Chapter 7:
Market Structures
Types of Market Structures
1) Perfect Competition
2) Monopoly
3) Monopolistic Competition
4) Oligopoly
Perfect Competition
A market structure in which a LARGE
number of firms all produced the SAME
product
Perfect Competition
Examples
Number of Sellers
Variety of goods
Wheat, Milk, Orange Juice,
Notebook Paper, Agriculture
Many
None
(Identical Products)
Price Control
None
(Consumers try to get the best deal)
Entry into Market
None
(easiest to enter)
Monopoly
A market structure dominated by a single
seller
Monopoly
Examples
Public Water, Post office
(Most are ILLEGAL)
Number of Sellers
One
Variety of Goods
None
Price Control
Complete
(total control)
Entry into Market
Complete Barriers
(most difficult to enter)
Monopolistic Competition
A market structure in which MANY
companies sell products that are SIMILAR
Monopolistic Competition
Example
Number of Sellers
Jeans, Books, Bagel shops, Gas
stations, Retail clothing stores, Video
rental stores, Fast food restaurants
Many
Variety of Goods
Some
Price Control
Little
Entry into Market
Low / Few
Oligopoly
A market structure in which a FEW larger
firms dominate the market
Oligopoly
Examples
Cars, Movie studios, breakfast
cereals, household appliances, air
travel, supermarkets, banks, steel, oil
Number of Sellers
A few dominate
Variety of Goods
Some
Price Control
Some
Entry into Market
High Barriers
Price Control
(least to most)
1.
2.
3.
4.
Perfect Competition
Monopolistic Competition
Oligopoly
Monopoly
Entry into Market—
Barriers to Enter the Market
(least to most)
1.
2.
3.
4.
Perfect Competition
Monopolistic Competition
Oligopoly
Monopoly
Vocabulary Words
Barriers to entry
Any factor that makes it difficult for a new firm
to enter the market
Like a brick wall…
Start-up Costs
• The expenses a firm must pay BEFORE it
can begin to produce and sell goods
Types of Market Structures
1) Perfect Competition
2) Monopoly
3) Monopolistic Competition
4) Oligopoly
Perfect Competition
Perfect Competition
A market structure in which a LARGE
number of firms all produced the SAME
product
Perfect Competition
Examples
Number of Sellers
Variety of goods
Wheat, Milk, Orange Juice,
Notebook Paper
Many
None
(Identical Products)
Price Control
None
(Consumers try to get the best deal)
Entry into Market
None
(easiest to enter)
Four (4) Conditions:
1) Many buyers and sellers
2) Identical products (commodity)
3) Well informed buyers and sellers
4) No barriers to enter or exit the market
Perfectly competitive markets
require everyone in the market
MUST accept the market
price given.
Perfect Competition
• What happens to the supply
curve? Supply curve shifts to
the Right
What SPENT variable would
this be? Number of Suppliers
(Increases)
What happens to the
equilibrium price? Decreases
Commodity
• A product that is the SAME, no matter who
produces it
Commodity Example
“In countries where farmers make up a small
fraction of the population, such as American and
Europe, the government provides large subsidies
for agriculture. But in countries where the
farming population is relatively large, such as
China and India, the subsidies go the other way.
Farmers are forced to sell their crops belowmarket prices so that urban dwellers can get basic
food items cheaply.”
Commodity Example
“If the government has to support the price of
milk, the real problem is that there are too
many dairy farmers…Governments should
not be in the business of providing
incentives for people that would not
otherwise make sense.”
--Naked Economics, p. 141-142
Imperfect Competition
• A market structure that does NOT meet the
conditions of perfect competition
How do Perfect Competitions
keep prices low?
Use inputs (such as technology) to their
best advantage (competition)
Monopoly
Types of Market Structures
1) Perfect Competition
2) Monopoly
3) Monopolistic Competition
4) Oligopoly
Why Are There Monopolies?
Q: What about a market causes there to be only one firm in operation?
A: Several possible factors. First, a firm could control a key resource
needed for the production of a good. For example, there can be only
one dam at any point along a river, so whoever owns the dam will
have a monopoly on the production of hydroelectric power there.
Second, the government could mandate that only one firm will
operate in a market. This is true with respect to mail delivery. Only
the U.S. Postal Service (a government monopoly) can deliver mail
into your mailbox. Other firms can deliver packages to your door,
but not to your mailbox. Finally, economies of scale in production
may dictate that one large firm is the most efficient way to provide a
product. This situation is called natural monopoly.
