chapter 7: different types of market structures sws 2006 2 what are markets? a market is where...

CHAPTER 7:DIFFERENT TYPES OF MARKET STRUCTURES

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What Are Markets?

A market is where buyers and sellers:A market is where buyers and sellers:–meet to exchange goods and services.–are affected by some level of competition.

The market may be in one specific placeor

It does not exist physically at all (IT IS JUST A THEORY!!)

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Markets are classified by Markets are classified by 4 structures structures

1. Pure (perfect) Competition

2. Monopolistic Competition

3. Oligopoly

4. Monopoly

What Are Markets?What Are Markets?

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1. Perfect Competition1. Perfect Competition

This is a theoretical situation. This is a theoretical situation. NONO TRUE TRUE Perfectly CompetitivePerfectly Competitive MarketMarket

exists. exists.

BEFORE WE BEGIN!!BEFORE WE BEGIN!!

IT IS ONLY A THEORY!IT IS ONLY A THEORY!

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The The 55 conditions of conditions of perfect competitionperfect competition

1)1) LARGELARGE number of number of SMALLSMALL firms. firms. No single buyer or seller can influence the price.No single buyer or seller can influence the price.

2)2) Buyers and sellers deal in Buyers and sellers deal in identicalidentical products. products. No product No product differences.differences. (EXAMPLES: Salt, Flour, Commodity, Corn)(EXAMPLES: Salt, Flour, Commodity, Corn)

3)3) Unlimited Competition:Unlimited Competition: so many firms, that suppliers lose so many firms, that suppliers lose the ability to set their own price.the ability to set their own price.

4)4) No Barriers to EntryNo Barriers to Entry. Sellers are free to enter the market, . Sellers are free to enter the market, conduct business and free to leave the market. (Low conduct business and free to leave the market. (Low cost to enter)cost to enter)

5)5) Each firm is aEach firm is a PRICE-TAKERPRICE-TAKER (more on this later)CONSUMERS HAVE THE LARGEST SELECTION OF BUYERS TO BUY GOODS FROM BECAUSE NO SINGLE GOOD IS MORE APPEALING THAN ANOTHER.

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The The 55 conditions of conditions of perfect competitionperfect competition

4)4) No Barriers to entryNo Barriers to entry. Sellers are free to enter the market, . Sellers are free to enter the market, conduct business and free to leave the market.conduct business and free to leave the market.

Perfect competition is the opposite of monopoly. Here, any firm can get into the market at very little cost.

The agricultural market is the best example of a perfectly competitive market.

Suppose there was a market for dandelions. Growing dandelions requires little start-up cost.

All you need are dandelion seeds, soil, water, and some sunlight.

There is no difference between one dandelion and another, so the market has a similar product.

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Perfect Competition

Each individual firm is Each individual firm is to influence prices. to influence prices. Price becomes Price becomes fixedfixed to everyone in the industry. to everyone in the industry.

EXAMPLE:EXAMPLE: the price of a bushel of wheat is set the price of a bushel of wheat is set only by the interaction of supply and demandonly by the interaction of supply and demand ..

too smalltoo small

Generally speaking, wheat is the same per bushel in North Georgia

as it is in Florida.

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Perfect Competition

Firms in a perfectly competitive market are Firms in a perfectly competitive market are price takers. . (they (they taketake the price they are given, they the price they are given, they can’t change the price)can’t change the price)

Since they have no control over their own Since they have no control over their own pricesprices, they have _______________________., they have _______________________.

In other words, no one will buy an overpriced In other words, no one will buy an overpriced dandelion. Why should they? dandelion. Why should they?

A 4-cent dandelion is the same as the 3-cent one, A 4-cent dandelion is the same as the 3-cent one, so there is no reason to spend that extra penny. so there is no reason to spend that extra penny.

NO MARKET POWERNO MARKET POWERMARKET POWER = MARKET POWER = “the ability to set one’s OWN prices”

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Monopolistic Competition

1) LARGE number of number of large large companies companies (but fewer than perfect competition).(but fewer than perfect competition). Sellers can influence the price through creating a Sellers can influence the price through creating a product identityproduct identity (more on this (more on this later)later)

2)2) Products are Products are NOT exactly identicalNOT exactly identical, , BUT VERY SIMILAR,BUT VERY SIMILAR, so so companies use companies use PRODUCT DIFFERENTIATIONPRODUCT DIFFERENTIATION

3)3) Heavy Competition:Heavy Competition: Firms must remain aware of their competitor’s Firms must remain aware of their competitor’s

actions, but they each have some ability to control their own prices.actions, but they each have some ability to control their own prices.

