Unit Six, Lesson One Economics Market Structures Unit Six, Lesson One Economics

Market Structures Laissez Faire—philosophy that the government should not interfere with commerce or trade (French term meaning “allow them to do”) Adam Smith’s theory that government is only to protect private property, enforce contracts, settle disputes, and protect domestic companies from foreign competitors

Market Structures Wealth of Nations, written by Adam Smith in 1776, enforced this Laissez Faire policy and the U.S. adopted many of its economic ideas and the government played a small (if any) roll in the market of good and services By the 1800s, however, competition was weakening

Market Structures Due to mergers and acquisitions, many small firms in an industry were combined into few very large businesses This is when government started stepping in and regulating the market more The government tries to keep competition active in most markets, but there are a number of different types of markets classified according to the conditions that prevail in them

Market Structure Market structure—the nature and degree of competition among firms in the same industry

Perfect Competition Perfect competition—large number of well informed independent buyers and sellers whom exchange identical products Example: local vegetable farming Necessary Conditions: Large number of buyers and sellers; no single buyer or seller is large enough or powerful enough to affect price

Perfect Competition Necessary Conditions (cont.) Buyers and sellers deal in identical products Each buyer and seller acts independently—this competition is one of the forces that keep prices low Buyers and sellers are reasonably well-informed about products and prices Buyers and sellers are free to enter into, conduct, or get out of business

Perfect Competition Market forces of supply and demand establish the equilibrium price. The perfectly competitive firms operate where marginal cost = marginal revenue; there profits are maximized.

Perfect Competition Few, if any, perfectly competitive markets exist, but local vegetable farming comes closest. Imperfect competition is the name given to a market that lacks one or more of the conditions of perfect competition; most firms in the U.S. fall into the imperfect competition classification. Perfect competition is still important because economists use it to evaluate other market structures.

Monopolistic Competition Monopolistic competition--market structure that has all the conditions of perfect competition EXCEPT for identical products Example: Athletic shoe industry Non-price competition—the use of advertising, give-aways, or other promotional campaigns to convince buyers that the product is somehow better than another brand

Monopolistic Competition Product differentiation—real OR imagined differences between competing products in the same industry If a firm can differentiate a product in the mind of the buyer, the firm can raise its price. Profit is again maximized where MC=MR

Oligopoly Oligopoly—a market structure in which a few very large sellers dominate the industry Product may be differentiated (like the auto industry) or standardized (like the steel industry). Examples: soft drinks, airlines, fast food, autos

Oligopoly Because oligopolists are so large, whenever one firm acts, the other firms usually follow. This is called interdependent behavior—prices tend to move together across the industry. Another type of interdependent behavior is collusion—a formal agreement to set prices or to cooperate in some manner.

Oligopoly A type of collusion is price fixing—agreeing to charge the same or similar prices for a product. Firms can also collude to divide the market so all are guaranteed to sell a certain amount. Because collusion usually restrains trade and fair competition, it is illegal.

Oligopoly Because prices within an oligopolistic market tend to move together, most firms tend to compete on a nonprice basis with advertising or other product differentiating. Oligopolists maximize profits where MC=MR.

Monopolies Monopoly—market structure with only one seller of a particular product Very few monopolies exist in the U.S. because of anti-trust laws—laws that outlaw monopolies.

Types of Monopolies Natural monopoly—a market situation where the costs of production are minimized by having a single firm produce the product. Examples: telephone companies in one area, public utilities Justification for a natural monopoly is economies of scale—a situation in which the average cost of production falls as the firm gets larger Geographic monopoly—a monopoly based on the absence of other sellers in a certain geographic area. Example: gas station on a lonely highway

Types of Monopolies Technological monopoly—a monopoly based on ownership or control of a manufacturing method, process, or other scientific agreement. Example: companies with patents or copyrights Government Monopoly—a monopoly the government owns and operates. Examples: uranium, water use, etc.

Monopolies Monopolies are price makers—they do not rely on supply and demand to set the market price (because they are the only supplier). Monopolies will charge more for its product if not regulated, but it will still operate at the profit maximizing point of MC=MR.