Explorations in Economics

Alan B. Krueger & David A. Anderson

Chapter 8: Exploring Economics

- Module 23: Monopoly - Module 24: Oligopoly and Monopolistic Competition - Module 25: Regulating Market Power

MODULE 23: MONOPOLY

KEY IDEA:

A monopoly is a market with just one firm that can earn continual profit if competitors have difficulty entering the market.

• • •

OBJECTIVES:

To explain the concept of market structure.

To describe the characteristics of a monopoly.

To explain the effects of price discrimination.

MARKET STRUCTURE Market structure

describes the nature of competition within a market.

MARKET STRUCTURE

The product market for a good includes all those products that consumers consider to be close substitutes for that good.

MARKET STRUCTURE

Imperfect competition

arises when there is not enough competition among firms to prevent individual firms from raising their price above the equilibrium level determined by supply and demand.

WHAT IS A MONOPOLY?

Market power is the ability of a firm to change the market price of a good or service.

Monopoly is a product market served by only one firm.

The one supplier in a monopoly is called a monopolist.

Barriers to entry are obstacles that prevent firms from entering particular markets.

WHAT IS A MONOPOLY?

A natural monopoly is a market in which high startup costs make it prohibitively expensive for more than one firm to operate.

WHAT IS A MONOPOLY?

The average cost is the total cost of production divided by the quantity of output.

Economies of scale exist if, in the long run, an increase in output results in a decrease in average cost.

WHAT IS A MONOPOLY?

The Four Main Sources of Market Power:

• High Start- Up Costs • Exclusive Access to a Critical Input • Government Protection • Unfair Practices

WHAT IS A MONOPOLY?

Threats to a Monopolist:

The major threat is introduction of competition.

Others include: • Technological change • The entry of international firms • The end of government protection

WHAT DO MONOPOLISTS DO?

Monopolists as Price Makers Maximizing Profit (MR=MC)

MONOPOLY: USING THE GRAPH

Find the output where MR = MC on the graph for the profit maximizing output.

THE INEFFICIENCY OF MONOPOLY

A consumer’s reservation price for a product is the highest price he or she is willing to pay to own one more unit of the product.

PRICE DISCRIMINATION

Price discrimination is the practice of charging different customers different prices for the same good .

1. Some customers must have higher reservation prices than others for the same good.

2. The firm must be able to distinguish between customers with higher and lower reservation prices.

3. It cannot be possible for customers to resell the good. 4. The firm must have market power. Under perfect competition, competitors would enter and drive the price down to the marginal cost of production.

PRICE DISCRIMINATION

Perfect Price Discrimination and Efficiency

Removes the inefficiency in single pricing models.

Price Discrimination in Practice

Examples: Movie ticket prices based on time, lunch versus dinner specials at restaurants; golf course prices on weekends versus weekdays

MONOPLY AND INNOVATION

Innovative new products improve our standard of living and promote economic growth.

• • High profits can support innovation.

Some profits strengthen barriers to entry.

What is… A. Imperfect competition?

B. Market structure?

C. Product market?

D. Monopoly?

E. Monopolist?

F. Market power?

G. Barriers to entry?

H. Natural monopoly?

I. Average cost?

J. Economies of scale?

K. Reservation price?

L. Price discrimination?

MODULE 23 REVIEW

MODULE 24: OLIGOPOLY AND MONOPOLISTIC COMPETITION KEY IDEA:

When there are many firms in a market, they can gain market power if they can differentiate their products. When there are only a few firms in a market, they might be able to work together to reduce output below the perfectly competitive level, charge a relatively high price, and raise their profits.

OBJECTIVES:

• To describe what characterizes oligopolies and how they operate.

• To explain why it is difficult for a small number of firms to enforce an agreement that restricts output.

• To analyze how firms in markets characterized by monopolistic competition behave with regard to pricing, advertising, product development, and quality of service.

OLIGOPOLY: A SMALL NUMBER OF FIRMS

An oligopoly is a market with a small number of firms.

An oligopolist is a firm in an oligopoly industry.

OLIGOPOLY: A SMALL NUMBER OF FIRMS

Collusion among oligopolists exists as they work together. A cartel is a group of firms that agree to work together and act like a monopoly.

MONOPOLISTIC COMPETITION

In a market characterized by monopolistic competition, many firms supply similar but not identical goods.

– – – Differentiated products are goods and services that differ somewhat from other competitive products.

Building Brand Loyalty gives customers reasons to buy a specific firm’s product Free Entry means that short run profits draws in new competition

MONOPOLISTIC COMPETITION Monopolistic Competition versus Perfect Competition and Monopoly

MONOPOLISTIC COMPETITION

• • •

Pros

offering a wider range of products competition for the service offered profits in the short run for firm • • •

Cons

higher price than perfectly competition markets Inefficiently low quantity of output profits fall as advertising budgets rise

MODULE 24 REVIEW

What is… A. Oligopoly?

B. Oligopolist?

C. Cartel?

D. Monopolistic competition?

E. Highly concentrated?

F. Collusion?

G. Differentiated products?

H. Quotas?

I. Chiseling?

MODULE 25: REGULATING MARKET POWER KEY IDEA:

Antitrust regulations are designed to limit the inefficiencies brought about by imperfectly competitive markets.

• • •

OBJECTIVES:

To analyze the effects of market structure on efficiency.

To discuss the pros and cons of price controls.

To explain the purpose of antitrust policy and how it is enforced.

MARKET STRUCTURE AND EFFICIENCY

Perfect Competition

Perfect Competition results in the efficient level of production.

Monopoly

Price will be higher and the quantity of output lower with increased market power.

Monopolistic Competition, Oligopoly, and Efficiency

Non-price competition (advertising and branding) create non competitive practices.

DIRECT REGULATION: PRICE CONTROLS

Price controls are policies by which the government sets the prices in an industry.

• • • The goal is to bring about efficient quantity of good.

Public utility rates set where MR=MC but many firms would not operate due to high start-up costs. So, regulated price is where price equals average total cost.

Difficult to set pricing policy as markets and consumer preferences change.

ANTITRUST POLICY

Antitrust policy is a set of laws designed to promote competition in the marketplace.

Anti-trust laws passed to: • limit non-competitive actions • limit price-fixing • prohibit predatory acts

The Enforcement of Antitrust Policy

The Department of Justice and the Federal Trade Commission regulate some business practices and examine proposed mergers.

MODULE 25 REVIEW

What is… A. Price controls?

B. Trust?

C. Tying?

D. Antitrust policy?

E. Interlocking directorates?

F. Predatory acts?