CHAPTER 7

Market Structure – the nature and degree of competition among firms operating in a given industry

Why Study Market Structures?

It is useful to understand how people and companies compete.It then becomes easier to spot marginally or non-competitive situations.Our economy requires competition and free markets to function properly.Government regulators are particularly interested in this kind of information.

In general, as competition increases, what happens to price? It decreases.

Types of Market Structures:

Perfect Competition

Monopolistic Competition

Oligopoly

Monopoly

PERFECT COMPETITION:Many producers sell the same UNDIFFERENTIATED products Individual firms are too small to influence

the price.

Four Necessary Conditions:1. Large number of buyers and sellers

No control over prices – no one buyer or seller can individually have an influence on total market quantity or total market price

2. Buyers and Sellers deal in identical products – no variety

Buyer will always choose the lowest priced one What is a commodity?

PERFECT/PURE COMPETITION:3. Buyers and sellers are well informed about the products

They know enough about the market for the product to find the best deal

4. Sellers are free to enter into or exit the business easily Firms need to be able to enter the market easily when they can

make money and leave the market easily when they no longer can

No strong barriers to entry which could lead to imperfect competition

Price would be lowest in true pure, or perfect competition market structure.

BARRIERS TO ENTRY Factors that make it difficult for a firm to enter

into the market For example? Start-up costs

Expenses a new firm must pay even before it can begin doing business……such as?

Technology Technological skills are a requirement for many

businesses These barriers to entry keep many entrepreneurs

from easily entering the market – lead to imperfect competition

Examples of (Almost) Perfect Competition

•On line ticket auctions•Truck farming•Salt •Gravel•Flea markets•Garage sales•On line sales in general

Price would be the lowest in true pure, or perfect competition market structure.Competition keeps prices and

production costs lowSo many sellers compete that the

high level of competition keeps prices down so low that they just cover the most-efficient costs of production

PERFECT COMPETITION:

MONOPOLYA market structure with NO competition.Only one seller of a

particular good/serviceA unique

product/serviceControls all output so

prices could be the highest in this type of market structure.

Massive barriers to entry – primary reason they have existed

MONOPOLYUtilize economies of scale: Efficiency of production

increases as the number of goods being produced increases. (Mass production!)

Average cost per unit decreases through increased production since fixed costs are shared over a larger number of goods.

How would you explain this?

New technologies work against monopolies Example?

Any monopolies today?

Types of Monopolies

Natural Monopoly - e.g. Utilities

Geographic Monopoly - A geographical area cannotsupport more than one.

Technological Monopoly – Patents; Copyrights Franchises (National parks), Licenses

Government Monopoly - e.g. First-Class mail; also:

What are the potential consequences of monopolies?--high prices, restricted supplies, poor quality, lack of innovation

Why are monopolies considered market (not business) failures?

Why are utilities & public transportation (natural monopolies) allowed to operate as monopolies?

Cartel – an international monopoly – THINK OIL!!

PRICE DISCRIMINATIONMonopolies use it – divide consumers into different groups and charge different prices … based on highest maximum price each group will pay for the good/service The prices charged are NOT based on production costs What kind of groups?

What is needed for price discrimination to work? Firm must have control over prices/market power Customers divided into distinct groups based on their

price sensitivity Buyers can’t easily resell the good/service

So…works best on goods that are immediately consumed such as theme park admissions, restaurant meals

Examples of Monopolies

Power companyCable TV provider Water and sewer Natural gasPost Office

MONOPOLISTIC COMPETITION

Producers provide the same kind of good or service but are able to DIFFERENTIATE their products from those of their competitors.Similar conditions to pure competition except

that products are not identicalProducts are made a little different to attract

more customers & monopolize a small portion of the market

Products similar but not identical; differences can be real or perceived

MONOPOLISTIC COMPETITION

4 conditions for Monopolistic Competition?1. Many firms

2. Few barriers to entry

3. Little control over price

4. Differentiated products

What kind of factors can differentiate products --- nonprice competition? Design & other physical characteristics, location, level of

service provided, advertising

Monopolistic competition is the most common type of market structure in a market economy!

Examples of Monopolistic Competition

•Clothing shops•Gas stations•Grocery stores•Athletic wear •Fast food restaurants •Business supply stores•Home Supply Stores•Pet foods

OLIGOPOLY

Market structure with just a few sellers of a similar good or service. If 4 largest firms in an industry produce 70% - 80%

of industry's output

High barriers to entry technological, government, market reality – start up costs

Product may be standardized as in steel, or there may be variety / differentiated products – as in automobiles

OLIGOPOLY

Single firms have ability to change output, sales, and prices for the industry

Firms tend to act together and sometimes collusion or price fixing takes place

Price wars – good for producer or consumer?What is collusion? What does it lead to?What is a cartel? Why do they usually not last?

Examples of Oligopolies

•Soft drink producers•Automobiles manufacturing•Domestic airlines•Mobile phone service•Cereal makers

                           

Which market structure would you like best if …..

You owned a business and were concerned only with profits?You were starting a new business?You are the consumer?You were a business owner - an oligopoly or monopolistic competition?You owned an advertising agency?

General Rule: as competition increases, price …..?

As competition decreases, market control …?

Market FailuresLack of Competition

No competition = a market failure

What problems are caused by a lack of competition? Inefficient resource allocationHigher prices, reduced outputBusiness can become too big

and become a political force

Role of Government in Markets

WAYS GOVERNMENTS CONTROL MONOPOLIES:Antitrust LegislationBegan in late 1800’s with Sherman

Antitrust ActBroke up Standard Oil and American

Tobacco in 19111982 – AT&T broken up into 7 companies

Also breaks up mergers

Role of Government in Markets

REGULATING AGENCIES – such as….? OSHA, FDA, FCC, FAA, EPA,

EEOC, SEC Requiring public disclosure so that

people have adequate information to make decisions – stocks, banks, etc.

DEREGULATION Done when government regulation

has become too expansive and is reducing competition

Deregulation = removal of some gov’t control over a market

What types of industries? Airlines, trucking, banking, RR,

natural gas, TV broadcasting

So what about Wal-Mart?Do its low-price benefits outweigh its impact on competition?Wal-Mart Christmas sweat shopsWal-Mart female class action lawsuit, 2011…..lost

Watch it grow!

Basic Principle of the Power of Market

Structures:

Basic Principle of relation between Price and Competition?

Comparison of Market Structures