Chapter Six

Market Structures: Why market competition affects you every time you shop!

Rule of Business:

The more competitive the industry, the more the consumer benefits.

Rule of Capitalism:

Encourage competition between firms in an industry (market).

The consumer benefits:

• $$$• Variety of products• Lots of information

about products

Two types of markets are highly competitive.

Perfect competitionMonopolistic competition

Perfect Competition

According to Adam Smith – the ideal market structure.Buyers and sellers compete fully and directly under the laws of supply and demand.

Conditions for Perfect Competition

Many buyers and sellers act independently.Sellers offer identical products.Buyers are well informed about products.Sellers can enter or exit the market easily.

Many Buyers and Sellers:

No single buyer or seller has enough power to control demand, supply or prices.

Think farming!

Identical Products

Corn is corn. Apples are apples.Buyers choose one product over another primarily based on price – not on unique characteristics.

Informed Buyers

Buyers are knowledgeable about products.Can compare products easily.

Easy Market Entry and Exit

For sellers to compete perfectly, they must be able to enter a profitable market - or exit an unprofitable market – EASILY.

THINK FARMING!

Monopolistic Competition

Differs in ONE key respect.

Sellers offer DIFFERENT, rather than identical, products.

Monopolistic Competition

Sellers seek to have monopoly-like power by selling a “unique” product.MOST COMMON MARKET STRUCTURE in the US!

Monopolistic Competition

Like perfect competition –

Supply / Demand laws apply.Many sellers and buyers acting independently.Buyers are well informed.Easy to enter / exit the market.

Product Differentiation – what makes

Monopolistic Competition DIFFERENT.Sellers in monopolistic competition try to DIFFERENTIATE – point out differences – between their products and competitors.

Nonprice Competition

Sellers compete on a basis other than price.Compete through advertising and emphasis on brand names.

Nonprice Competition

The main goal of product differentiation is to increase profits.Convince the buyer to make decision based on nonprice factors – not price alone.

Examples of Monopolistic Competition:

Telephone companiesAirlinesClothing makersHamburger jointsSodas

Imperfectly Competitive Markets

OligopoliesMonopolies

Oligopolies

There are a few large sellers that control the production of the good or service.

There are only a few large sellers.Sellers offer identical or similar products.Other sellers cannot enter the market easily.

Oligopolies: Few large sellers

A market (industry) is considered an oligopoly when three or four firms control 70% of the market’s total output.

Oligopolies: Identical or similar products

Each seller has a large share of the overall sales in the market.So much at stake – less likely to take risks.

Not offering new products.

Oligopolies: Difficult entry and exit in the market

New sellers cannot easily enter the market.

Big start-up costsGovt. regulationConsumer loyalty to established products

Oligopolies at work: legal and efforts to control prices.

Nonprice competition to differentiate the products.Efforts of Kelloggs, General Mills, and Post (80% of the market) create numerous brand names to look like they compete.

Oligopolies at work: legal means to control price

Interdependent Pricing: Base prices on the pricing actions of competitors.Not only similar products – but similar prices.

Price leadership

The most common form of interdependent pricing.

Largest sellers “set” the price of the product and the competitors follow. Control the price of the product.Oligopolies and Monopolies are Price Setters – not price takers as in perfect competition / monopolistic competition.

What happens when competing companies don’t follow along in oligopolies?

PRICE WAR!

Price Wars:Opportunity Benefits: prices can benefit consumer

Opportunity Costs: Sellers lose money and if the price war is on for long – might be forced out of the market.

Unemployment up Even less competition in the market

Oligopolies Dark Side: COLLUSION

Sellers secretly agree to set production levels and prices for their products.ILLEGAL!Oligopoly behaves like a monopoly.

Higher prices and lower quality for consumer.

Oligopolies Dark Side: Cartels

Sellers openly organize a system of price setting and market sharing.Illegal in the US.

Infamous Cartels

De Beers Diamonds

Creates scarcity by buying and stockpiling stones from other producers.

OPECBeen to the gas pump lately?

The good news about cartels

Often unstable and short lived.Greed makes members break ranks and try to sell more.

Price wars break out.

The ultimate bad guy: Monopolies

There is a single sellerNo close substitute goods are availableOther sellers cannot enter the market easily

Prices UP and quality of products DOWN because NO COMPETITION!

Types of MonopoliesNatural

REMEMBER: Economies of Scale

GeographicTechnological

Patents: seller gets 17 year monopolyCopyright protects written works and art

Government: Public goods

Monopolies at Work

Monopoly markets have a great deal of control over prices.

Three Things Limit Monopoly Control Over Setting Prices

Consumer DemandPotential CompetitionGovernment Regulation

Market Regulation

Government was laissez-faire with business until close to the 20th century.

The Era of Big Business

Rockefeller, Carnegie, JP Morgan-

Smaller companies were forced out of business or taken over by bigger businesses.TRUSTS = Big Business

Antitrust Legislation – Govt. takes on Big Business

Sherman Antitrust Act (1890) said govt. could monitor and regulate big business.

Used to break up Standard Oil’s monopoly in 1911.

• Today the company is called EXXON of EXXON MOBIL.

Clayton Antitrust Act

(1914) – prohibited specific unfair business practices.

Price Discrimination

• Offering different prices to different customers under the same circumstances.

Federal Trade Commission

Since 1914 – the government’s “police” who investigate business.

Monopoly Breakups

AT&T (1982)Standard Oil (1911)Microsoft????

Is Microsoft a Predatory Monopoly?

What “proof” is there that Microsoft is a predatory monopoly? What should be done?