Transcript Chapter 7: Market Structures

CHAPTER 7:
MARKET STRUCTURES
Economics
Mr. Robinson
Section 1:
Perfect Competition
The Four Conditions for Perfect Competition
Many Buyers and Sellers
• There are many participants on both the buying
and selling sides.
2. Identical Products
• There are no differences between the products
sold by different suppliers.
3. Informed Buyers and Sellers
• The market provides the buyer with full
information about the product and its price.
4. Free Market Entry and Exit
• Firms can enter the market when they can make
money and leave it when they can't.
1.
What is Perfect Competition?
Why is market price accepted as given?
• Goods in a perfectly competitive market are
commodities.
• All commodities are essentially the same.
• The buyer will not pay extra for one
particular company’s goods.
• Because there are many buyers and
sellers, no one is powerful enough to
influence the market.
Why is market price accepted as given?
• Perfect
Information:
$2.70
$2.60
S
Marty’s Price
$2.50
$2.40
Price per Gallon ($)
▫ Consumers have
access to price
information for a
variety of gas
stations.
▫ Suppose Marty’s
Mobil sets its price
above the market
equilibrium price…
▫ Consumers will buy
their gas from
another local
station.
Market Supply and Demand for Gasoline
$2.30
$2.20pe
$2.10
$2.00
$1.90
$1.80
D
$1.70
$1.60
$1.50
8,850
9,000
9,150
9,300
9,450
9,600
9,750
qe
G allons per Day
9,900
10,050
10,200
10,350
10,500
Barriers to Entry
• Factors that make it difficult for new firms to enter a
market are called barriers to entry.
• Start-up Costs
• The expenses that a new business must pay before the
first product reaches the customer are called start-up
costs.
• Technology
• Some markets require a high degree of technological
know-how. As a result, new entrepreneurs cannot
easily enter these markets.
Barriers to Entry, cont.
• Landscaping presents few technical challenges and start-
up costs are low.
• However, an auto repair shop requires advanced
technical skills and the equipment needed to run the shop
makes start-up costs another significant barrier to entry.
Price and Output
Supply
Equilibriu
m Price
Equilibriu
m Quantity
characteristics of
perfectly competitive
markets is that they
are efficient.
• In a perfectly
competitive market,
price and output reach
their equilibrium levels.
• Prices are the lowest
sustainable prices
Market Equilibrium in Perfect
Competition
Price
• One of the primary
Quantit
y
Demand
Section 2:
Monopoly
MONOPOLY
• A market structure characterized by a single seller
of a unique product with no close substitutes.
• As the single seller of a unique good with no close
substitutes, a monopoly has no competition.
• The demand for output produced by a monopoly
is THE market demand, which gives monopoly
extensive market control.
• The inefficiency that results from market control
also makes monopoly a key type of market
failure.
Characteristics of Monopoly
Single Supplier:
• First and foremost, a monopoly is a monopoly
because it is the only seller in the market.
• The word monopoly actually translates as "one
seller."
• As the only seller, a monopoly controls the
supply-side of the market completely.
• If anyone wants to buy the good, they must buy
from the monopoly.
Characteristics of Monopoly
Unique Product
• A monopoly achieves single-seller status because
the good supplied is unique.
• There are no close substitutes available for the
good produced by a monopoly.
Characteristics of Monopoly
Barriers to Entry:
• A monopoly often acquires and generally
maintains single seller status due to restrictions
on the entry of other firms into the market.
• Some of the key barriers to entry are:
1.
2.
3.
4.
5.
government license or franchise,
resource ownership,
patents and copyrights,
high start-up cost, and
decreasing average total cost.
Characteristics of Monopoly
Specialized Information:
• A monopoly often possesses information not
available to others.
• This specialized information comes in the form of
legally-established patents, copyrights, or
trademarks.
Why does a monopoly form?
• Monopolies achieve their single-seller
status for three interrelated reasons:
1. economies of scale
2. government decree
3. resource ownership
Why does a monopoly form?
Economies of Scale:
• Many real world monopolies emerge due to
economies of scale and decreasing average cost.
• If average cost decreases over the entire range of
demand, then a single seller can provide the good at
lower per unit cost and more efficiently than multiple
sellers.
• This often leads to what is termed a natural monopoly.
• Many public utilities (such as electricity distribution,
natural gas distribution, garbage collection) have this
natural monopoly inclination.
Economies of Scale
• If a firm's start-up costs are high, and its average costs fall
for each additional unit it produces, then it enjoys what
economists call economies of scale.
