Market Structures & Competition
There are several possibilities for free
market competition:
Perfect Competition
Monopolistic Competition
Monopoly
Oligopoly
Inadequate Competition
Perfect Competition
A large # of buyers and sellers exchange
identical products under 5 conditions:
1. Large # of buyers and sellers
2. Products are identical between suppliers
3. Buyers and sellers act independently
4. Buyers and sellers are well-informed
5. Buyers and seller are free to enter,
conduct, or get out of business. NO Barriers
to entry other than start-up costs or
technology
Price and Output
One of the primary characteristics of perfectly competitive
.
markets is that they are efficient.
In a perfectly competitive
market, price and output reach their equilibrium levels.
Market Equilibrium in Perfect Competition
Equilibrium
Price
Equilibrium
Quantity
Price
Supply
Quantity
Demand
Monopolistic Competition
In monopolistic competition, many companies compete in
an open market to sell products which are similar, but
not identical. Best example: OTC pain relievers
1. Many Firms--As a rule, monopolistically competitive
markets are not marked by economies of scale or high
start-up costs, allowing more firms.
2. Few Artificial Barriers to Entry--Firms in a
monopolistically competitive market do not face high
barriers to entry.
3. Slight Control over Price--Firms in a monopolistically
competitive market have some freedom to raise prices
because each firm's goods are a little different from
everyone else's. EX: Tylenol, Aleve, and Bayer
4. Differentiated Products--Firms have some control
over their selling price because they can differentiate,
or distinguish, their goods from other products in the
Non-Price Competition
Nonprice competition is a way to attract customers
through style, service, or location, but not a lower price
1. Characteristics of Goods--The simplest way for a firm
to distinguish its products is to offer a new size, color,
shape, texture, or taste.
2. Location of Sale--A convenience store in the middle
of the desert differentiates its product simply by selling
it hundreds of miles away from the nearest competitor.
3. Service Level--Some sellers can charge higher prices
because they offer customers a higher level of service.
EX: Insurance companies
4. Advertising Image--Firms also use advertising to
create apparent differences between their own
offerings and other products in the marketplace.
Oligopoly
• Oligopoly describes a market dominated by a few large,
profitable firms through collusion or cartel. It is further
away from perfect competition than monopolistic
competition is. Final prices are higher for consumers.
• Collusion--an agreement among members of an
oligopoly to set prices and production levels. 2 forms of
collusion: Price- fixing is an agreement among firms to
sell at the same or similar prices. Dividing up the
market is another. Collusion is illegal in the U.S.
Cartel--an association by producers established to
coordinate prices and production.
Oligopolists act independently by lowering prices soon
after the first seller announces the cut, but they
typically prefer nonprice competition.
Activity: Deciding How Much to Produce
Monopoly
Only 1 seller of a particular product.
It’s VERY DIFFICULT to define a true monopoly
Americans prefer competitive trade; few
monopolies in U.S.
The monopolist is larger than a perfect
competitor, allowing it to be a price MAKER.
Herfendahl Index used to measure monopolies;
nowadays the trend is to analyze Barriers to
Entry
Types of Monopolies
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. An industry that enjoys economies
of scale can easily become a natural monopoly. Good
example: Broadband and Cable TV industries
Natural Monopolies--a market that runs most efficiently
when one large firm provides all of the output.
Sometimes the development of a new technology can
destroy a natural monopoly.
Geographic Monopoly—occurs when a location cannot
support two or more businesses EX: Small-town
drugstore or barbershop
Government Monopoly—see next slide
Types of Gov’t Monopolies
• Technological Monopolies
The government grants patents, licenses that give the
inventor of a new product the exclusive right to sell it
for a certain period of time, and copyrights, the
exclusive right to protect written or performed work.
EX: Artists get lifetime + 50 yrs.
• Franchises and Licenses
A franchise is a contract that gives a single firm the right
to sell its goods within an exclusive market. A license is
a government-issued right to operate a business. Local
cable companies are frequently franchised.
• Industrial Organizations
In rare cases, such as sports leagues, the government
allows companies in an industry to restrict the number
Interesting Thoughts About
Monopolies…
Anti-trust lawyers try to expand the definition of
monopoly; corporate attorneys try to narrow it.
Even if there is no competition, you must act as if
there are other competitors, or you will provide an
incentive to compete
Efficiency is NOT a barrier to entry.
