Industry Structure & Public Policy

1. Industry Structure & Public Policy “I don’t think it’s right that only one company gets to make the game Monopoly.” Steven Wright Comedian EIGHT

2. Industry Structure & Public Policy • In this chapter: • Meaning of ‘industry structure” • Characteristics of the four structures • Market power • Why firms behave the way the do

3. Industry Structure Industry Structure Makeup of an industry as defined by certain factors: Number and size distribution of sellers Nature of the product Barriers (or lack of barriers) to entry and exit These factors determine whether a firm has market power, ability to set price.

4. Industry Structure (Four Types)

5. Industry Structure (Four Types)

6. Industry Structure (Four Types)

7. Industry Structure (Four Types) Which do you suppose has most market power? Ability to set price? WHY?

8. Market Power • Market power (and ability to set price) is highest when: • Number of sellers is smaller • With many sellers, setting price too high will drive consumers away from you to lower priced rivals. • Product is differentiated • If products are close substitutes, consumers are more likely to be driven away because you aren’t the only game in town. • Barriers to entry/exit are high • If barriers are low, profits will attract more firms into the industry, lowering profits and driving price down.

9. Firm Behavior Due to Industry Structure Monopolistic Competition • Examples: Restaurants, convenience stores, gas stations, nail shops, hair salons. • Part “monopoly”, part “competition”: • Monopoly because it is selling a unique product. • Competition because there are lots of close substitutes. • Considered inefficient by economists because of “excess capacity” • The Thai restaurant on WT Harris usually has more tables than they need. But at peak times they can fill every seat. Most of the time they have excess capacity. • Economists don’t mind the inefficiency in this case because it provides variety of consumption, increases social welfare. • Imagine what would happen if there was no excess capacity in restaurant market . . .

10. Firm Behavior Due to Industry Structure Oligopoly • Examples: Soft drinks, airlines, athletic shoes, beer, cigarettes, satellite TV. • High market power, but not free to change price: • Oligopolists have high market share because there are so few firms in the industry (Coke, Pepsi and Cadbury Schweppes have 90% of market) • A big player cannot change their price without first considering what their rivals will do in response: • What will they do if I raise price? • What if I lower my price? • Olgipolies are characterized by non-price rivalry: • Tend to see oligopolists advertise without mentioning price – usually quality, convenience, taste-tests, sex appeal . . .

11. Firm Behavior Due to Industry Structure Monopoly • Examples: Charlotte Observer, Duke Power, Pharmaceutical companies over certain drugs, the only dry cleaner in a small town. • Firms can be natural monopolies: • If one firm can produce a very large quantity of a good at a lower average cost per unit than several firms, the government may allow them to be a monopoly and erect high barriers to keep rivals out. • Example: Duke Power, Pharmaceuticals

12. Industry Structure & Public Policy • Key Terms: • Barriers to entry • Collusion • Heterogeneous • Homogeneous • Industry structure • Monopolistic competition • Monopoly • Natural monopoly • Oligopoly • Perfect competition