Ch. 7: Market Structures

1. Ch. 7: Market Structures

2. Sec. 1: What Is Perfect Competition?

3. The Characteristics of Perfect Competition • Economists classify markets based on how competitive they are • Market structure – • Perfect competition – • useful as a model, but real markets are never perfect • economists assess how competitive market is by determining where it falls short of a perfect competition

4. 5 Characteristics • 1.– no one seller or buyer has control over price • 2.– a product that consumers consider identical in all essential features to other products in the same market • 3.– buyer and sellers are free to enter and exit the market, no govt. regulations prevent participation nor is any business or custom required to participate in the market

5. 4.– buyers cannot join other buyers and sellers cannot join other sellers to influence prices • 5.– both buyers and sellers are well-informed about market conditions, buyers can do comparison shopping and sellers can learn what their competitors are charging • Price taker – is a business that cannot set the prices for its products but instead accepts the markets price set by the interaction of supply and demand • only efficient producers make enough money to serve perfectly competitive markets

6. Characteristic 1: Many Buyers and Sellers • Large # of buyers and sellers necessary for perfect competition so that no one buyer has power to control the price in the market • many sellers – buyers can chose to buy from different producer if one tries to raise price above the market level • b/c many buyers – sellers able to sell product at market price • ex – Smith family selling at Montclair Farmers’ Market – sell raspberries • many farmers grow and sell at market – charge same price • if one tries to sell at higher price – buyers buy from someone else • all know they can sell at market price b/c of sufficient demand

7. Characteristic 2: Standardized Product • In perfect competition – • products are perfect substitutes • ex. – eggs, milk, wheat, notebook paper, gold • No 2 pints of raspberries are exactly alike – similar enough consumers will buy from any producer that offers raspberries • price is only basis to choose one product over another

8. Characteristic 3: Freedom to Enter and Exit Markets • Perfectly competitive markets – • investment to enter is low • market forces encourage producers to freely enter or leave • Smiths consider market price for raspberries when planting – if they can make a profit – grow it

9. Characteristic 4: Independent Buyers and Sellers • Perfectly competitive market – • buyers and sellers act independently • interaction of supply and demand set equilibrium price • independent action ensures market will remain competitive

10. Characteristic 5: Well-Informed Buyers and sellers • Perfectly competitive market – • buyers compare prices among different sellers • sellers know what prices competitors are charging and what buyers will pay

11. Competition in the Real World • In real world – no perfectly competitive markets b/c real markets do not have all of the characteristics of perfect competition • Imperfect competition – • wholesale markets for beef & corn come close to perfect competition

12. Example 1: Corn • In US – thousands of farmers grow corn – no one farmer can control price of corn • all accept market price • can decide how much to produce to offer for sale

13. Example 1: Corn • Large # of buyers – price on wholesale market easy to determine • corn fairly standardized – buyers no reason to prefer one over another • buyers will not pay more than market price • reality – • US govt. pays subsidies to farmers to protect from low prices • some corn farmers band together to try & influence price of corn

14. Example 2: Beef • Many cattle producers and little variation in a particular cut from another • wholesale buyers primary concern is price • buyers and sellers can easily determine the market price • sellers can only adjust production to reflect market price

15. Example 2: Beef • Reality – • cattle ranchers may try to join together to influence the price of beef • producers try to persuade buyers that there are significant differences in product that warrant higher prices

16. Sec. 2: The Impact of Monopoly

17. The Characteristics of a Monopoly • Perfect competition is the most competitive market structure • Monopoly – • it is the least competitive market • term can be used for the market structure or monopolistic business • pure monopoly as rare as pure competition – some businesses come close

18. Cartel – • Price maker – a business that does not have to consider competitors when setting its prices • consumers either accept the price or do not buy the product • Barrier to entry – • ex. – large size, govt. regulation, special resource, technology • 3 characteristics of a monopoly – De Beers Diamonds

19. Characteristic 1: Only One Seller • A single business is identified with the industry b/c it controls the supply of a product that has no close substitute • De Beers once produced more than half of world’s diamond supply and bought the rest from smaller producers

20. Characteristic 2: A Restricted, Regulated Market • In some cases • De Beers – worked with the South African govt. • new mines required to sell through De Beers • company restricted access to market for raw diamonds for producer outside South Africa

