Ch 5: Prices & Ch. 6: Market Structures

Section 5.1: The Price System The Language of Prices – Prices serve as the main form of communication between producers and consumers in a free-enterprise market If consumers buy a product at the established price, producers may be satisfied & maintain current production levels and prices – On the other hand, producers may decide to try to increase profits by raising prices » In return consumers may see the price increase as unacceptable and buy less of the product

Section 5.1: The Price System Benefits of the Price System – Using the price system as a form of communication between producer and consumers has several benefits: Information Incentives Choice Efficiency Flexibility

Section 5.1: The Price System Information – Producers and Consumers can gather info through the price system The prices of resources tell producers how much they must pay to make their products Prices inform consumers of the relative worth of the goods and services they purchase Incentives – The price system also provides producers and consumers w/ incentives to participate in the market High prices, when combined w/ low costs encourages producers to supply more products Low prices give consumers an incentive to buy more products

Section 5.1: The Price System Choice – By encouraging participation in markets, the price system also in creases the choices available in those markets The higher the incentive to supply products to the marketplace, the greater the choice of products supplied

Section 5.1: The Price System Efficiency – The key benefit of the price system – The price system brings about efficiency in 2 main ways Provides for the wise use of resources – Prices tell producers which products consumers want to buy » High prices encourage producers to use resources to provide products that consumers want » Low prices lead to producers to stop using resources to provide products that consumers do not want Quickly delivering info to producers and consumers – Prices immediately signal the value of a good or service in relation to other goods or services » Producers can easily compare the prices of resources & consumers can do the same for goods and services

Section 5.1: The Price System Flexibility – The supply & demand of goods changes almost constantly Limitations of the Price System – Market failures: the limitations of the price system – Externalities The production of goods sometimes results in side effects for not directly connected w/ the production or consumption of the goods, these side effects are externalities that can be negative or positive – A negative externality exists when someone who does not make or consume a certain product nonetheless bears part of the cost of its production – A positive externality exists when someone who does not sell or buy a certain product nonetheless benefits from its production

Section 5.1: The Price System Public Goods – Any good or service that is consumed by members of a group Public goods include: national defense and law enforcement Instability – Although the price system’s ability to adapt to change is generally considered a benefit, this flexibility can make the system somewhat unstable As the system reacts to natural disasters or a global crisis, prices can swing quickly between extremes

Section 5.2 Determining Prices Equilibrium – Market equilibrium is the situation that occurs when the quantity supplied and the quantity demanded for a product are equal at the same price At this point the needs of both producers and consumers are satisfied and the forces of supply and demand are in balance – Surpluses Exist when the quantity supplied exceeds the quantity demanded – They tell producers that they’re charging too much for their product – Shortages Exists when the quantity demanded exceeds the quantity supplied at the price offered – They tell producers that they are charging too little for their product

Section 5.2 Determining Prices Shifts in Equilibrium – When either the demand or the supply curve shifts, the equilibrium point also shifts to the new intersection of the curves

Section 5.3: Managing Prices Setting Prices – Governments sometimes set prices to protect producers & consumers from dramatic price swings Gov’ts accomplish this through price ceilings and price floors – Price Ceilings A government regulation that establishes a maximum price for a particular good – Producers can’t charge prices above this set level – Price Floors A government regulation that establishes a minimum level for prices – Minimum Wage: another example of a price floor, established by federal law, this wage is the lowest amount an employer legally can pay a worker for a job

Section 5.3: Managing Prices Rationing – Sometimes the supply of a good is so low that a government rations the good – Rationing is a system in which a government or other institution decides how to distribute a product Under a rationing system, a product is distributed on the basis of policy decisions rather than on the basis of prices determined by supply and demand

Section 5.3: Managing Prices Consequences of Rationing – The system is seen as: Unfair Expensive Creates black markets – Unfairness Rationing distributes goods and services unfairly, b/c the gov’t chooses who gets the products – Cost Rationing is costing to put into effect – Bureaucrats that distribute the rationed goods cost money – Black Markets Rationing encourages black markets, in which goods are exchanged illegally at prices

