CHAPTER 7: DIFFERENT TYPES OF MARKET STRUCTURES Sharrock 2006

What Are Markets? A market is where buyers and sellers: meet to exchange goods and services. are affected by some level of competition. The market may be in one specific place or It does not exist physically at all (IT IS JUST A THEORY!!) SWS 2006

What Are Markets? 1. Pure (perfect) Competition Markets are classified by 4 structures 1. Pure (perfect) Competition 2. Monopolistic Competition 3. Oligopoly 4. Monopoly SWS 2006

IT IS ONLY A THEORY! 1. Perfect Competition BEFORE WE BEGIN!! This is a theoretical situation. NO TRUE Perfectly Competitive Market exists. IT IS ONLY A THEORY! SWS 2006

The 5 conditions of perfect competition LARGE number of SMALL firms. No single buyer or seller can influence the price. Buyers and sellers deal in identical products. No product differences. (EXAMPLES: Salt, Flour, Commodity, Corn) Unlimited Competition: so many firms, that suppliers lose the ability to set their own price. No Barriers to Entry. Sellers are free to enter the market, conduct business and free to leave the market. (Low cost to enter) Each firm is a PRICE-TAKER (more on this later) CONSUMERS HAVE THE LARGEST SELECTION OF BUYERS TO BUY GOODS FROM BECAUSE NO SINGLE GOOD IS MORE APPEALING THAN ANOTHER. SWS 2006

The 5 conditions of perfect competition No Barriers to entry. Sellers are free to enter the market, conduct business and free to leave the market. Perfect competition is the opposite of monopoly. Here, any firm can get into the market at very little cost. Suppose there was a market for dandelions. Growing dandelions requires little start-up cost. All you need are dandelion seeds, soil, water, and some sunlight. There is no difference between one dandelion and another, so the market has a similar product. The agricultural market is the best example of a perfectly competitive market. SWS 2006

Perfect Competition too small Each individual firm is to influence prices. Price becomes fixed to everyone in the industry. EXAMPLE: the price of a bushel of wheat is set only by the interaction of supply and demand. Generally speaking, wheat is the same per bushel in North Georgia as it is in Florida. SWS 2006

MARKET POWER = “the ability to set one’s OWN prices” Perfect Competition Firms in a perfectly competitive market are price takers. (they take the price they are given, they can’t change the price) Since they have no control over their own prices, they have _______________________. NO MARKET POWER MARKET POWER = “the ability to set one’s OWN prices” In other words, no one will buy an overpriced dandelion. Why should they? A 4-cent dandelion is the same as the 3-cent one, so there is no reason to spend that extra penny. SWS 2006

Monopolistic Competition The 5 conditions of Monopolistic Competition LARGE number of large companies (but fewer than perfect competition). Sellers can influence the price through creating a product identity (more on this later) Products are NOT exactly identical, BUT VERY SIMILAR, so companies use PRODUCT DIFFERENTIATION Heavy Competition: Firms must remain aware of their competitor’s actions, but they each have some ability to control their own prices. Low Barriers to Entry: harder to get started because of the amount of competition. Monopolistic competition takes its name and its structure from elements of monopoly and perfect competition. SWS 2006

Monopolistic Competitive Market STUDY TIP: The key idea to understanding monopolistic competition is that firms sell products that are similar, but not exactly alike. EXAMPLE: Hand Soap Essentially, all hand soaps are the same. Yet firms can create a brand identity that separates their hand soap from their competitor’s. This brand identity can be formed through packaging, product support, and especially advertising. If effective, consumers will positively identify a certain brand and purchase it even if hand soap costs more. SWS 2006

Conditions of Monopolistic Competition The point is that firms in Monopolistic Competition must use Product Differentiation & Non-price Competition to sell their products. Product Differentiation: The real or imagined differences between competing products in the same industry. Differences may be real or imagined. Differentiation may be color, packaging, store location, store design, store decorations, delivery, service….. anything to make it stand out! SWS 2006

Conditions of Monopolistic Competition The point is that firms in Monopolistic Competition must use Product Differentiation & Non-price Competition to sell their products. Non-Price Competition: Non-Price Competition involves the advertising of a product's appearance, quality, or design, rather than its price. Advertising to help the consumer believe that this product is different and worth more money. Notice these commercials never mention price. VS SWS 2006

Examples of Monopolistic Competition Auto, Steel, Gas, Fast Food, Airlines. SWS 2006

MERGERS OF LARGE COMPANIES Sometimes companies fall victim to market failure. However, not all businesses close their doors and empty their factories and stores. Many get “swallowed up” by another company. This “take-over” or acquisition of a company is known as a merger. There are THREE types of mergers: HORIZONTAL, VERTICAL, and CONGLOMERATE. 1.) HORIZONTAL: involve firms in the SAME market, such as between two oil companies. Reason: Diversification 2.) VERTICAL: involve one firm buying a resource provider. EXAMPLE: steel company buys an automaker 3.) CONGLOMERATE: a company buys a business in a UNRELATED industry. SWS 2006

Conditions of an Oligopoly What is an Oligopoly? A market in which a two-three large sellers control most of the production of a good or service and they work together on setting prices. Conditions of an Oligopoly Very few Sellers that control the entire market. Products may be differentiated or identical (but they are usually standardized) Medium barriers to entry: Difficult to Enter the market because the competitors work together to control all the resources & prices. The actions of one affects all the producers. Collusion = an agreement to act together or behave in a cooperative manner. SWS 2006

