CHAP 7 MARKET STRUCTURE.

MARKET STRUCTURE—A TERMS THAT REFERS TO HOW COMPETITION EXISTS WITHIN THE MARKET PLACE.

PERFECT COMPETITIONTHIS IS A RARE MARKET SITUATION THAT EXISTS WHEN 4 CHARACTERISTICS ARE IN

PLACE:• 1)A LARGE NUMBER OF BUYERS AND SELLERS. BECAUSE

THERE IS SUCH A LARGE NUMBER OF BUYERS AND SELLERS PRICE IS SET ALMOST WHOLLY BY THE INTERACTION OF SUPPLY AND DEMAND. http://www.youtube.com/watch?v=61GCogalzVc

* 2)SELLERS OFFER IDENTICAL PRODUCTS. ANY PRODUCT THAT IS THE SAME NO MATTER WHO SELLS IT IS A COMMODITY. BECAUSE THERE ARE SO MANY SUBSTITUTES FOR PRODUCTS, THE NUMBER OF COMMODITIES CAN BE LIMITED. THIS IS PROBABLY THE MAIN REASON WHY PERFECT COMPETITIONIS SO RARE.

PERFECT COMPETITION– 3) BUYERS AND SELLERS ARE WELL

INFORMED ABOUT THE PRODUCT. THIS IS CALLED PRODUCT KNOWLEDGE. TO OBTAIN THIS KNOWLEDGE, THE BUYER AND SELLER FACE A TRADEOFF BETWEEN THEIR TIME AND THE INFORMATON THAT THEY GAIN.

– 4) NO BARRIERS TO ENTRY IN THE MARKETPLACE. A BARRIER TO ENTRY IS ANYTHING THAT WOULD PREVENT A SUPPLIER FROM ENTERING OR COMPETING IN THE MARKET PLACE. BARRIERS TO ENTRY MIGHT INCLUDE: HIGH START UP COSTS, LACK OF TECHNOLOGY,

GOVT. REGULATIONS.

PERFECT COMPETITION MARKETS

• TEND TO BE VERY EFFICIENT. THE F.O.P. MUST BE USED TO THEIR GREATEST POTENTIAL.

• PRICES ARE USUALLY THE LOWEST THAT ARE POSSIBLE, A REACTION TO SUPPLY AND DEMAND.

• SELLERS LOOK FOR THE EQUILIBRIUM POINT—WHERE SHORTAGE AND SURPLUS DO NOT EXIST

IMPERFECT COMPETITION.

• WHEN BARRIERS TO ENTRY BECOME TOO COMPLEX OR NUMEROUS, THEN YOU ENTER INTO AN AREA CALLED “IMPERFECT COMPETITION”.

• THERE ARE 3 TYPES OF “IMPERFECT COMPETITION”.

3 TYPES OF IMPERFECT COMPETITION.

• MONOPOLY– A MARKET CONTROLLED BY ONE SELLER THAT

SELLS A PRODUCT THAT HAS NO SUBSTITUTE – http://www.youtube.com/watch?v=7UWgKZsKZOc

• OLIGOPOLY– A MARKET WHERE 3-4 BUSINESSES CONTROL 70-

80% OF THE MARKET– http://www.youtube.com/watch?v=kVsVUSPb0fg&feature=re

lated

• MONONPOLISTIC COMPETITION– A MARKET WHERE MANY SELLERS SELL

IDENTICAL OR PRODUCTS THAT CAN VARY. – http://www.youtube.com/watch?v=ExxS9KCsGWY&feature=

related

IMPERFECT COMPETITION“THE MONOPOLY”

• CHARACTERISTICS INCLUDE:• A) ONE FIRM SELLING A PRODUCT• B) PRODUCT HAS NO VARIETY OR

SUBSTITUTE• C) BARRIERS TO ENTRY TO THIS MARKET

ARE COMPLETE• D) COMPLETE PRICE CONTROL

THE MONOPOLY THE MONOPOLY IS A MARKET WHERE ONE FIRM IS

THE SOLE PROVIDER OF A PRODUCT FOR WHICH THERE IS NO SUBSTITUTE.

• FEW IF ANY TRUE MONOPOLIES’ EXIST. MOST ARE CALLED NEAR MONOPOLIES.

• A PRICE INCREASE BY A MONOPOLIST WILL USUALLY HAVE A SIMILAR EFFECT AS WITH OTHER MARKETS, IT WILL CAUSE FEWER PRODUCTS TO BE SOLD.

• WHEN A MONOPOLIST CUTS PRICES TO SELL MORE, A SITUATION WHERE MARGINAL REVENUE IS LESS THAN PRICE EXISTS.