Section 6.1: Highly Competitive Markets Perfect Competition (pure competition) – An ideal market structure in which buyers (consumers) and sellers (producers) each compete directly and fully under the laws of supply and demand This means that no one buyer or seller controls demand, supply, or prices; nothing prevents competition among both buyers and sellers – The 4 Conditions of 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

Section 6.1: Highly Competitive Markets Many Buyers & Sellers – When there are many buyers & sellers, each one accounts for only a small share of the overall purchases or sales in the market Therefore, no single buyer or seller in a market has enough power to control demand, supply, or prices; instead levels of production & prices are set by the market forces of supply & demand Identical Products – Sellers offer identical products, so buyers make purchasing decisions by comparing “apples to apples” rather than “apples to oranges” This means that buyers choose one product over another primarily on price, not on unique characteristics – Monopoly: one seller controls all production of a good or service

Section 6.1: Highly Competitive Markets Informed Buyers – Under perfect competition, buyers must be knowledgeable about products W/out accurate & readily available product info, buyers cannot compare products effectively – Sellers can compete perfectly only when buyers can make informed decisions Easy Market Entry and Exit – For sellers to compete perfectly, they must be able to enter a profitable market or leave an unprofitable one, easily

Section 6.1: Highly Competitive Markets Monopolistic Competition – Unlike perfect competition, in monopolistic competition sellers offer different rather than identical products Each seller seeks to have monopoly-like power by selling a unique product – Similarities between perfect competition and monopolistic competition: Buyers & sellers compete under the laws or supply & demand Many buyers & sellers acting independently Buyers well-informed Easy entry and exit into the market

Section 6.1: Highly Competitive Markets Monopolistic Competition continued – Product Differentiation Sellers in monopolistic competition try to differentiate (point out differences) between their products and those of their competitors By pointing out differences which can be real or merely seem real to consumers; sellers used product differentiation to set apart their products – Nonprice Competition Any attempt by a seller to attract consumers from its competitors other than by lowering price – Ex: advertising – Profits By setting a sellers product apart from competition & convincing buyers to base their decisions on non-price factors, a seller can raise the price of its product above the competitive level & make more profit

Section 6.2: Imperfectly Competitive Markets Oligopolies – The most common noncompetitive market in the US – A market structure in which few large sellers control most of the production of a good or service – Oligopolies exist under 3 conditions: Only a few large sellers Seller offer identical or similar products Other sellers can’t enter the market easily

Section 6.2: Imperfectly Competitive Markets Oligopolies continued – Few large sellers A market is considered oligopoly when the largest 3 or 4 sellers produce most (like 70% or more) of the market’s output – Identical or Similar Products Sellers in oligopolies tend to offer identical or similar products – Difficult Market Entry High start-up costs, government regulation, and consumer loyalty to known brands makes market entry very difficult

Section 6.2: Imperfectly Competitive Markets Nonprice competition – Oligopolistic sellers attempt to differentiate their products through advertising & encouraging consumers to develop loyalty to particular brand names Interdependent Pricing – Being very responsive to or dependent on the pricing actions of their competitors – Price leadership In which one of the largest sellers in the market takes the lead by setting a price for its product – Competitors match the price of the price leader – Price War Where sellers aggressively undercut each other’s princes in an attempt to gain market share

Section 6.2: Imperfectly Competitive Markets Collusion – When sellers meet secretly agree to set production levels or prices for their products; this practice is illegal Collusion creates higher prices than supply and demand would have created Cartels – Sellers openly organize a system of price setting and market sharing Illegal in the United States Ex: OPEC, oil cartel

Section 6.2: Imperfectly Competitive Markets Monopolies – A single seller controls all production of a good or service, the conditions found in a monopoly are the opposite of those found in perfect competition – The 3 conditions of a monopoly: Single seller No close substitute goods available Other sellers can’t enter the market easily