• ATC is total cost divided by quantity of output
• Example: A firm doubles output, but the total cost of inputs does not
double, but increases by a smaller amount
Average total cost without
economies of scale
Average total cost with
economies of scale
Cost
Cost
ATC
ATC
Output
Output
Why does a monopoly form?
Government Decree:
• The monopoly status of a firm can be
established by the mandate of government.
Government simply gives one and only one
firm the legal authority to supply a particular
good.
• Technological Monopolies
• Franchises and Licenses
• Industrial Organizations
Why does a monopoly form?
Resource Ownership:
• A monopoly is likely to arise if a firm has complete
control over a key input or resource used in
production.
• If the firm controls the input, then it controls the
output.
• Monopolies have arisen over the years due to
control over material resources, labor resources
or information resources
A Monopoly’s Revenue
• The monopolist
has a downwardsloping demand
curve.
• This is because
the industry
demand curve is
the firm’s
demand curve.
Demand Curve for a firm in a
Perfectly Competitive market
A Monopoly’s Revenue
• Even a monopolist faces a limited choice – it can choose
to set either output or price, but not both.
Because a monopoly is a
price maker with extensive
market power, it faces a
negatively-sloped demand
curve.
To sell a larger quantity of
output, it must lower the
price.
The monopoly can sell 1 unit for $10. However, if it wants
to sell 2 units, then it must lower the price to $9.50.
A Monopoly’s Revenue
• The marginal revenue
generated from selling
extra output is less than
price.
• While the price of the
second unit sold is $9.50,
the marginal revenue
generated by selling the
second unit is only $9.
• While the $9.50 price
means the monopoly gains
$9.50 from selling the
second unit, it loses $0.50
due to the lower price on
the first unit ($10 to $9.50).
The net gain in revenue, that
is marginal revenue, is thus
only $9 = ($9.50 - $0.50).
Demand and Marginal-Revenue Curves for a Monopoly
Price
$11
10
9
8
7
6
5
4
3
2
1
0
–1
–2
–3
–4
If a monopoly wants to sell
more, it must lower price.
($9, 2)
Price falls for ALL units sold.
($8, 3)
This is why MR is < P.
Demand
(average
revenue)
1
2
3
4
5
6
7
8
Quantity of Water
Marginal
revenue
A Monopoly’s Revenue
• A monopoly maximizes profit by producing
the quantity at which marginal revenue
equals marginal cost.
• All profit-maximizing firms set MR = MC.
• It then uses the demand curve to find the
price that will induce consumers to buy that
quantity.
Profit Maximization for a Monopoly
Costs and
Revenue
2. . . . and then the demand
curve shows the price
consistent with this quantity.
B
Monopoly
price
1. The intersection of the
marginal-revenue curve
and the marginal-cost
curve determines the
profit-maximizing
quantity . . .
Average total cost
A
Demand
Marginal
cost
Marginal revenue
0
Q
QMAX
Q
Quantity
Price Discrimination
• Price discrimination is the division of customers
into groups based on how much they will pay for
a good.
• Can be practiced by any company with market
power.
• Price discrimination requires some market
power, distinct customer groups, and difficult
resale.
• Examples: student discounts & manufacturers’
rebate offers
Section 3:
Monopolistic Competition and Oligopoly
Monopolistic Competition
• A market structure characterized by a large
number of relatively small firms.
• While the goods produced by the firms in
the industry are similar, slight differences
often exist.
• As such, firms operating in monopolistic
competition are extremely competitive but
each has a small degree of market control.
Four Conditions of
Monopolistic Competition
1. Many Firms
•
•
•
A monopolistically competitive industry
contains a large number of small firms, each of
which is relatively small compared to the
overall size of the market.
This ensures that all firms are relatively
competitive with very little market control over
price or quantity.
In particular, each firm has hundreds or even
thousands of potential competitors.
Four Conditions of
Monopolistic Competition
2. Few Artificial Barriers to Entry
•
•
•
Monopolistically competitive firms are
relatively free to enter and exit an industry.
There might be a few restrictions, but not
many.
These firms are not "perfectly" mobile as with
perfect competition, but they are largely
unrestricted by government rules and
regulations, start-up cost, or other substantial
barriers to entry.
Four Conditions of
Monopolistic Competition
3.
•
•
•
•
Slight Control over Price
Each firm in a monopolistically competitive market
sells a similar, but not absolutely identical,
product.
The goods sold by the firms are close substitutes
for one another, just not perfect substitutes.
Most important, each good satisfies the same
basic want or need.