• A MONOPOLIST MAXIMIZES PROFITS WHEN IT CHOOSES A LEVEL WHERE MARGINAL REVENUE IS EQUAL TO OR GREATER THAN MARGINAL COST.

THE ADVANTAGES OF THE MONOPOLY:

• THEY CAN REDUCE THEIR COSTS TO PRODUCE AS THEY PRODUCE EACH ADDITIONAL UNIT, PASSING THE SAVINGS ON TO THE CONSUMER. THIS ABILITY TO REDUCE COSTS AS IT PRODUCES IS CALLED ECONOMY OF SCALE.

• MARKET POWER—THE ABILITY TO CONTROL PRICES AND THE AMOUNT OF PRODUCT SUPPLY.

THE DISADVANTAGE OF THE MONOPOLY

• USUALLY HIGH START UP COSTS—CREATES A BARRIER TO ENTRY.

• COSTS REMAIN HIGH UNTIL ECONOMY OF SCALE STARTS.

• SUBJECT TO GOVERNMENT REGULATIONS—ANTI-TRUST LAWS

TYPES OF MONOPOLIES

• THE NATURAL MONOPOLY• RUNS MOST EFFICIENTLY WHERE ONLY ONE

FIRM PROVIDES THE ENTIRE PRODUCT—AVOIDS WASTING RESOURCES.

• (EXAMPLES: UTILITIES, GEOGRAPHIC LIMITATIONS)

• TECHNOLOGY HAS LIMITED OR ELIMINATED THE NUMBER OF NATURAL MONOPOLIES

• ALLOWED TO OPERATE AND REGULATED BY THE GOVT. BY PRICE CONTROLS AND QUALITY STANDARDS.

TYPES OF MONOPOLIES

• THE GOVERNMENT MONOPOLY

• A MONOPOLY CREATED BY THE GOVERNMENT AS THE SOLE PROVIDER OF A GOOD OR SERVICE.

• (EXAMPLES OF GOV’T. PRODUCTS—MAIL, NATIONAL DEFENSE, POLICE, FIRE, ETC)

IN WHAT WAYS DOES THE GOVERNMENT CREATE OR ISSUE A

COMPANY MONOPOLY POWER?

• ISSUING A PATENT----SETS UP A TECHNOLOGICAL MONOPOLY BY GIVING ONE COMPANY EXCLUSIVE RIGHTS TO SELL ONE PRODUCT FOR A PERIOD OF TIME.

• *** GOVERNMENT BELIEVES THAT A PATENT WILL ENCOURAGE PRODUCT RESEARCH AND DEVELOPMENT.

• ISSUING A COPYRIGHT—GIVES EXCLUSIVE RIGHTS TO WRITERS, PAINTERS, AND OTHER ARTISTS FOR THEIR WORKS.

IN WHAT WAYS DOES THE GOVERNMENT CREATE OR ISSUE A

COMPANY MONOPOLY POWER?• ISSUE A FRANCHISE

– PERMISSION BY AUTHORITIES TO GIVE A SINGLE FIRM EXCLUSIVE RIGHTS WITHIN A MARKET.

• EXAMPLE—THE SCHOOL GRANTS FRANCHISE RIGHTS TO PEPSI TO SUPPLY SOFT DRINKS AND VENDING MACHINES FOR ALL THE SCHOOL AND IT’S FUNCTIONS.

• ISSUE A LICENSE – LICENSE THAT GIVES A COMPANY THE RIGHT TO

OPERATE.– EXAMPLE—THE F.C.C. ISSUES A LICENSE TO

TELEVISON AND RADIO STATIONS.

INDUSTRIAL MONOPOLY

• SOMETIMES THE GOVERNMENT WILL ALLOW A MARKET TO LIMIT THE NUMBER OF FIRMS IT WILL ALLOW

• LIKE MAJOR LEAGUE BASEBALL LIMITS THE LOCATION OF MANY OF THEIR TEAMS / FRANCHISES.

PRICING IN THE MONOPOLY

• PRICE DISCRIMINATION– DIVISION OF CUSTOMERS INTO GROUPS

BASED UPON HOW MUCH THEY WILL PAY FOR A GOOD.

– PRACTICED BY ANY COMPANY WITH MARKET POWER.

• ABILITY TO CONTROL PRICES AND MARKET OUTPUT

TYPES OF PRICE DISCRIMINATION ARE:

• Discounted Airline Tickets—Discounts based on advance purchase and travel flexibility.

• Rebates—Money back offers for those who agree to take time to fill out forms.

• Senior Citizen or Student Discounts—Discounts received by those based on small incomes or fixed income.

• Children for free discounts—Children stay or eat for free to attract parents and young customers.

WHAT LIMITS ARE PLACED ON PRICE DISCRIMINATION?

