Chapter 7
MARKET STRUCTURES
Monopoly & Oligopoly
IT’S MISTER
SMITH TO
YOU,
Moneybags!!!
Market Structures


Economists classify a firm’s market
structure based upon its producing
and selling environment.
Four market structures:




Perfect competition
Monopoly
Monopolistic competition
Oligopoly
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
Conditions for Perfect Competition
1.
2.
3.
4.
Many buyers and sellers participate
in the market.
Sellers offer identical products.
Buyers and sellers are well
informed about products.
Sellers are able to enter and exit
the market freely.
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)
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
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.
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.
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.
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
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.
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
Examples
of
Monopolies:
• Miner and buyer of 7090% of world’s
diamonds
• Price-maker
• Created barriers to entry
to other companies
• Marketed as proof of
LOVE : the diamond
engagement ring is
basically a DeBeers
invention!
TM
Forming a Monopoly
1. Economies of Scale: Factors that
cause a producer’s 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.
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
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)
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
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
EXAMPLES
•Subway system
•Public water supply
•Mail
•Electricity
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.)
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)
Monopolies and Price


Monopolies cannot charge any
price it wants.
Price does determine demand
for almost all goods or services.
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.
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.

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.
Monopolistic Competition, cont.
 The
FOUR Conditions of
Monopolistic Competition:
 Many
firms
 Few artificial barriers to entry
 Slight control over price
 Differentiated products
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.
The Four Conditions of
Monopolistic Competition, cont.

SLIGHT CONTROL OVER PRICE:


Firms can have a little control over
price because each firm’s 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 rival’s
product.

Example: Coke/Pepsi vs. store brand
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
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
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
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
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.
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.
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.)
Cooperation and Collusion
Some firms work together to act as a
monopoly (illegal)
Practices that concern the
Government:



Price Leadership
Collusion
Cartel
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
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.
􀂄
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.
Prisoner’s Dilemma at End of
Show if Time Allows…

Starts at Slide #47
Section 4: Regulation &
Deregulation
 Predatory
Pricing:
Selling a product below
cost to drive competition
out of the market.
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 Justice’s Antitrust
Division watch firms closely to ensure
that firms do not unfairly force out
competitors.
These policies are known as antitrust
laws.
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
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.
Deregulation
 Deregulation
is the
removal of some
government control over
a market.
Cartels and the Prisoner’s
Dilemma
Each firm has an incentive
to cheat by producing more.
Situation fits a “Prisoner’s
Dilemma” -- game
theory:
Ann and Pete are arrested
and put in different cells.
They are guilty. What should
they do?
Confess or stay quiet?
Payoff matrix
Nicole
Confess
Remain silent
Krystie
Confess
Remain silent
each
5 years
Nicole (10
years)
Krystie (free)
Nicole (free)
Krystie (10
years)
each
6 months
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
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.
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).
Prisoner’s Dilemma
The outcome of games do not always lead to the best
result for all parties.
In the prisoner’s 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