Conditions of Oligopoly What is an Oligopoly? A market in which a two-three large sellers control most of the production of a good or service and they work together on setting prices. Conditions of Oligopoly Collusion = an agreement to act together or behave in a cooperative manner. Collusion Agreements: usually illegal, among producers to fix prices, limit output, or divide markets. (hard to prove that a group of companies is doing this) It is also called Price Fixing: setting the same prices across the industry. THIS IS IN VIOLATION OF ANTI-TRUST LAWS. WHY? Basically, the companies are acting a one large monopoly. SWS 2006

Price Behavior in Oligopoly Now, sometimes businesses do not agree with each other about the price, and if that happens, a WAR will result. Price Wars: Series of price cuts that competitors must follow or lose business. it is a fierce price competition between sellers, sometimes the price is lower than the cost of production. Why is that bad??? Oligopolists would like to be Independent Price setters: a firm sets prices based on demand, cost of input and other factors (not based on other companies prices). SWS 2006

2 Types of Price Behavior in an Oligopoly Price Leader: independent pricing decisions made by a dominate firm on a regular basis that results in generally uniform industry-wide prices. ADVANTAGE: you are the company leading the price. Independent Pricing: policy by a competitor that ignores other producer’s prices. DISADVANTAGE: other firms shut you down by agreeing to set lower prices than yours. SWS 2006

Conditions of Monopoly Exact Opposite of Pure Competition. A price maker. (set their own price, without regard to supply and demand) There is a single seller No close substitute goods are available High Barriers to Entry: Other sellers cannot enter the Market. SWS 2006

WHY WOULD GOVERNMENT DO THIS??? Types of Monopolies 4 Distinct Types of Monopolies: Natural Monopoly: Where costs are minimized by having a single producer of the product. Gas, water, electricity: government creates Natural Monopolies by Franchising some utilities. Franchise - the right to produce or do business in a certain area without competition. Government franchises come with government regulation. Georgia PSC (Public Service Commission) WHY WOULD GOVERNMENT DO THIS??? Economies of Scale: As natural monopolies grow larger, this reduces its production costs (economies of scale). Because normally companies become more efficient as the firm becomes larger. Example: It is cheaper for the Tennessee Valley Authority (TVA) to provide power in Georgia than two or three companies. SWS 2006

EXAMPLE: Only person selling water in the desert. Types of Monopolies Geographic Monopoly: The only business in a location due to size of market. Decreasing in the U.S. because of mobility. EXAMPLE: Only person selling water in the desert. SWS 2006

Types of Monopolies Technological Monopoly: Firm has discovered a new process or product. Constitution gave government the right to grant technological monopolies. Patent: 17 years exclusive rights to a developed technology. Copyright: (Artists and writers) Life plus 50 years. SWS 2006

Types of Monopolies Government Monopoly: Retained by the government. Liquor sales in some counties, uranium production, water, etc. SWS 2006

3 Conditions of Efficient & Successful Markets Markets work best when four conditions are met: Adequate competition must exist in all markets. Buyers and sellers are reasonably well-informed about conditions and opportunities. Resources must be free to move from one industry to another. Market Failure occurs when any of the 3 conditions alter significantly. SWS 2006

Types & Causes for Market Failure Inadequate Competition: Dangers to monopolies Monopolies may waste and misallocate scarce resources because there is no competition. Inadequate Information: A free enterprise economy requires information. It is difficult to employ resources for the fullest benefit of society without adequate information. Resource Immobility: The efficient allocation or resources require that land, labor, capital and entrepreneurs be free to move to markets where returns are the highest Externalities / Side Effects: A side effect that benefits or harms a third party that was not directly involved in the activity. Negative Externality: People are harmed or inconvenienced by an economic decision. SWS 2006

The Role of Government Government has the power to maintain competition, regulate monopolies, or to run government-owned monopolies. Since the late 1800s the US have passed laws to restrict and regulate monopolies and trusts. Trust: a legally formed combination of companies. SWS 2006

Antitrust Legislation The Role of Government Antitrust Legislation Interstate Commerce Act: Passed by Congress in 1887. It was aimed at the railroads. Charges of unfair pricing prompted Congress to act. 1887 PRESENT 1887: Interstate Commerce Act SWS 2006

The Role of Government 1890 - Sherman Antitrust Act - law against monopolies that hindered competition or made competition impossible because of the “restraint of trade” that is created by a monopoly. 1887 PRESENT 1887: Interstate Commerce Act 1890: Sherman Antitrust Act SWS 2006

The Role of Government 1914 - Clayton Antitrust Act - outlawed price discrimination - charging different customers different prices for the same product. Further defined Sherman. (preferred pricing) 1887 PRESENT 1887: Interstate Commerce Act 1890: Sherman Antitrust Act 1914: Clayton Antitrust Act SWS 2006

The Role of Government 1914 - Federal Trade Commission Act - passed to enforce the Clayton Antitrust Act. It gave the authority to issue Cease and Desist order. Cease and Desist Order: FTC ruling requiring a company to stop an unfair business practice that reduces or limits competition. 1887 PRESENT 1887: Interstate Commerce Act 1890: Sherman Antitrust Act 1914: Clayton Antitrust Act 1914: Federal Trade Commission Act SWS 2006

STUDY FOR YOUR TEST!! SWS 2006