Chapter 7 Powerpoint - Student

 Economists
classify markets based on
how competitive they are
 Market structure –
 Perfect competition –
• useful as a model, but real markets are never
• economists assess how competitive market is by
determining where it falls short of a perfect
 1.–
no one seller or buyer has control
over price
 2.– a product that consumers consider
identical in all essential features to other
products in the same market
 3.– buyer and sellers are free to enter
and exit the market, no govt. regulations
prevent participation nor is any business
or custom required to participate in the
4.– buyers cannot join other buyers and sellers
cannot join other sellers to influence prices
 5.– both buyers and sellers are well-informed
about market conditions, buyers can do
comparison shopping and sellers can learn what
their competitors are charging
• Price taker – is a business that cannot set the prices for its
products but instead accepts the markets price set by the
interaction of supply and demand
• only efficient producers make enough money to serve
perfectly competitive markets
Large # of buyers and sellers necessary for
perfect competition so that no one buyer has
power to control the price in the market
• many sellers – buyers can chose to buy from different
producer if one tries to raise price above the market level
• b/c many buyers – sellers able to sell product at market
 ex – Smith family selling at Montclair Farmers’ Market – sell
• many farmers grow and sell at market – charge same
 if one tries to sell at higher price – buyers buy from someone
 all know they can sell at market price b/c of sufficient
 In
perfect competition –
• products are perfect substitutes
• ex. – eggs, milk, wheat, notebook paper, gold
 No
2 pints of raspberries are exactly
alike – similar enough consumers will
buy from any producer that offers
• price is only basis to choose one product over
 Perfectly
competitive markets –
• investment to enter is low
• market forces encourage producers to freely
enter or leave
 Smiths
consider market price for
raspberries when planting – if they can
make a profit – grow it
 Perfectly
competitive market –
• buyers and sellers act independently
• interaction of supply and demand set
equilibrium price
• independent action ensures market will remain
 Perfectly
competitive market –
• buyers compare prices among different sellers
• sellers know what prices competitors are
charging and what buyers will pay
 In
real world – no perfectly competitive
markets b/c real markets do not have all
of the characteristics of perfect
 Imperfect competition –
• wholesale markets for beef & corn come close to
perfect competition
 In
US – thousands of
farmers grow corn –
no one farmer can
control price of corn
• all accept market
• can decide how much
to produce to offer for
Large # of buyers – price
on wholesale market
easy to determine
• corn fairly standardized –
buyers no reason to prefer
one over another
buyers will not pay more
than market price
reality –
US govt. pays subsidies to
farmers to protect from low
some corn farmers band
together to try & influence
price of corn
Many cattle producers
and little variation in a
particular cut from
• wholesale buyers
primary concern is price
• buyers and sellers can
easily determine the
market price
• sellers can only adjust
production to reflect
market price
 Reality
• cattle ranchers may try
to join together to
influence the price of
• producers try to
persuade buyers that
there are significant
differences in product
that warrant higher
 Perfect
competition is the most
competitive market structure
 Monopoly –
• it is the least competitive market
• term can be used for the market structure or
monopolistic business
• pure monopoly as rare as pure competition –
some businesses come close
 Cartel
 Price maker – a business that does not have
to consider competitors when setting its
• consumers either accept the price or do not buy the
 Barrier to entry –
• ex. – large size, govt. regulation, special resource,
characteristics of a monopoly – De Beers
single business is
identified with the
industry b/c it
controls the supply of
a product that has no
close substitute
• De Beers once
produced more than
half of world’s
diamond supply and
bought the rest from
smaller producers
 In
some cases
 De Beers – worked
with the South African
• new mines required to
sell through De Beers
• company restricted
access to market for
raw diamonds for
producer outside
South Africa
Monopolists control
prices b/c no close
substitutes for their
product & no
• economic downturn
reduced demand – De
Beers created artificial
shortage by withholding
diamonds from the
• cartel could continue
charging higher price
 Several
reasons why monopolies exist
and not all are harmful
 Natural monopoly –
 Govt. monopoly
– is a monopoly that exist
b/c the govt. either owns and runs the
business or authorizes only one producer
 Technological
 Geographic
monopoly –
monopoly – is a monopoly
that exists b/c there are no other
producers or sellers within a certain
 In
some markets –
• most public utilities fall into this category
 Water
company – pumps water – through
pipes to homes, businesses, public
• monitors water quality for safety, removes and
treats wastewater
• waste of community resources to have several
companies do this same job
 Economic
scale –
• more customers –
more efficient as high
fixed costs are spread
• these economic scales
get govt. support of
natural monopolies
• govt. regulates so do
not charge excessively
high prices
 Govt. run
businesses provide goods &
services that could not be provided by
private firms or are not attractive due to
insufficient profit opportunity
• oldest govt. monopoly –
• at first, only govt. could provide this in efficient and
cost effective manner
• today – new services and new technology chipping
 also – people send by email, fax, text message, pay bills
1947 – Edwin Land
(founder of Polaroid)
invented 1st instant
• with patents – created
monopoly in instant
photography market
Patent –
• govt. support tech.