EX: Microsoft wins because its software is compatible
with everything. Apple screwed up. Don’t like
Microsoft? Try Linux, or try to beat Microsoft.
Large companies can spring up to take on large
monopolies who practice predatory pricing.
Predatory Pricing
The concept: Drive your competitors out of business
by charging less than cost for a good or service. Once
your opponents are gone, raise prices and screw
consumers.
How do you define it? Grocery stores often sell some
items under cost to entice consumers. Is that wrong?
Predatory pricing cannot work in the long-term.
German Bromine Cartel existed around 1910. Sold
bromine for 45¢. Dow in the U.S. sold for 36¢.
Germans got mad, sold bromine for 15¢. Dow bought
up all the bromine and sold it in Europe at 27¢!
Germans eventually gave up.
More on Efficiency
John D. Rockefeller led Standard Oil
At one point, he owned 90% of the refineries in
the U.S.
Company was broken up when he only owned
64%.
Yet, under Rockefeller, the price of kerosene
had DROPPED!!!
1869– 30 cents/gal.
1880—9 cents/gal.
1897—5.9 cents/gal. (cheaper than electricity)
Inadequacies in the Market
Inadequate competition—decreases in competition due
to mergers/acquisitions can create market failure
Resource problems: Inefficient resource allocation
occurs when there’s no incentives to use resources
wisely. Resources must also avoid immobility (in case a
market tanks)
Companies may not market products properly, even if
they are cheaper and better (Sony Betamax loses to JVC
VHS)
Monopolies can reduce supply, raise prices
A large business can exert political power (USX)
Market failures on the demand side are harder to
correct than failures on the supply side.
Consumers, businesspeople, and government officials
must be able to obtain market conditions quickly and
easily.
Price Discrimination
Price discrimination is the division of customers into
groups based on how much they will pay for a good.
Although price discrimination is a feature of
monopoly, it can be practiced by any company with
market power. Market power is the ability to control
prices and total market output.
Targeted discounts, like student discounts and
manufacturers’ rebate offers, are one form of price
discrimination.
Price discrimination requires some market power,
distinct customer groups, and difficult resale.
Comparison of Market Structures
Markets can be grouped into four basic structures: perfect
competition, monopolistic competition, oligopoly, and monopoly.
Comparison of Market Structures
Perfect
Competition
Monopolistic
Competition
Oligopoly
Monopoly
Number of firms
Many
Many
Two to four dominate
One
Variety of goods
None
Some
Some
None
Control over prices
None
Little
Some
Complete
Barriers to entry and exit
None
Low
High
Complete
Wheat,
shares of stock
Jeans,
books
Cars,
movie studios
Public water
Examples
Section 3 Review
The differences between perfect competition and monopolistic
competition arise because
 (a) in perfect competition the prices are set by the government.
 (b) in perfect competition the buyer is free to buy from any
seller he or she chooses.
 (c) in monopolistic competition there are fewer sellers and more
buyers.
 (d) in monopolistic competition competitive firms sell goods
that are similar enough to be substituted for one another.
An oligopoly is
 (a) an agreement among firms to charge one price for the same
good.
 (b) a formal organization of producers that agree to coordinate
price and output.
 (c) a way to attract customers without lowering price.
 (d) a market structure in which a few large firms dominate a
market.
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.
EX: Telecommunications sector in U.S. Effects have
been mixed.
Government and Competition
Government policies keep firms from controlling the
prices and supply of important goods. Antitrust laws
are laws that encourage competition.
Sherman Antitrust Act (1890) was the 1st U.S. law
against monopolies
Clayton Antitrust Act (1914) outlawed price
discrimination
Federal Trade Commission (1914) was empowered to
issue cease and desist orders to companies practicing
unfair business practices
Robinson-Patman Act (1936) outlawed special
discounts to some consumers
Government also taxes to regulate businesses with
negative externalities (Chemical manufacturers)
Government also requires public disclosure
Section Review—Role of Gov’t
Antitrust laws allow the U.S. government to do all of the
following EXCEPT
 (a) regulate business practices.
 (b) stop firms from forming monopolies.
 (c) prevent firms from selling new experimental
products.
 (d) break up existing monopolies.
The purpose of both deregulation and antitrust laws is
to
 (a) promote competition.
 (b) promote government control.
 (c) promote inefficient commerce.
 (d) prevent monopolies.