Monopoly
A market structure dominated by a single
seller
Monopoly
Examples
Public Water, Post office
(Most are ILLEGAL)
Number of Sellers
One
Variety of Goods
None
Price Control
Complete
(total control)
Entry into Market
Complete Barriers
(most difficult to enter)
Monopoly Example 1:
DMV
“ Think about the Department of Motor Vehicles,
which has a monopoly on the right to grant
driver’s licenses. What is the point of being
friendly, staying open longer, making customers
comfortable, adding clerks to shorten lines,
keeping the office clean, or interrupting a
personal call when a customer comes to the
window?”
--Naked Economics, page 64
Monopoly Example 1:
DMV
“ None of these things will produce even one more
customer! Every single person who needs a
driver’s license already comes to the DMV and
will continue to come no matter how unpleasant
the experience. There are limits, of course. If
service becomes bad enough, then voters may
take action against the politician in charge.
But,that is an indirect, cumbersome process.”
--Naked Economics, page 64
Monopoly Example 1:
DMV
“ Compare that to your options in the private
sector. If a rat scampered across the counter at
your favorite Chinese take-out restaurant, you
would (presumably) just stop ordering there.
End of problem. The restaurant will get rid of
the rats or go out of business.”
--Naked Economics, page 64
Monopoly Example 1:
DMV
“ Meanwhile, if you stop going to the Department
of Motor Vehicles, you may end up in jail.”
--Naked Economics, page 64
Monopoly Example 2:
Post Office
“ [S]everal weeks ago when a check I was
expecting from Fidelity, the mutual fund
company, failed to show up in the mail. (I
needed the money to pay back my mother, who
can be a fierce creditor.) Day after day went
by—no check. Meanwhile, my mother was
“checking in” with increasing frequency.”
--Naked Economics, page 64
Monopoly Example 2:
Post Office
“ One of two parties was guilty, Fidelity or the U.S.
Postal Service, and I was getting progressively
more angry. Finally I called Fidelity to demand
proof that the check had been mailed. I was
prepared to move all of my (relatively meager)
assets into Vanguard, Putnam, or some other
mutual fund company (or at least make the
threat).
--Naked Economics, page 64-65
Monopoly Example 2:
Post Office
“ Instead, I spoke with a very friendly customer
assistant who explained that the check had been
mailed two weeks earlier but apologized
profusely for my inconvenienced anyway. She
canceled the check and issued another one in a
matter of seconds. Then she apologized some
more for a problem that, it was now apparent, her
company did not cause.”
--Naked Economics, page 65
Monopoly Example 2:
Post Office
“The culprit was the post office. So I got even
angrier and then… I did nothing. What exactly
was I supposed to do? The local postmaster does
not accept complaints by phone. I did not want
to waste time writing a letter (which might never
arrive anyway). Nor would it help to complain to
our letter carrier, who has never been consumed
by the quality of his service.”
--Naked Economics, page 65
Monopoly Example 2:
Post Office
“The point, carefully disguised in this diatribe, is
that the U.S. Postal Service has a monopoly on
the delivery of first-class mail. And it shows.”
--Naked Economics, page 65
Monopoly Example 3:
Miss Kroope
“One of the largest government monopolies
remaining in the United States is public
education.”
--Naked Economics, page 66
Economies of Scale
• Factors that cause a producer’s average cost
per unit to fall as output rises
Economies of Scale
They occur because Start-up costs are
high.
As production Increases, the firm becomes
more efficient, even at a level of output high
enough to supply the entire market. An
example: Hydroelectric plant
Natural Monopolies
• A market that runs most efficiently when l
large firm supplies ALL output
Natural Monopolies
• Result: Usually only ONE business remains
• Examples: telecommunications, public
water, electricity, mail delivery
Natural Monopolies
• Why does the government usually step in to
allow these to happen for necessary
services?
Ensures we don’t waste resources
building additional plants when only one
is needed
• In return, the government controls prices.
There are 4 Types of
Government Monopolies:
A)Patent
B)Franchise
C)License
D)Industrial Organization
Patent
•
A license that gives the inventor a new
product the exclusive right to sell it during a
certain period of time
Patent
• Patents encourage companies to research
and develop new products
• Patents benefit society as a whole.
How Long Does a Patent Last?