monopolies by issuing
• patents allow business to
recover costs in
developing invention or
Polaroid controlled
technology through its patents
& a barrier for other firms
• 1985 – Polaroid won lawsuit
against Kodak for patent
• blocks Kodak from instant
photography market
Technology monopolies last
as long as the patent –
generally 20 years
• or when new technology creates
a substitute-new tech for instant
camera – easy to use 35mm, one
hour photo processing, digital
Today – instant camera is
minor segment of
photography market
Major sports require
teams be associated with
a city or region & limit #
on teams in each league
• leagues create a restricted
• most teams draw fans from
large surrounding
geographic region
• owner are able to charge
higher prices for tickets
than if there was
• also have a ready market
for apparel & merchandise
with logo & colors
Physical isolation is creates
geographic monopoly –
gas station in middle of
desert off interstate
• Joe only supplier of gas with
no close substitute
• drivers can either buy gas or
risk running out
• Joe can control the price &
its expensive
Geographic monopolies
have become less common
in US – people can travel
greater distances, catalog
orders, internet business
 Monopoly
is only firm with product –
cannot charge any price
• still faces a downward sloping demand curve –
ie. will sell more at lower prices
 Monopolist
can cause demand by
causing a shortage of the product –
artificially raising the equilibrium price
• most countries have laws preventing monopolies
 Pharmaceutical
Manufacturers –
• drug patents generally
last 11 years in US
• try to maximize profits
until patent runs out –
then face competition
from generic drugs
 Generic
drugs –
 Claritin
– approved
as prescription in
1993 – but patented
• did not make users
drowsy – became top
seller - $3 billion in
annual sales
• patent expired in 2002
– generic came out –
sales dropped to $1
billion in annual sales
 Most
markets in real world fall between
models of perfect competition &
 Monopolistic competition –
• eg. – T-shirts with images or slogans
 market is competitive due to many buyers and many
• monopolistic b/c sellers have influence over a
small segment of the market with products that
are not exactly like those of competitors
 Distinguishing
features – product
differentiation & non-price competition
 Product differentiation –
• ex – substantial differences – gas mileage
• ex – life of batteries – reality - difference in
battery life is minimal
 Nonprice
competition –
• the cool gizmo from a fast food chain
 1. Many
buyers for many sellers
 2. Similar
but differentiated products
 3. Limited
lasting control over prices
 4. Freedom
to enter and exit the market
 In monopolistic competition –
• perfectly competitive market - # of sellers is
usually smaller – but enough for meaningful
• sellers act independently in choosing what
product to make, how much & price
 Hamburgers –
• no seller has a large enough share of market to
control supply of price
• the restaurants with your favorite have a
monopoly on your business though
In monopolistic competition –
sellers gain limited monopoly
by making a distinctive product
or convincing consumers that
their product is different from
the competition
Burgers – restaurants will say
quality of ingredients or way its
• distinctive packaging, money back
guarantee if unhappy
• one way to win over is with brand
names & encouraging loyalty
• advertising informs consumers of
How to decide to
differentiate burgers –
market research
• gathering and evaluating info
about consumer preferences
for goods & services
• for local – listening to
consumer praise & complaints
& competitors
Focus group –
• used by large chain
restaurants to gain consumer
lifestyles and product
Surveys –
Product differentiation give
producers limited control of
• charge different prices based on
how they want to appeal to
• low priced burgers for parents of
young eaters on tight budget
• name brand burgers with better
ingredients are higher priced
 if differences are important enough –
consumers will pay
• if price goes too high – consumers
will switch to substitutes and
