advertising.
• Example Prada, Dolce Gabbana

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Price, Output Profits

• Prices Prices can be higher than with perfect
  competition because firms have the power to raise
  prices.
• Output Total output is in between perfectly
  competitive firms and monopolies.
• Profit Firms earn just enough to cover all of
  their costs.

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Oligopoly

• An oligopoly is a market structure in which a few
  large firms dominate the market.
• The four largest firms produce 70-80 of the
  output
• Usually set prices higher and output lower.
• Examples air travel, breakfast cereal,
  household appliances.
• The distinctive feature of oligopolies is
  interdependence among firms.

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Oligopoly, cont.

• Barriers to Entry
• 1. High start- up costs,
• (machinery, airplanes)
• 2. Government licenses/patents,
• 3. Economies of scale
• (only 3 or 4 firms can remain profitable. If
  more firms enter, no one will profit.)

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Cooperation and Collusion

• Some firms work together to act as a monopoly
  (illegal)
• Practices that concern the Government
• Price Leadership
• Collusion
• Cartel

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Cooperation and Collusion, cont.

• Price Leadership
• Market leader sets price
• Can lead to price wars A series of competitive
  price cuts that lowers the market price below the
  cost of production.
• bad for producers, good for consumers

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Cooperation and Collusion, cont.

• Collusion An agreement among firms to divide
  the market, set prices, and production levels.
• Illegal in the United States
• An outcome of collusion is
• Price fixing An agreement among firms to charge
  one price for the same good.

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Cooperation and Collusion, cont.
??

• Cartels A formal organization of producers that
  agree to coordinate prices and production.
• If each member of the cartel obeys the
• established agreement, then joint profits
• in the industry are maximized.
• Illegal in the US, but legal in other countries
  and international organizations.
• Cartels usually do not last long.

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Prisoners Dilemma at End of Show if Time Allows

• Starts at Slide 47

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Section 4 Regulation Deregulation

• Predatory Pricing Selling a product below cost
  to drive competition out of the market.

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Government Competition

• The government uses a number of policies to keep
  firms from controlling the price and supply of
  important goods.
• The Federal Trade Commission and the Department
  of Justices Antitrust Division watch firms
  closely to ensure that firms do not unfairly
  force out competitors.
• These policies are known as antitrust laws.

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Government Competition, cont.

• Antitrust Laws Laws that encourage competition
  in the marketplace.
• Trust Like a cartel, a trust is an illegal
  grouping of companies that discourages
  competition.
• Breaking up monopolies
• Standard Oil (Rockefeller) 1911
• AT T 1982

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Government Competition, cont.

• Blocking Mergers To prevent monopolies, the
  government can stop mergers that might reduce
  competition and lead to higher prices.
• Merger A combination of 2 or more companies into
  a single firm.
• Prices will rise if the number of firms in an
  industry falls.
• The government must act carefully because some
  mergers might help the customer with lower prices.

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Deregulation

• Deregulation is the removal of some government
  control over a market.

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Cartels and the PrisonersDilemma
Each firm has an incentive to cheat by producing
more. Situation fits a Prisoners Dilemma --
game theory Ann and Pete are arrested and put
in different cells. They are guilty. What should
they do?
Confess or stay quiet?
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Payoff matrix
Confess Remain silent
Confess each 5 years Nicole (10 years) Krystie (free)
Remain silent Nicole (free) Krystie (10 years) each 6 months
Nicole Krystie
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Possible outcomes

• Nicole confesses, Krystie confesses
• Nicole 5 years, Krystie 5 years
• Nicole confesses, Krystie does not
• Nicole free, Krystie 10 years
• Krystie confesses, Nicole does not
• Nicole 10 years, Krystie free
• Neither confesses each gets 6 months

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What will Nicole do?

• CONFESS!!!
• In deciding what to do in strategic situations,
  it is normally important to predict what others
  will do. This is not the case here ? Hence THE
  DILEMMA!!!
• If you knew the other prisoner would stay silent,
  your best move is to confess as you then walk
  free instead of receiving the minor sentence. If
  you knew the other prisoner would confess, your
  best move is still to confess, as you receive a
  lesser sentence than by staying quiet. Confessing
  is a dominant strategy.
• The other prisoner reasons similarly, and
  therefore also chooses to confess. By both
  defecting they get a lower payoff than they would
  get by staying quiet.
• Rational self-interested play results in each
  prisoner being worse off than if they had stayed
  silent.

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Cont.

• Note that the paradox of the situation lies in
  that the prisoners are not defecting in hope that
  the other will not. Even when they both know the
  other to be rational and selfish, they will both
  play defect. Defect is what they will play no
  matter what, even though they know fully well
  that the other player is playing defect as well
  and that they will both be better off with a
  different result.
• One experiment based on the simple dilemma found
  that approximately 40 of participants cooperated
  (i.e., stayed silent).

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Prisoners Dilemma

• The outcome of games do not always lead to the
  best result for all parties.
• In the prisoners dilemma, both parties would be
  better off if they colluded and did not confess.
• However, each individual in seeking to maximize
  his or her advantage chooses an outcome that does
  not maximize the joint benefit.

Outcomes Cooperative outcome Non-cooperative
outcome