• Utility Patent - 20 years from the date of
filing of the earliest application
• Design Patent - 14 years from the grant
of the patent
• Plant Patent - 20 years from the date of
filing of the earliest application
Patent Example
“Don’t try to sell sildenafil citrate on a street
corner or you may end up in jail. This is not
a drug that you snort or shoot up, nor is it
illegal.”
--Naked Economics, page 14
Patent Example
“It happens to be Viagra, and Pfizer holds the
patent, which is a legal monopoly granted
by the U.S. government.”
--Naked Economics, page 14
Patent Example
“Viagra cost pennies a pill, but because
Pfizer has a patent on Viagra giving it a
monopoly on the right to sell the product for
twenty years, the company sells each pill
for as much as $7. This huge markup,
which is common with new HIV/AIDS
drugs and other lifesaving products, is often
described as some kind of social injustice
perpetrated by…the ‘big drug companies.’”
--Naked Economics, page 53
Patent Example
“Indeed, when a drug comes off patent—the
point at which generic substitutes become
legal—the price usually falls by 80-90
percent.”
--Naked Economics, page 53
Patent Example
“The average cost of bringing a new drug to
market is somewhere in the area of $600
million. And for every successful drug,
there are many expensive research forays
that end in failure”
--Naked Economics, page 53
Patent Example
“Yes, the government could buy the patent when a
new drug is invented. The government would pay
a firm up front a sum equal to what the firm would
have earned over the course of its twenty-year
patent….That’s an expensive solution that comes
with some problems of its own. For example,
which drug patents would the government buy?”
--Naked Economics, page 53
Franchise
• Right to sell a good or service within an
exclusive market
• Example: Dominos, Dunkin Donuts
License
• Government issued right to operate a
business
Industrial Organizations
• Allows, but can restrict number of firms in
the market
• Example: National Football League (NFL)
Industrial Organizations
• What is a problem with industrial
organizations?
• Team owners may charge high prices for
tickets
Industrial Organizations
For example, if there is limited number of
suppliers, which usually does not change,
and there are an increasing number of
demanders.
Industrial Organizations
Price
Demand
1
Demand
2
Supply
25
100
200
100
50
80
175
100
75
60
150
100
100
40
125
100
125
20
100
100
Industrial Organizations
Price
Demand
1
Demand
2
Supply
25
100
200
100
50
80
175
100
75
60
150
100
100
40
125
100
125
20
100
100
Industrial Organizations
1) Why is the supply curve
vertical?
It is a stadium—where there is
a constant number of seats!
2) What happens to equilibrium
price when there is more
demand?
Equilibrium price INCREASES
Output Decisions
1. A monopolist faces a limited choice—it can
choose either output or price. A
monopolist looks at the big picture and
tries to maximize profits. This usually
means monopolists will produce fewer
goods at a higher price.
Output Decisions
2. To
maximize profits, a seller should set its marginal
revenue, or the amount it earns from the last unit
sold, equal to its marginal cost, or the extra cost
from producing that unit.
3. When a firm has some control over price--and can
cut price to sell more--marginal revenue is less than
price.
Output Decisions
4. What happens to the
supply curve?
What SPENT variable
would this be?
What happens to the
equilibrium price?
Output Decisions
4. What happens to the supply
curve?
SHIFTS TO THE LEFT
What SPENT variable would
this be?
N- Number of Suppliers
What happens to the
equilibrium price?
INCREASES
Price Discrimination
• Division of customers into groups based on
how much they pay for a good
• Examples in Oligopoly
(Airplanes and grocery stores)
Price Discrimination
Example 1 for Oligopolies
“Grocery stores appear to be the model of one
price for all. But even today, they post one
price, charge another to shoppers willing to
clip coupons and a third to those with frequentshopper cards that allow stores to collect
detailed data on buying habits.”
--Naked Economics, page 17
Price Discrimination
Example 2 for Oligopolies
“A firm can attempt to sell the same item to
different people at different prices. The next
time you are on an airplane, try this
experiment: Ask the person next to you how
much he or she paid for the ticket. It’s
probably not what you paid; it may not even be
close.”
--Naked Economics, page 16
Price Discrimination
Example 2 for Oligopolies
“You are sitting on the same plane, traveling to
the same destination, eating the same bad
food—yet the prices you and your row mate
paid for your tickets may not even have the
same number of digits.”
--Naked Economics, page 16
Price Discrimination
Example 2 for Oligopolies
“[T]he airline industry is to separate business
travelers, who are wiling to pay a great deal for
a ticket, from pleasure travelers who are on a
tighter budget.”