• Price discriminating firms MUST have some control over pricing.

• Firms Must be able to divide customers into distinct groups.

• Products purchased must be difficult for resale , more often consumed or used immediately. Example—Food or travel discounts are used pretty easily and immediately, they are hard to transfer

A SECOND FORM OF IMPERFECT COMPETITION

• MONOPOLISTIC COMPETITION– Not a type of Monopoly

• A MARKET STRUCTURE IN WHICH MANY COMPANIES SELL PRODUCTS THAT ARE SIMILAR BUT NOT IDENTICAL

• MOST RETAIL STORES ARE MONOPOLISTIC

CHARACTERISTICS OF MONOPOLISTIC COMPETITION

• MANY FIRMS—SINCE THERE IS ONLY A NEED FOR A SMALL INVESTMENT, MANY FIRMS ARE INVOLVED IN THIS TYPE OF MARKET.

• THERE ARE FEW RESTRICTIONS OR BARRIERS TO ENTRY INTO THIS MARKET

CHARACTERISTICS OF MONOPOLISTIC COMPETITION

• FIRMS HAVE SOME CONTROL OVER PRICES—A FIRM CAN ALTER PRICES BECAUSE THE PRODUCTS MAY BE DIFFERENT, BUT CONTROL IS LIMITED DUE TO THE SUBSTITUTION EFFECT.

• PRODUCT DIFFERENTIATION—FIRMS CAN CREATE MORE PRODUCTS (WIDER VARIETY) BY SLIGHT DIFFERNTIATION OF THEIR ORIGINAL PRODUCTS.– THIS IS CONSIDERED THE MOST

IMPORTANT CHARACTERISTIC OF MONOPOLISTIC COMPETITION!!

NON-PRICE COMPETITION—THE ALTERNATIVE TO PRICE CHANGES

• IN NON-PRICE COMPETITION, FIRMS USE ALTERNATIVE METHODS TO CHANGE OR AFFECT PRICES.

• THESE METHODS ARE ALL PART OF AN ECONOMIC PRACTICE CALLED “MARKETING”

• 50% OR MORE OF ANY PRODUCT COSTS COMES FROM THE COST OF MARKETING

• http://www.youtube.com/watch?v=XtvHNfomZL8

TYPES OF NON-PRICE COMPETITION

• PHYSICAL CHARACTERISTICS—A WAY FOR A FIRM TO DISTINGUISH THEIR PRODUCTS FROM OTHERS. (PACKAGING)– USE OF COLORS, SHAPES OF PACKAGES, TEXTURE,

TASTE ARE EXAMPLES. – http://videos.smallbusinessnewz.com/2008/07/25/c

olors-tell-all/

• LOCATION—DETERMINES WHAT TYPES OF PRODUCTS YOU CAN SELL AND HOW MUCH DIFFERNTIATION IS NEEDED.– EXAMPLE--A FAST FOOD RESTAURANT ON THE

EDGE OF A MAJOR CITY ON A BUSY ROADWAY.

TYPES OF NON-PRICE COMPETITION cont.

• SERVICE LEVEL—SELLERS CAN CHARGE DIFFERENT PRICES BASED ON THE AMOUNT OF SERVICE THEY PROVIDE WITH THEIR PRODUCTS. THIS CAN INCLUDE THINGS LIKE WARRANTIES OF ANY TYPE, REBATES, AND PERSONAL INDIVIDUAL SERVICE.

• ADVERTISING—FIRMS USE ADVERTISING TO SHOW OR CREATE THE DIFFERENCES BETWEEN THEIR PRODUCT AND THE COMPETITION’S PRODUCT. THERE ARE 2 TYPES OF ADVERTISING:

• 1) Informative Advertising—Gives buyers product information.• 2) Competitive Advertising—Tries to convince the buyer that this

product is superior to the competition or that this product is necessary to improve their lives!

PRICE, OUTPUT, AND PROFITS IN MONOPOLISTIC

COMPETITION• PRICES• 1) PRICES HIGHER THAN IN

PERFECT COMPETITION• 2) PRICES ARE KEPT UNDER

CONTROL BY:• a) Product differentiation—creates substitutes• b) Competition of businesses in the market• c) New businesses in the market

PRICE, OUTPUT, AND PROFITS

• OUTPUT• 1) AFFECTED BY THE LAW OF DEMAND• 2) OUTPUT FALLS BETWEEN PERFECT

COMPETITION (LARGE SUPPLY OF PRODUCT) AND MONOPOLY ( LIMITED OR SET SUPPLY)

PRICE, OUTPUT, AND PROFITS

• PROFIT• 1) SEEK A SITUATION WHERE TOTAL

REVENUE IS EQUAL TO OR GREATER THAN TOTAL COSTS. T.R. = / > T.C.

