Identifying Markets and Market Structures

1. Chapter 10 Identifying Markets and Market Structures

2. Economic Principles • The use of cross elasticity to define markets • The relationship between firms, industries, and markets • Market structures • The characteristics of monopoly Gottheil - Principles of Economics, 4e

3. Economic Principles • The characteristics ofmonopolistic competition • The characteristics of perfect competition • The role of advertising Gottheil - Principles of Economics, 4e

4. Defining the Relevant Market Relevant market • The set of goods whose cross elasticities with others in the set are relatively high and whose cross elasticities with goods outside the set are relatively low. Gottheil - Principles of Economics, 4e

5. Defining the Relevant Market The relevant market can be defined narrowly or broadly. What gets included in the relevant market will be determined by this definition. Gottheil - Principles of Economics, 4e

6. Defining the Relevant Market Example: Automobiles and transportation. • A relevant market can be narrowly defined as just the automobile industry. Gottheil - Principles of Economics, 4e

7. Defining the Relevant Market Example: Automobiles and transportation. • Transportation is a broader definition of the relevant market. It would include the automobile industry as well as all other possible forms of transportation, including taxis, buses, railways and airlines. Gottheil - Principles of Economics, 4e

8. Defining the Relevant Market 1. What makes up the relevant market for oil? • All possible sources of oil, such as Saudi Arabia and the United States. Gottheil - Principles of Economics, 4e

9. Defining the Relevant Market 2. What makes up the relevant market for energy? • Oil, hydroelectric power, coal, wood, solar and nuclear sources. Gottheil - Principles of Economics, 4e

10. Courts and Markets In many cases the courts are called upon to determine what the market is. Gottheil - Principles of Economics, 4e

11. Courts and Markets Example: DuPont’s relevant market. • In 1953 the government filed suit against DuPont, charging it illegally dominated the cellophane market because it produced over 80 percent of all cellophane. Gottheil - Principles of Economics, 4e

12. Courts and Markets Example: DuPont’s relevant market. • DuPont countered that its relevant market was not cellophane, but the broader market of flexible packaging materials. Gottheil - Principles of Economics, 4e

13. Courts and Markets Example: DuPont’s relevant market. • By that definition, DuPont controlled less than 20 percent of the market. Gottheil - Principles of Economics, 4e

14. Courts and Markets Example: DuPont’s relevant market. • The court decided in favor of DuPont. Gottheil - Principles of Economics, 4e

15. Courts and Markets The decision of the courts is not revealed truth, but rather an impartial judgment concerning the issue of what constitutes a relevant market. Gottheil - Principles of Economics, 4e

16. Courts and Markets One tool the courts use to identify the relevant market is cross elasticity of demand. Gottheil - Principles of Economics, 4e

17. Cross Elasticity Definesthe Market The relevant market can be delineated by comparing the cross elasticities among goods within the set and outside the set. Gottheil - Principles of Economics, 4e

18. Cross Elasticity Definesthe Market It has been suggested that when the cross elasticity (e) between two goods is greater than or equal to three, the goods can be regarded as belonging to the same market. Gottheil - Principles of Economics, 4e

19. EXHIBIT 1 DELINEATING THE MARKET Gottheil - Principles of Economics, 4e

20. Exhibit 1: Delineating the Flower Market In Exhibit 1, what is the market for each zone? • Zone A is the Peace rose market. • The cross elasticity for goods within the set is infinite – any Peace rose will be a good substitute. • The cross elasticity for goods outside the set is zero – nothing but a Peace rose will substitute. Gottheil - Principles of Economics, 4e

21. Exhibit 1: Delineating the Flower Market In Exhibit 1, what is the market for each zone? • Zone A and B are the rose market. • The cross elasticity of goods within the set is relatively high (e = 25)—for most people, any rose will be a good substitute. • The cross elasticity of goods outside the set is relatively low—for most people, only a rose will make a good substitute.

22. Exhibit 1: Delineating the Flower Market In Exhibit 1, what is the market for each zone? • Zone A, B and C are the flower market. • The cross elasticity of goods within the set is still relatively high (e = 10)—for most people, any kind of flower will be a good substitute. • The cross elasticity of goods outside the set is relatively low—for most people, nothing but flowers will make a good substitute.