--Naked Economics, page 16
Price Discrimination
1. Based on the idea that each customer has his/her own
maximum price s/he will pay for a good.
2. If a monopolist sets a low price, the monopolist will gain a
lot of customers but the monopolist will lose the profits it
could have made from the customers who bought at the
low price but were willing to pay more
Price Discrimination
3. Price discrimination can be practices by any
company with market power.
However, some companies enjoy market
power without holding a monopoly.
Market Power
• Ability of a company to change prices and
output
Market Power
If you do NOT have another choice—you can
either accept the item at the price it is being
offered at or do NOT accept the item at all.
Business know if there product is good enough
and there is no other option—people will buy
their product!
Price Discrimination
4. List 4 EXAMPLES of price discrimination
(targeted discounts)
a)
b)
c)
d)
Discounted airline fares
Manufacturers’ rebate offers
Senior citizen or student discounts
Children fly or stay free promotion
Price Discrimination
5. List 3 LIMITS on price discrimination
a) Some market power
(is rare in highly competitive markets)
b) Distinct customer groups
(based on sensitivity to price)
c) Difficult resale
(ex: airline tickets)
Monopolistic Competition
•
Monopolistic Competition
A market structure in which MANY
companies sell products that are SIMILAR
Monopolistic Competition
Example
Number of Sellers
Jeans, Books, Bagel shops, Gas
stations, Retail clothing stores, Video
rental stores, Fast food restaurants
Many
Variety of Goods
Some
Price Control
Little
Entry into Market
Low / Few
Monopolistic Competition
• What is the main difference between a
perfect competition and a monopolistic
competition?
PC – Identical products (commodity)
MC – Not identical; a fact of everyday life
Monopolistic Competition
• List the 4 Conditions of a Monopolistic
Competition:
•
•
•
•
1. Many firms
2. Few artificial barriers to entry
3. Slight control over prices
4. Differentiated price
Differentiation
• Making a product different from other
similar products
Nonprice Competition
• A way to attract customers through other
means EXCEPT price.
FOUR (4) forms of Nonprice
Competition:
1. Physical Characteristics (ex: shape, size,
color, texture, taste)
2. Location (where sold?)
3. Service level
4. Advertising
(anything, EXCEPT PRICE!!!)
Monopolistic Competition
• Prices under Monopolistic competition will be
higher than they would be in a perfect
competition, because firms have some power to
raise prices. However, the number of firms and
ease of entry prevent companies from raising
prices as high as they would if they were a true
monopoly. If a monopolistically competitive
firm raised prices too high, most customers
would ignore any differences and buy the
cheaper product.
Monopolistic Competition
If monopolistically competitive firms started to earn
profits well above their costs, market trends would
work to take them away.
1. Fierce competition would encourage rivals to think
of new ways to differentiate their products and lure
customers back.
2. New firms will enter the market with slightly
different products that cost a lot less than the
market leaders. If the original good costs too much
consumers will switch to these substitutes.
Oligopoly
Oligopoly
A market structure in which a FEW larger
firms dominate the market
(4 Largest firms produce at least 70-80% of the output.)
Oligopoly
Examples
Number of Sellers
Cars, Movie studios, breakfast
cereals, household appliances,
air travel, supermarkets, banks
A few dominate
Variety of Goods
Some
Price Control
Some
Entry into Market
High Barriers
Oligopoly Example
“The airline industry is far less competitive than it
appears to be. You and some… friends could
start a new airline relatively easily; the problem is
that you wouldn’t be able to land your planes
anywhere. There are a limited number of gate
spaces available at most airports, and they tend to
be controlled by the big guys.”
--Naked Economics, page 14
Oligopoly
• A. The FOUR largest firms produce at least 70 to 80%
of the output
• B. The biggest firms in an oligopoly may well set
prices higher and output lower than in a perfectly
competitive market
• C. Oligopolies can form high barriers to enter the
market to keep new companies from entering the
market and to compete with existing firms.
Oligopoly
•
List 4 reasons there can be high barriers to
enter an Oligopoly:
a)
b)
c)
d)
Licenses
Patents
High start-up costs
Economics of scale
Oligopoly
E. When determined oligopolists work together
illegally to set prices and bar competing firms from the
market, they can become as damaging to the consumer
as a monopoly.
• F. There are 3 practices that concern government the
most because they represent ways that firms in an
oligopoly can try to control a market. These practices
don’t always work.