21. Characteristic 3: Control of Prices • Monopolists control prices b/c no close substitutes for their product & no competition • economic downturn reduced demand – De Beers created artificial shortage by withholding diamonds from the market • cartel could continue charging higher price

22. Types of Monopolies Several reasons why monopolies exist and not all are harmful Natural monopoly – Govt. monopoly – is a monopoly that exist b/c the govt. either owns and runs the business or authorizes only one producer

23. Types of Monopolies Technological monopoly – Geographic monopoly – is a monopoly that exists b/c there are no other producers or sellers within a certain region

24. Example 1: Natural Monopoly: A Water Company • In some markets – • most public utilities fall into this category • Water company – pumps water – through pipes to homes, businesses, public facilities • monitors water quality for safety, removes and treats wastewater • waste of community resources to have several companies do this same job

25. Example 1: Natural Monopoly: A Water Company • Economic scale – • more customers – more efficient as high fixed costs are spread out • these economic scales get govt. support of natural monopolies • govt. regulates so do not charge excessively high prices

26. Example 2: Govt. Monopoly: The Postal Service • Govt. run businesses provide goods & services that could not be provided by private firms or are not attractive due to insufficient profit opportunity • oldest govt. monopoly – • at first, only govt. could provide this in efficient and cost effective manner • today – new services and new technology chipping away • also – people send by email, fax, text message, pay bills online

27. Example 3: Technological Monopoly: Polaroid • 1947 – Edwin Land (founder of Polaroid) invented 1st instant camera • with patents – created monopoly in instant photography market • Patent – • govt. support tech. monopolies by issuing patents • patents allow business to recover costs in developing invention or technology

28. Example 3: Technological Monopoly: Polaroid • Polaroid controlled technology through its patents & a barrier for other firms • 1985 – Polaroid won lawsuit against Kodak for patent infringement • blocks Kodak from instant photography market • Technology monopolies last as long as the patent – generally 20 years • or when new technology creates a substitute-new tech for instant camera – easy to use 35mm, one hour photo processing, digital cameras • Today – instant camera is minor segment of photography market

29. Example 4: Geographic Monopoly: Professional Sports • Major sports require teams be associated with a city or region & limit # on teams in each league • leagues create a restricted market • most teams draw fans from large surrounding geographic region • owner are able to charge higher prices for tickets than if there was competition • also have a ready market for apparel & merchandise with logo & colors

30. Example 4: Geographic Monopoly: Professional Sports • Physical isolation is creates geographic monopoly – gas station in middle of desert off interstate • Joe only supplier of gas with no close substitute • drivers can either buy gas or risk running out • Joe can control the price & its expensive • Geographic monopolies have become less common in US – people can travel greater distances, catalog orders, internet business

31. Profit Maximizations by Monopolies • Monopoly is only firm with product – cannot charge any price • still faces a downward sloping demand curve – ie. will sell more at lower prices • Monopolist can cause demand by causing a shortage of the product – artificially raising the equilibrium price • most countries have laws preventing monopolies

32. Example: Drug Manufacturer • Pharmaceutical Manufacturers – • drug patents generally last 11 years in US • try to maximize profits until patent runs out – then face competition from generic drugs • Generic drugs –

33. Claritin – approved as prescription in 1993 – but patented earlier • did not make users drowsy – became top seller - $3 billion in annual sales • patent expired in 2002 – generic came out – sales dropped to $1 billion in annual sales

34. Sec. 3: Other Market Structures

35. Characteristics of Monopolistic Competition • Most markets in real world fall between models of perfect competition & monopoly • Monopolistic competition – • eg. – T-shirts with images or slogans • market is competitive due to many buyers and many sellers • monopolistic b/c sellers have influence over a small segment of the market with products that are not exactly like those of competitors

36. Characteristics of Monopolistic Competition • Distinguishing features – product differentiation & non-price competition • Product differentiation – • ex – substantial differences – gas mileage ratings • ex – life of batteries – reality - difference in battery life is minimal • Nonprice competition – • the cool gizmo from a fast food chain

37. Four major characteristics 1. Many buyers for many sellers 2. Similar but differentiated products 3. Limited lasting control over prices 4. Freedom to enter and exit the market

38. Characteristic 1: Many Sellers and Many Buyers • In monopolistic competition – • perfectly competitive market - # of sellers is usually smaller – but enough for meaningful competition • sellers act independently in choosing what product to make, how much & price • Hamburgers – • no seller has a large enough share of market to control supply of price • the restaurants with your favorite have a monopoly on your business though