23. Exhibit 1: Delineating the Flower Market In Exhibit 1, what is the market for each zone? • Zone D lies outside these markets. • The cross elasticity of goods within the set is zero (e = 0)—fish do not substitute for flowers. Gottheil - Principles of Economics, 4e

24. Markets and Market Structure Market structure • A set of market characteristics such as number of firms, ease of firm entry, and substitutability of goods. Gottheil - Principles of Economics, 4e

25. Markets and Market Structure The most important characteristic that distinguishes one market structure from another is the number of producers selling in the market. Gottheil - Principles of Economics, 4e

26. Markets and Market Structure The number of producers within a market determines: • The control an individual producer has in the market. • How producers respond to decisions consumers make. Gottheil - Principles of Economics, 4e

27. Markets and Market Structure The number of producers within a market determines: • How producers respond to decisions other producers in their market make. • How producers respond to the the market prices they face. Gottheil - Principles of Economics, 4e

28. EXHIBIT 2 THE MARKET STRUCTURE SPECTRUM Gottheil - Principles of Economics, 4e

29. Exhibit 2: The Market Structure Spectrum 1. How is the monopoly market structure characterized? • Only one firm is producing goods. • The goods have no substitutes. • No other firm can enter the market. Gottheil - Principles of Economics, 4e

30. Exhibit 2: The Market Structure Spectrum 2. How is the perfectly competitive market structure characterized? • A considerable number of firms are producing goods. • The goods are perfect substitutes. • Firms can easily enter the market. Gottheil - Principles of Economics, 4e

31. Exhibit 2: The Market Structure Spectrum 3. How is the monopolistic competition market structure characterized? • Greater than a few, but fewer than a considerable number of firms are producing goods. • Firms can enter the market, but without the ease allowed in perfectly competitive markets. Gottheil - Principles of Economics, 4e

32. Exhibit 2: The Market Structure Spectrum 4. How is the oligopoly market structure characterized? • Only a few firms are producing goods. • Entry into the market is relatively difficult. Gottheil - Principles of Economics, 4e

33. Markets and Market Structure Mutual interdependence • Any price change made by one firm in the oligopoly affects the pricing behavior of all other firms in the oligopoly. Gottheil - Principles of Economics, 4e

34. The World of Monopoly Monopoly • A market structure consisting of one firm producing a good that has no close substitutes. Firm entry is impossible. Gottheil - Principles of Economics, 4e

35. The World of Monopoly Complete this sentence: _____ is the most important characteristic defining a monopoly. i. The size of the firm. ii. Being the only firm. Gottheil - Principles of Economics, 4e

36. The World of Monopoly Complete this sentence: _____ is the most important characteristic defining a monopoly. i. The size of the firm. ii. Being the only firm. Gottheil - Principles of Economics, 4e

37. The World of Monopoly Industry • A collection of firms producing the same good. Gottheil - Principles of Economics, 4e

38. The World of Monopoly If only one firm firm produces a good, then the firm is the industry. Gottheil - Principles of Economics, 4e

39. EXHIBIT 3 A MONOPOLY’S DEMAND CURVE Gottheil - Principles of Economics, 4e

40. Exhibit 3: A Monopoly’s Demand Curve How does the market demand curve compare to the monopoly demand curve? • The curves are identical. Gottheil - Principles of Economics, 4e

41. The World of Monopoly In a monopoly market structure, it is impossible for other firms to enter the market. Factors that contribute to impossible entry include the nature of the market, exclusive access to resources, the patent system, and acquisition. Gottheil - Principles of Economics, 4e

42. The Natural Monopoly Natural monopoly • The result of a combination of market demand and firm’s costs such that only one firm is able to produce profitably in a market. Gottheil - Principles of Economics, 4e

43. EXHIBIT 4 THE NATURAL MONOPOLY

44. Exhibit 4: The Natural Monopoly 1. What happens before the Blues enter the baseball market in Exhibit 4? • The Reds charge $7 per person and draw a crowd of 40,000. The ATC is $5. The Reds’ profit = $(7 - 5) × 40,000 = $80,000. Gottheil - Principles of Economics, 4e

45. Exhibit 4: The Natural Monopoly 2. What happens after the Blues enter the baseball market and each team charges $7 per person? • Attendance is split between the Blues and Reds. With an attendance of only 20,000, the ATC climbs to $11. Losses for each team = $(7-11) × 20,000 = -$80,000. Gottheil - Principles of Economics, 4e

46. Exhibit 4: The Natural Monopoly 3. What happens when the Blues and the Reds lower the price per person to $4? • At $4 per person, attendance climbs to 35,000 per team. The ATC is $5.50. Losses for each team = $(4 - 5.50) × 35,000 = -$52,500. Gottheil - Principles of Economics, 4e

47. Exclusive Access to Resources Some firms, by chance or by design, acquire exclusive access to a nonreproducible good. New discoveries of the resource or the creation of alternatives to the resource destroy the monopoly. Gottheil - Principles of Economics, 4e

48. Exclusive Access to Resources How might a monopoly on coal power as a source of energy be destroyed? • A new producer finds a new source of coal and is able to enter the market. • Alternatives to coal, such as solar and wind power, are developed. Gottheil - Principles of Economics, 4e

49. The Patent System Patent • A monopoly right on the use of a specific new technology or on the production of a new good. The monopoly right is awarded to and safeguarded by the government to the firm who introduces the new technology or good. Gottheil - Principles of Economics, 4e

50. Acquisition Buying out all of the competition is another way to create a monopoly market structure. Andrew Carnegie, the first U.S. steel mogul, built his empire by consuming the competition. Gottheil - Principles of Economics, 4e