Price War
• Series of competitive price cuts that lowers
the market BELOW the cost of production
Who are price wars harmful to? Producers
Who do price wars benefits? Consumers
Price War Example
• Initially benefit consumers by lowering prices
• Some sellers can be severely hurt by price wars—
some can lose money and/or go out of business.
• When the price war ends, prices tend to rise again
• If one or more sellers have gone out of business
prices may rise even higher than before the war
because there is less competition
Collusion
• Agreement among firms to divide the
market, set prices, or limit production
a. One outcome of collusion is: Price fixing
Collusion Example
• When selling secretly do this, it is
ILLEGAL and carries heavy penalties (fine
and prison)
• Raises prices higher than they would be
under competitive forces
Price Fixing
• An agreement among firms to charge ONE
price for the SAME good
a. In the United States, collusion is Illegal
Cartel
• A formal organization of producers that
agree to coordinate prices and production
• a. In the United States, cartels are Illegal
b. In other countries and international
organizations, cartels are Legal
Cartel
Cartels can only survive if every member
keeps to its agreed output levels and NO more!
Otherwise, prices will fall and firms will lose
profits. However, each member has a strong
incentive to cheat and produce more than its
quota. If every member cheats, too much
product reaches the market, and prices fall
Cartels can also collapse if some producers are
left out of the group and decide to lower their
prices below the cartel’s levels.
Cartel
• Do cartels typically last very long?
NO
Results of an Oligopoly
•
As the number of sellers in an oligopoly
grow larger, an oligopolistic market looks
more like:
a)
b)
c)
d)
Monopoly
Monopolistic Competition
Perfect Competition
Collusion as a solution
Market Power
How do firms try to increase its Market
Power by controlling prices and output?
A. Form a cartel
B. Combine with one another
C. Predatory Pricing
Predatory Pricing:
• Selling a product below cost to drive
competitors out of the market
Regulation
The federal government has a number of policies that
keep firms from controlling the price and supply of
important goods. If a firm controls a large share of a
market, the Federal Trade Commission (FTC) and the
Department of Justice’s Antitrust Division will watch
that firm closely to ensure that it does not unfairly force
out its competitors.
In addition to breaking monopolistic companies, the
government has the power to prevent the rise of
monopolies
Antitrust Laws:
• Laws that encourage competition in the
marketplace
(forbids companies from conspiring together
in ways that erase the benefits of
competition –Naked Economics, p. 56)
Antitrust Laws (Question)
The purpose of antitrust laws is to:
a) Regulate the prices charged by a monopoly
b) Increase competition in an industry by preventing
mergers and breaking up large firms.
c) Increase merger activity to reduce costs and raise
efficiency
d) Create public ownership of natural monopolies
e) Do all of the above
Antitrust Laws
Rationalization:
If a business does NOT allow competition,
we believe that it goes against our country’s
fundamental belief of encouraging
competition—and therefore, we do NOT
allow it.
Trust
• An illegal grouping of companies that
discourages competition
Sherman Antitrust Act (1890)
• Outlawed mergers and monopolies that
limit trade between states
Merger
• Combination of two or more companies into a
single firm
• There are 3 types of Corporate Combination.
Each corporate combination can lead to larger,
more Efficient firms. Often, larger firms can
produce and sell their products at LOWER prices.
However, their size can also give some of these
combinations more Monopoly Power.
Types of Corporate Combinations
• Add info here!!!
Deregulation
• The removal of some government controls
over a market
Deregulation
While deregulation weakens government
control, antitrust laws strengthen it.
The government uses BOTH of these tools–
deregulation and anti-trust laws for the
same purpose: to promote competition.
Federal Agencies
Federal Agencies
What do they do?
Food and Drug
Administration (FDA)
Regulates food and drugs
consumed by individuals
Federal Trade Commission
(FTC)
Regulates trade between
states
Federal Communications
Commission (FCC)
Regulates television, phone,
radio, and other
communication products
Federal Aviation
Administration (FAA)
Regulates airplanes,
helicopters, and other aviation
devices
Federal Agencies
What do they do?
Equal Employment
Opportunity Commission
(EEOC)
Environmental Protection
Agency (EPA)
Regulates the hiring and firing
practices of employers to
ensure equal opportunity
Regulates environmental
concerns
Occupational Safety and
Health Administration
(OSHA)
Regulates safety and health in
businesses
Consumer Product Safety
Commission (CPSC)
Reports and requests recalls
for consumer products
Standards
• 6.2.12 H
• 6.4.12 A