producers know this
 No huge barrier to enter this type of market
• to open burger stand – not need for huge amount of
• when firms earn profit – other firms will enter &
increase competition
 increased competition means finding ways to differentiate
the product
• competition more intense for smaller businesses
rather than larger businesses
• those firms that take losses – signals time to get out
 In
restaurant market – sell off equipment - if
finances are solid – look for new market
 Oligopoly –
• a few large firms have a large market share and
dominant the market
 Market
share – a percent of total sales in a
• movies – movie (only a few major studios), theaters
(only a few chains) – oligopolies
 Start-up costs –
• few firms due to high start-up costs
• making a movie – expensive if to compete with
major studios, need network of promoters &
 1. Few
sellers but many buyers
 2. Industrialized
market – standardized
product & in consumer market –
differentiated product
 3. Few
 4. To
sellers have more power to control
enter or exit market is difficult
A few firms dominant the
entire market
• not a single supplier – but fewer
firms than in monopolistic
• produce a large part of the total
product in the market
Economists consider an
industry to be an oligopoly if
the 4 largest firms control 40%
of market
• half of manufacturing industries
in US fall into this
Breakfast industry in US
dominated by 4 firms who
control 80%
• lots of variety of cereal – but
less competition
Depending on market – will sell
one or the other
• many industrial products are
standardized and a few large firms
control this
 ex – steel, aluminum, flat glass
• firms differentiate based on brand
names, service, location
Consumer products offered are
• ex – breakfast cereals, soft drinks
Market product using strategies
similar to monopolistic
• use surveys, focus groups & market
research techniques to find likes
• brand names can be marketed
across country and world
Few sellers –
• each breakfast cereal maker has enough of a share of
market – that decisions made about supply and price
affect the market as a whole
• seller in oligopoly is not as independent as seller in
monopolistic competition
• decision made by one seller may cause other to respond
in the same way
 ex – if one seller drops prices – others will follow so not to
lose customers
 ex – but if one raises prices – other will not follow so to try
and gain customers
• firms in an oligopoly try to anticipate how competitors
will respond to actions before making decisions on price,
output or marketing
Start-up costs can be extremely high
• entering breakfast cereal industry on small scale is not very expensive
– but low profits
• to compete against the majors – need factories, warehouses & other
infrastructure – is expensive
 also – manufacturers may hold patents
Firms in oligopolies have establish brands and plentiful
resources – make it tough for new firm
• manufacturing firms have agreements with grocery stores for best
shelf space
• existing manufacturers have economies of scale to help expenses low
 smaller firms lack economies of scale
Investment in an oligopoly make it difficult to leave the
• when major breakfast cereal maker losses money – too vast and
complex to sell and reinvest
• must trim operation & stimulate demand for its product
 Each
structure had different benefits &
• each creates different balance of power between
producer and consumer
 Consumers
get most value in markets
that approach perfect competition
• no perfect competitive markets
• prices set by supply and demand
• a standardized product - consumers have little
choice other than best price
Monopolistic competition –
• -businesses gain some control over prices – more likely to earn profit
• -opening a business in this is relatively affordable
Oligopoly –
• -businesses gain more control of price – making it easier to earn a
• -cost to do business in this market is high
Monopoly –
• -faces little or no competition from other companies
• -consumers the least amount of influence over price
• -consumers decide only whether they are willing to buy the product at
the price
British economist – b. Oct.