• 2) PROFIT LIMITED BY COMPETITION & SUBSTITUTION EFFECT.

IMPERFECT COMPETITIONTHE OLIGOPOLY MARKET

• THE OLIGOPOLY MARKET IS A SITUATION WHERE A FEW FIRMS (3-4) CONTROL A MAJORITY (AT LEAST 70-80%) OF THE OUTPUT / SUPPLY.

• SERVICE INDUSTRY BUSINESSES OR CONSUMER DURABLES ARE USUALLY OLIGOPOLYS

. CHARACTERISTICS OF THE OLIGOPOLY

• A FEW FIRMS THAT CONTROL THE MARKET.• (EXAM/--HOUSEHOLD DURABLES, AIRLINES, SOFT DRINK

COMPANIES, AUTO MAKERS)

• B) PRODUCTS MAY BE THE SAME OR BE DIFFERENTIATED

• C) THE OLIGOPOLIST HAS SOME CONTROL OVER PRICES

• D) THERE ARE A NUMBER OF BARRIERS TO ENTRY INTO THIS MARKET. ( EXAM.—HIGH START UP COSTS,

GOVERNMENT REGULATIONS, INABILITY TO ACHIEVE ECONOMY OF SCALE)

PRODUCTION AND PRICING PROBLEMS OF THE

OLIGOPOLY• ) PRICING• 1) PRICE LEADERSHIP—ONE FIRM

SETS THE PRICE AND OTHER FIRMS WILL FOLLOW AND SET PRICES IN A SIMILAR WAY!

• 2) THOSE WHO REFUSE TO ACCEPT OF PRACTICE PRICE LEADERSHIP WILL BEGIN INDEPENDENT PRICING OR TRY TO UNDERCUT THEIR COMPETITORS PRICES BY STARTING A PRICE WAR!

PRODUCTION & PRICING IN THE OLIGOPOLY

• COLLUSION—WHEN FIRMS IN THE SAME MARKET AGREE TO SET THE SAME PRODUCTION LEVELS AND SET THE SAME PRICES. THIS PRACTICE IS ILLEGAL IN THE U.S. (IN THEORY)

• PRICE FIXING—A FORM OF COLLUSION WHERE MEMBERS SET THE SAME PRICE IN THE MARKET, DESTROYING

COMPETITION!

CARTELS

• A FORMAL ORGANIZATION OF FIRMS OR COUNTRIES TO COORDINATE AND SET PRODUCTION AND PRICES.

• 2) ILLEGAL IN THE U.S.

• O.P.E.C.--World famous cartel, “Organization of Petroleum Exporting Countries.

GOVERNMENT REGULATION AND DEREGULATION

• *** THE GOVERNMENT OVERSEES THE ACTIVITIES OF THE VARIOUS MARKETS IN ORDER TO INSURE SAFE PRODUCTS AND FAIR AND REASONABLE COMPETITION.

MARKET POWER-THE ABILITY TO CHANGE PRICES AND

OUT PUT• A) MARKETS WILL USE PRACTICES TO

INCREASE THEIR MARKET POWER ;

• 1) FORM CARTELS

• 2) MERGERS OR FORM TRUSTS

• 3) PREDATORY PRICING—LOWERING PRICES TO DRIVE COMPETITION OUT OF BUSINESS

THE GOVERNMENT REGULATES COMPETITION

• ANTI-TRUST LEGISLATION—LAWS DESIGNED TO LIMIT UNFAIR BUSINESS COMBINATIONS AND PRACTICES:

• 1) SHERMAN ANTI-TRUST ACT. It prohibits certain business activities that reduce competition in the marketplace,

• 2) CLAYTON ANTI-TRUST ACT Prohibits any mergers that lead to illegal price discrimination.

• 3) ROBINSON-PATMAN ACT Further the laws against price discrimination by making it illegal to set prices at different levels for different puirchasers.

THE GOVERNMENT REGULATES BUSINESS BY

ERA• 1900-1970’S --ERA OF REGULATION

– GOVERNMENT LAWS PASSED TO REGULATE BUSINESS AND CONTROL BUSINESS ACTIVITY

• 1970’S--1980--ERA OF DEREGULATION– GOVERNMENT RELAXED LAWS IN AREAS LIKE

BANKING, TRUCKNG, AIRLINES, ETC.– LED TO THE INFAMOUS S&L SCANDAL

• 1990--TODAY--ERA OF REREGULATION– GOVERNMENT RENEWS EFFORTS TO REGULATE

BUSINESS.– EFFORTS TO BREAK UP TRUSTS LIKE MICROSOFT

AND A.T.&T.