39. Characteristic 2: Similar but Differentiated Products • In monopolistic competition – sellers gain limited monopoly by making a distinctive product or convincing consumers that their product is different from the competition • Burgers – restaurants will say quality of ingredients or way its cooked • distinctive packaging, money back guarantee if unhappy • one way to win over is with brand names & encouraging loyalty • advertising informs consumers of differences

40. Characteristic 2: Similar but Differentiated Products • How to decide to differentiate burgers – market research • gathering and evaluating info about consumer preferences for goods & services • for local – listening to consumer praise & complaints & competitors • Focus group – • used by large chain restaurants to gain consumer lifestyles and product preference • Surveys –

41. Characteristic 3: Limited Control of Prices • Product differentiation give producers limited control of price • charge different prices based on how they want to appeal to customers • low priced burgers for parents of young eaters on tight budget • name brand burgers with better ingredients are higher priced • if differences are important enough – consumers will pay • if price goes too high – consumers will switch to substitutes and producers know this

42. Characteristic 4: Freedom to Enter or Exit Market • No huge barrier to enter this type of market • to open burger stand – not need for huge amount of capital • when firms earn profit – other firms will enter & increase competition • increased competition means finding ways to differentiate the product • competition more intense for smaller businesses rather than larger businesses • those firms that take losses – signals time to get out • In restaurant market – sell off equipment - if finances are solid – look for new market

43. Characteristics of an Oligopoly • Oligopoly – • a few large firms have a large market share and dominant the market • Market share – a percent of total sales in a market • movies – movie (only a few major studios), theaters (only a few chains) – oligopolies • Start-up costs – • few firms due to high start-up costs • making a movie – expensive if to compete with major studios, need network of promoters & distributors

44. Four major characteristics of Oligopoly 1. Few sellers but many buyers 2. Industrialized market – standardized product & in consumer market – differentiated product 3. Few sellers have more power to control prices 4. To enter or exit market is difficult

45. Characteristic 1: Few Sellers and Many Buyers • A few firms dominant the entire market • not a single supplier – but fewer firms than in monopolistic competition • produce a large part of the total product in the market • Economists consider an industry to be an oligopoly if the 4 largest firms control 40% of market • half of manufacturing industries in US fall into this • Breakfast industry in US dominated by 4 firms who control 80% • lots of variety of cereal – but less competition

46. Characteristic 2: Standardized or Differentiated Products • Depending on market – will sell one or the other • many industrial products are standardized and a few large firms control this • ex – steel, aluminum, flat glass • firms differentiate based on brand names, service, location • Consumer products offered are differentiated • ex – breakfast cereals, soft drinks • Market product using strategies similar to monopolistic competition • use surveys, focus groups & market research techniques to find likes • brand names can be marketed across country and world

47. Characteristic 3: More Control of Prices • Few sellers – • each breakfast cereal maker has enough of a share of market – that decisions made about supply and price affect the market as a whole • seller in oligopoly is not as independent as seller in monopolistic competition • decision made by one seller may cause other to respond in the same way • ex – if one seller drops prices – others will follow so not to lose customers • ex – but if one raises prices – other will not follow so to try and gain customers • firms in an oligopoly try to anticipate how competitors will respond to actions before making decisions on price, output or marketing

48. Characteristic 4: Little Freedom to Enter or Exit Market • Start-up costs can be extremely high • entering breakfast cereal industry on small scale is not very expensive – but low profits • to compete against the majors – need factories, warehouses & other infrastructure – is expensive • also – manufacturers may hold patents • Firms in oligopolies have establish brands and plentiful resources – make it tough for new firm • manufacturing firms have agreements with grocery stores for best shelf space • existing manufacturers have economies of scale to help expenses low • smaller firms lack economies of scale • Investment in an oligopoly make it difficult to leave the market • when major breakfast cereal maker losses money – too vast and complex to sell and reinvest • must trim operation & stimulate demand for its product

49. Comparing Market Structures • Each structure had different benefits & problems • each creates different balance of power between producer and consumer • Consumers get most value in markets that approach perfect competition • no perfect competitive markets • prices set by supply and demand • a standardized product - consumers have little choice other than best price

50. Comparing Market Structures