Buyers treat the goods as similar, but different and
allows a firm to have limited control over price
Four Conditions of
Monopolistic Competition
4. Differentiated Products
•
•
•
The goods produced by firms operating in a
monopolistically competitive market are
subject to product differentiation.
The goods are essentially the same, but they
have slight differences.
Product differentiation is the primary reason
that each firm operating in a monopolistically
competitive market is able to create a little
monopoly all to itself and profit.
Nonprice Competition
Nonprice competition is a way to attract customers
through style, service, or location, but not a lower price.
1. Characteristics of
Goods
▫
New size, color,
shape, texture, or
taste.
2. Location of Sale
▫
Differentiation of goods
by where they are sold
3. Service Level
▫
Offer customers a
higher level of service.
4. Advertising Image
▫
Use advertising to
create apparent
differences between
their own offerings and
other products.
Monopolistically Competitive Firms:
Prices, Profits, and Output
Prices
▫ Firms have a small amount of power to raise prices.
▫ Monopolistic Competition > Perfect Competition
Profits
▫ Competitive firms can earn profits in the short run
▫ Have to work hard to keep their product distinct enough to
stay ahead of their rivals.
Costs and Variety
▫ Cannot produce at the lowest average price due to the
number of firms in the market.
▫ Offer a wide array of goods and services to consumers.
Oligopoly
• A market structure characterized by a small
number of large firms that dominate the
market, selling either identical or
differentiated products, with significant
barriers to entry into the industry.
• Because an oligopolistic firm is relatively
large compared to the overall market, it has
a substantial degree of market control.
Behavior of Oligopolies
Interdependence:
• Each oligopolistic firm keeps a close eye on the
activities of other firms in the industry.
• Decisions made by one firm invariably affect
others and are invariably affected by others.
• Competition among interdependent oligopoly
firms is comparable to a game or an athletic
contest.
• One team's success depends not only on its own
actions but on the actions of its competitor
Behavior of Oligopolies
Rigid Prices:
• Many oligopolistic industries (not all, but many)
tend to keep prices relatively constant, preferring
to compete in ways that do not involve changing
the price.
• The prime reason for rigid prices is that
competitors are likely to match price decreases,
but not price increases. As such, a firm has little
to gain from changing prices.
Behavior of Oligopolies
Nonprice Competition:
• Because oligopolistic firms have little to gain
through price competition, they generally rely on
nonprice methods of competition.
• Three of the more common methods of nonprice
competition are: advertising, product
differentiation, and barriers to entry.
• The goal for most oligopolistic firms is to attract
buyers and increase market share, while holding
the line on price.
Behavior of Oligopolies
Mergers:
• Oligopolistic firms perpetually balance
competition against cooperation. One way to
pursue cooperation is through merger--legally
combining two separate firms into a single firm.
• Because oligopolistic industries have a small
number of firms, the incentive to merge is quite
high.
• Doing so then gives the resulting firm greater
market control.
Behavior of Oligopolies
Collusion:
• Another common method of cooperation is through
collusion--two or more firms that secretly agree to
control prices, production, or other aspects of the
market.
• When done right, collusion means that the firms
behave as if they are one firm, a monopoly.
• As such they can set a monopoly price, produce a
monopoly quantity, and allocate resources as
inefficiently as a monopoly.
• A formal method of collusion, usually found among
international produces is a cartel.
Comparison of Market Structures
• Markets can be grouped into four basic structures: perfect
competition, monopolistic competition, oligopoly, and
monopoly
Section 4:
Regulation and Deregulation
Market Power
• Market power is the ability of a company to
control prices and output.
• Markets dominated by a few large firms
tend to have higher prices and lower output
than markets with many sellers.
• To control prices and output like a
monopoly, firms sometimes use predatory
pricing.
Predatory Pricing
How it works:
1. The predatory firm lowers its price below the
average cost of itself and its competitor(s).
2. The competitor(s) must either
Lower its prices, or
b. Lose any market share, due to loss of sales, that it
previously held.
a.
3. The prey goes out of business due to
bankruptcy (variable costs > revenue)
4. The predator then increases its price to restore
its profits.
Government and Competition
• Government policies keep firms from
controlling the prices and supply of
important goods.
• Antitrust laws are laws that encourage
competition in the marketplace.
• Regulating Business Practices
• Breaking Up Monopolies
• Blocking Mergers
• Preserving Incentives
Deregulation
• Deregulation is the removal of some
government controls over a market.
• Deregulation is used to promote
competition.
• Many new competitors enter a market that
has been deregulated.
• This is followed by an economically healthy
weeding out of some firms from that
market, which can be hard on workers in
the short term.