4)4) Low Barriers to Entry:Low Barriers to Entry: harder to get started because of the amount harder to get started because of the amount of competition.of competition.

5)5) Monopolistic competition takes its name and its structure from Monopolistic competition takes its name and its structure from elements of elements of monopolymonopoly and and perfect competitionperfect competition..

The 5 conditions of Monopolistic Competition

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Monopolistic Competitive Market

Essentially, all hand soaps are the same. Yet firms Essentially, all hand soaps are the same. Yet firms can create a can create a brand identitybrand identity that separates their that separates their hand soap from their competitor’s. hand soap from their competitor’s.

This This brand identitybrand identity can be formed through can be formed through packagingpackaging, , product supportproduct support, and , and especially especially advertisingadvertising. .

If effective, consumers will positively identify a If effective, consumers will positively identify a certain brand and purchase it even if hand soap certain brand and purchase it even if hand soap costs costs moremore. .

The key idea to understanding monopolistic competition is that The key idea to understanding monopolistic competition is that firms sell products that are firms sell products that are similarsimilar, but not exactly alike., but not exactly alike.

STUDY TIP:STUDY TIP:

EXAMPLEEXAMPLE: Hand Soap: Hand Soap

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Conditions of Monopolistic Competition

The point is that firms in Monopolistic Competition must use Product DifferentiationProduct Differentiation & Non-price CompetitionNon-price Competition to sell their products.

Product Differentiation:Product Differentiation: The real or imagined differences The real or imagined differences

between competing products in the between competing products in the same industry.same industry.

Differences may be real or imagined.Differences may be real or imagined.

DifferentiationDifferentiation may be may be colorcolor, , packagingpackaging, , store store locationlocation, , store designstore design, , store decorationsstore decorations, , deliverydelivery, , serviceservice….. anything to make it stand ….. anything to make it stand out!out!

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The point is that firms in Monopolistic Competition must use Product DifferentiationProduct Differentiation & Non-price CompetitionNon-price Competition to sell their products.

Conditions of Monopolistic Competition

Non-Price Competition:Non-Price Competition: Non-Price CompetitionNon-Price Competition involves the advertising of a involves the advertising of a

product's appearance, quality, or design, product's appearance, quality, or design, rather than its rather than its priceprice..

Advertising to help the consumer believe that this product Advertising to help the consumer believe that this product is different and worth more money.is different and worth more money.

VS

Notice these commercials never

mention price.

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Examples of Monopolistic Competition

Auto, Steel, Gas, Fast Food, Airlines.Auto, Steel, Gas, Fast Food, Airlines.

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MERGERS OF LARGE COMPANIES Sometimes companies fall victim to market failure. However, Sometimes companies fall victim to market failure. However,

not all businesses close their doors and empty their factories not all businesses close their doors and empty their factories and stores.and stores.

Many get “Many get “swallowed upswallowed up” by another company. This ” by another company. This ““take-take-overover”” or or acquisitionacquisition of a company is known as a of a company is known as a mergermerger..

There are There are THREETHREE types of mergers: types of mergers: HORIZONTALHORIZONTAL, , VERTICALVERTICAL, and , and CONGLOMERATECONGLOMERATE..

1.) 1.) HORIZONTAL:HORIZONTAL: involve firms in the involve firms in the SAMESAME market, such as between two oil market, such as between two oil companies.companies.

EXAMPLE:EXAMPLE: steel company buys an automakersteel company buys an automaker

Reason: Diversification

2.) 2.) VERTICAL:VERTICAL: involve one firm involve one firm buying a resource providerbuying a resource provider..

3.)3.) CONGLOMERATE:CONGLOMERATE: a a company company buys a business in a buys a business in a UNRELATED industryUNRELATED industry..

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What is an Oligopoly?A market in which a A market in which a two-three large sellerstwo-three large sellers control control

most of the production of a good or service and they most of the production of a good or service and they work togetherwork together on setting prices. on setting prices.

Conditions of an Conditions of an OligopolyOligopoly

1)1) Very Very fewfew Sellers that control the entire market. Sellers that control the entire market.

2)2) Products may be differentiated or identical Products may be differentiated or identical (but (but they are usually standardized)they are usually standardized)

3)3) Medium barriers to entry:Medium barriers to entry: Difficult to Enter the Difficult to Enter the market because the competitors work together market because the competitors work together to control all the resources & prices.to control all the resources & prices.