Section 6.2: Imperfectly Competitive Markets Types of Monopolies – Natural Monopolies When competition is inconvenient and impractical in a market, thus a single large seller produces a product most efficiently – Economies of scale: the seller’s large scale allows it to use its resources more efficiently and economically than if several smaller producers attempted to make the product – Geographic Monopolies When a monopoly forms b/c a market’s potential profit is so limited by its geographic location that only a single seller decides to enter the market

Section 6.2: Imperfectly Competitive Markets Types of Monopolies continued – Technological Monopolies Some monopolies develop when a producer develops new technology that enables the creation of a new product or that changes the way an existing product is made Patent: grant a company or an individual the exclusive right to produce, use, rent, and sell an invention or discovery for a limited time (20 years in the US) Copyright: the US gov’t gives authors, musicians, and artists exclusive rights to publish, duplicate, perform, display, and sell their creative works – Government Monopolies Any market in which a government is the sole seller of a product

Section 6.2: Imperfectly Competitive Markets Monopolies at Work – The single seller of a monopoly has a great deal of control over prices; three forces limit them from setting whatever price they want – Consumer demand At some point consumers will not pay certain price for a good even if there is only one seller of the product – Potential Competition High profits may make a potential competitor courageous enough to enter the market – Government regulation To protect consumers from excessively high prices, government monitors and regulates monopolies

Characteristics Perfect Competition Monopolistic Competition OligopolyPure Monopoly Number of firms in each industry Many Few (3 or 4)One Market Concentration Low HighAbsolute Type of ProductSimilar or Identical Similar or Identical Similar or Differentiated Unique (no substitutes) Availability of Information Much (Advertising) Much (Advertising) Much (Advertising) Some (Advertising) Entry into IndustryVery EasyFairly EasyDifficultImpossible Control over PricesNoneLittleSomeComplete Example Industries AgricultureLong-distance phone services Automobile industry Electric Company

Section 6.3: Market Regulation Era of Big Business – After the civil war, fierce business competitions takes out small businesses and leaves several large companies This is the Era of Big Business Trusts: huge monopolies that dominate their markets – At first the US Gov’t did not interfere with the trusts because of the idea of laissez-faire (the government does not interfere w/ the market in any way) As the trusts gained more wealth and power, there was a clamor for the government to take action against the trusts

Section 6.3: Market Regulation Early Antitrust Legislation – Antitrust legislation Acts designed to monitor & regulate big business, prevent monopolies from forming, and dismantle existing monopolies Interstate Commerce Act (1887):created the Interstate Commerce Commission (ICC) to oversee railroad rates Sherman Antitrust Act (1890): prohibits any agreements, contracts, or conspiracies that would restrain interstate trade or cause monopolies to form

Section 6.3: Market Regulation Early Antitrust Legislation continued – Clayton Antitrust Act: clarified & strengthened the Sherman Antitrust Act by prohibiting price discrimination, local price cutting,, mergers that reduce competition, & exclusive sales contracts Price discrimination: the practice of offering different prices to different customers under the same circumstances – Federal Trade Commission Act (1914) Created the Federal Trade Commission (FTC) to investigate charges of unfair methods of competition and commerce – Robinson-Patman Act (1936) Protects small retail business by prohibiting wholesalers from charging small retailers higher prices than they charged large retailers & prohibiting large retailers from setting artificially low prices

Section 6.3: Market Regulation Antitrust Policy in Recent Decades – Celler-Kefauver Act (1950) Amended the Clayton Act to prohibit corporate acquisitions when they substantially decrease competition – Antitrust Procedures & Penalties Act (1975) Increased penalties for violating antitrust laws – Parens Patriae Act (1976) Gives states the right to sue companies on behalf of citizens harmed by the company's antitrust violations, requires large companies to inform the gov’t about planned mergers