31, 1903 – d. Aug. 5, 1983
• one of the first to write about
market structures
1933 – 1st major book – The
Economics of Imperfect
• described market structures
that existed between
monopoly & perfect
Came out shortly after
Edward Chamberlin –
Theory on Monopolistic
• developed ideas
Described competition among firms w/differentiated
• firms gain more control over price – but control limited by
amount of competition
• described nature of oligopoly & monopsony
Monopsony – market structure in which there are
many sellers but only one large buyer
• contributed important ideas her whole career
• theory of imperfect competition remain key element of field of
Her ideas more accurately reflected modern market
economies in which firms compete through product
differentiation and advertising and in which many
industries are controlled by oligopolies
Forces of marketplace usually keep businesses competitive
w/one another & attentive to consumer welfare
Regulation –
Antitrust legislation – laws that define monopolies and give
govt. the power to control them and break them up
• most important laws that promote competition
Trust –
• govt. regulates business mergers to keep trusts from forming
Merger – is when one company combines with or purchases
another to form a single firm
Late 1800s – a few large
trusts dominated oil,
steel & railroad
industries in US
• govt. worried would use
power to control price &
1890 –
• gave govt. power to control
monopolies and regulate
business practices that
might reduce competition
• other laws strengthened
govt. ability to regulate
business & encourage
Ex – late 1880s –
Standard Oil – gained
control of 90% of US oil
• could set production
levels & prices
1911 – US won lawsuit
to force a breakup of
the trust
• forced to give up control
of 33 companies that
were in the trust
 At
various times –
• govt. might allow large firm to remain intact b/c
most efficient producer
 May
also order company to change
business practices to allow other firms
compete more easily
Responsibility for enforcing antitrust legislation:
• 1. Federal Trade Commission (FTC)
• 2. Department of Justice
 major focus is assessment of mergers
• govt. supports mergers that will benefit consumers
Larger firms that are able to operate more
efficiently and lower operating costs – lead to
lower costs for consumers
 Govt. blocks mergers that lead to greater market
concentration in the hands of a few firms
• merger that makes it more difficult for new firms to enter
cause concern
To evaluate a merger –
• company proposing a merger would define a market as
broadly as possible to make its control seem smaller
 ex – soft drink producer might say its market is all beverages
– water, tea, juice
Determine whether merger will increase
concentration in the market and decrease
competition, govt. considers the market share of
the firms before and after the proposed merger
• looks at whether the merger allows a firm to eliminate
• will deny merger if analysis shows reduced competition &
possible higher prices
Govt. tries to make
sure that businesses do
not engage in practices
that would reduce
• when businesses take
steps that counteract
effects of competition,
prices go up and
supplies go down
In US – laws prohibit
most of these practices
 Business
that seek to counteract market
forces can use a variety of practices
 Price fixing –
• similar – when businesses agree to restrict their
output – driving up prices
 Mid-1990s
– 5 major recorded music
distributors began enforcing a “minimum
advertised price” – for CDs sold
• result – CD price remained artificially high
 2000
– FTC reached agreement to end
anticompetitive practice
 Market allocation –
• by staying out of each other’s territory, businesses
develop limited monopoly power & can charge
higher prices
• ex – early 1990s – agribusiness Archer Daniels
Midland – conspired w/companies in Japan & Korea
to divide world market for lysine (additive in
livestock feed)
 also conspired w/European companies for citric acid –
additive to soft drinks
• agreements also included price fixing
 Department
of Justice charged them with
antitrust violations
• pleaded guilty & paid $100 million in fines
 Business
can use
methods to drive
other firms out of
 Predatory pricing –
• can be difficult to
distinguish from
competitive pricing
Cease and desist order –
a ruling that requires a
firm to stop unfair
business practices
Public disclosure – which
requires business to
reveal product
information to consumers
• protects consumers and
promotes competition by
giving consumers the info
they need to make
informed buying decisions
Govt. – enforces laws to ensure competitive
markets & regulating other aspects if business
• Federal Trade commission – promoting competition &
preventing unfair business practices
• Federal Communications Commission and Securities and
Exchange Commission regulate specific industries
• Food & Drug Administration, Environmental Protection
Agency, Consumer Product Safety Commission – regulate
multiple industries to ensure the safety and quality of
specific products and to protect consumer health
 Govt. regulation
in 20th Century focused
on controlling industries
 1970s – trend toward deregulation
 Deregulation –
• has benefits & drawbacks – generally results in
lower prices for consumers
• deregulation may lead to fewer protections for
Airline Deregulation Act
of 1978 – removed all
govt. control of airline
routes & rates
• only safety regulation
remain in place
• result – new carriers
entered the market &
industry expanded
Greater efficiency –
prices fell 10-18% - most
sharply on heavily
traveled routes
• more people now traveled
by air due to lower prices
Quality of service fell
• cuts in food & other in-
flight amenities
• crowded airports
• took time for local govt.
to expand facilities
Financial pressures led
to large # of
bankruptcies of airline
• increased layoffs, lower
wages, loss of pensions

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