4)4) The actions of The actions of oneone affects affects allall the producers. the producers.

5)5) CollusionCollusion == an agreement to act together or an agreement to act together or behave in a cooperative manner.behave in a cooperative manner.

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A market in which a A market in which a two-three large sellerstwo-three large sellers control control most of the production of a good or service and they most of the production of a good or service and they

work together on setting prices.work together on setting prices.

What is an Oligopoly?

Conditions of Conditions of OligopolyOligopoly5)5) CollusionCollusion == an agreement to act together or an agreement to act together or

behave in abehave in a cooperativecooperative manner.manner. Collusion Agreements:Collusion Agreements: usually usually illegalillegal, among , among producers to fix prices, limit output, or divide markets.producers to fix prices, limit output, or divide markets.(hard to prove that a group of companies is doing this)(hard to prove that a group of companies is doing this) It is It is also called also called Price Fixing:Price Fixing: setting the same setting the same

prices across the industry.prices across the industry.THIS IS IN VIOLATION OF ANTI-TRUST LAWS. WHY?

Basically, the companies are acting a one large monopoly.

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Price Behavior in Oligopoly

Oligopolists would like to be Oligopolists would like to be Independent PriceIndependent Price setters: setters: a firm sets prices based on demand, cost of input a firm sets prices based on demand, cost of input

and other factors and other factors (not based on other companies prices).(not based on other companies prices).

Price WarsPrice Wars:: Series of price cuts that competitors must Series of price cuts that competitors must follow or lose business.follow or lose business. it is ait is a fierce price competition between sellers, sometimes fierce price competition between sellers, sometimes

the price is the price is lowerlower than the cost of production. than the cost of production.Why is that bad???Why is that bad???

Now, sometimes businesses do not agree with each other about the price, and if that happens, a WAR will result.

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2 Types of Price Behavior in an Oligopoly

Independent Pricing:Independent Pricing: policy by a competitor that policy by a competitor that ignores other producer’s prices.ignores other producer’s prices.

Price Leader:Price Leader: independent pricing decisions made by independent pricing decisions made by a dominate firm on a regular basis that results in a dominate firm on a regular basis that results in generally uniform industry-wide prices.generally uniform industry-wide prices.

DISADVANTAGE:DISADVANTAGE: other firms shut you down by other firms shut you down by agreeing to set lower prices than yours.agreeing to set lower prices than yours.

ADVANTAGE:ADVANTAGE: you are the company leading the price.you are the company leading the price.

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Conditions of Monopoly

There is a There is a singlesingle seller seller

No No closeclose substitute goods are available substitute goods are available

High Barriers to Entry:High Barriers to Entry: Other sellers Other sellers cannot enter the Market.cannot enter the Market.

Exact Opposite of Pure Competition. Exact Opposite of Pure Competition. A A price makerprice maker. . (set their own price, without regard to (set their own price, without regard to

supply and demand)supply and demand)

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Types of Monopolies

1)1) Natural Monopoly:Natural Monopoly: Where costs are minimized by Where costs are minimized by having a single producer of the product.having a single producer of the product.Gas, water, electricity: government creates Gas, water, electricity: government creates Natural Natural

MonopoliesMonopolies by Franchising some utilities. by Franchising some utilities. FranchiseFranchise - the right to produce or do business in a certain - the right to produce or do business in a certain

area without competition. area without competition. Government franchises come with government regulation. Government franchises come with government regulation.

Georgia PSC Georgia PSC (Public Service Commission)(Public Service Commission)

WHY WOULD GOVERNMENT DO THIS???WHY WOULD GOVERNMENT DO THIS???

Economies of Scale:Economies of Scale: As natural monopolies grow larger, this reduces its As natural monopolies grow larger, this reduces its production costs production costs (economies of scale)(economies of scale)..Because normally companies become more efficient as Because normally companies become more efficient as

the firm becomes larger.the firm becomes larger. Example:Example: It is cheaper for the It is cheaper for the Tennessee Valley AuthorityTennessee Valley Authority

(TVA) to provide power in Georgia than two or three (TVA) to provide power in Georgia than two or three companies.companies.

44 Distinct Types of Monopolies:Distinct Types of Monopolies:

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Types of Monopolies

2)2) Geographic Monopoly:Geographic Monopoly: The only business in The only business in a location due to size of market.a location due to size of market.

DecreasingDecreasing in the U.S. because of mobility. in the U.S. because of mobility.

EXAMPLE:EXAMPLE: Only Only person selling person selling

water in the water in the desert.desert.

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3)3) Technological Monopoly:Technological Monopoly: Firm has Firm has discovered a new process or product.discovered a new process or product.

Constitution gave government the right to grant Constitution gave government the right to grant technological monopolies.technological monopolies.

Patent:Patent: 17 years exclusive rights to a developed 17 years exclusive rights to a developed technology.technology.

Copyright:Copyright: (Artists and writers)(Artists and writers) Life plus 50 years. Life plus 50 years.

Types of Monopolies

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4)4) Government Monopoly:Government Monopoly: Retained by the Retained by the government. government.

Liquor sales in some counties, uranium Liquor sales in some counties, uranium production, water, etc.production, water, etc.

Types of Monopolies

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Markets work best when Markets work best when fourfour conditions are met: conditions are met:1)1) Adequate competition must exist in all Adequate competition must exist in all

markets.markets.2)2) Buyers and sellers are reasonably well-Buyers and sellers are reasonably well-

informed about conditions and informed about conditions and opportunities.opportunities.

3)3) Resources must be free to move from one Resources must be free to move from one industry to another.industry to another.

Market Failure occurs when any of the 3 Market Failure occurs when any of the 3 conditions alter significantly.conditions alter significantly.

3 Conditions of Efficient & Successful Markets

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Types & Causes for Market Failure

1) Inadequate Competition: Dangers to monopolies Dangers to monopolies Monopolies may waste and misallocate scarce Monopolies may waste and misallocate scarce

resources because there is no competition.resources because there is no competition.

2) Inadequate Information: A free enterprise economy A free enterprise economy requires information.requires information.

It is difficult to employ resources for the fullest benefit of It is difficult to employ resources for the fullest benefit of society without adequate information.society without adequate information.

3) Resource Immobility: The efficient allocation or resources The efficient allocation or resources require that land, labor, capital and entrepreneurs be free to move require that land, labor, capital and entrepreneurs be free to move to markets where returns are the highestto markets where returns are the highest

4) Externalities / Side Effects: A side effect that benefits or harms A side effect that benefits or harms a third party that was not directly involved in the activity.a third party that was not directly involved in the activity.

Negative Externality: People are harmed or inconvenienced People are harmed or inconvenienced by an economic decision.by an economic decision.

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The Role of Government

Government has the power to maintain competition, Government has the power to maintain competition, regulate monopolies, or to run government-owned regulate monopolies, or to run government-owned monopolies.monopolies.

Since the late 1800s the US have passed laws to Since the late 1800s the US have passed laws to restrict and regulate monopolies andrestrict and regulate monopolies and truststrusts..

TrustTrust:: a a legallylegally formed combination of formed combination of companies. companies.

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Antitrust LegislationAntitrust Legislation

Interstate Commerce Act:Interstate Commerce Act: Passed by Congress Passed by Congress in 1887. It was aimed at the railroads. in 1887. It was aimed at the railroads. Charges of unfair pricing prompted Congress Charges of unfair pricing prompted Congress to act.to act.

1887: Interstate Commerce Act

1887 PRESENT

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1890 - Sherman Antitrust Act1890 - Sherman Antitrust Act - law against - law against monopolies that hindered competition or made monopolies that hindered competition or made competition impossible because of the “restraint competition impossible because of the “restraint of trade” that is created by a monopoly.of trade” that is created by a monopoly.


1887 PRESENT

1890: Sherman Antitrust Act

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1914 - Clayton Antitrust Act1914 - Clayton Antitrust Act -- outlawed price outlawed price discrimination - charging different customers different discrimination - charging different customers different prices for the same product. Further defined Sherman. prices for the same product. Further defined Sherman. ((preferred pricingpreferred pricing) )


1887 PRESENT


1914: Clayton Antitrust Act

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1914 - Federal Trade Commission Act -1914 - Federal Trade Commission Act - passed passed to enforce the Clayton Antitrust Act. It gave the to enforce the Clayton Antitrust Act. It gave the authority to issue authority to issue Cease and Desist order.Cease and Desist order.


1887 PRESENT


1914: Clayton Antitrust Act

Cease and Desist Order:Cease and Desist Order: FTC ruling requiring a company to stop an FTC ruling requiring a company to stop an unfair business practice that reduces or limits competition.unfair business practice that reduces or limits competition.

1914: Federal Trade Commission Act

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STUDY FOR YOUR TEST!!STUDY FOR YOUR TEST!!

chapter 7: different types of market structures sws 2006 2 what are markets? a market is where...

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