C hapter 10 Identifying Markets and Market Structures © 2002 South-Western

2 Economic Principles The use of cross elasticity to define markets The relationship between firms, industries, and markets Market structures The characteristics of monopoly

3 Economic Principles The characteristics of monopolistic competition The characteristics of perfect competition The role of advertising

4 Defining the Relevant Market Relevant market The set of goods whose cross elasticities with others in the set are relatively high and whose cross elasticities with goods outside the set are relatively low.

5 Defining the Relevant Market The relevant market can be defined narrowly or broadly. What gets included in the relevant market will be determined by this definition.

6 Defining the Relevant Market Example: Automobiles and transportation. A relevant market can be narrowly defined as just the automobile industry.

7 Defining the Relevant Market Example: Automobiles and transportation. Transportation is a broader definition of the relevant market. It would include the automobile industry as well as all other possible forms of transportation, including taxis, buses, railways and airlines.

8 Defining the Relevant Market 1. What makes up the relevant market for oil? All possible sources of oil, such as Saudi Arabia and the United States.

9 Defining the Relevant Market 2. What makes up the relevant market for energy? Oil, hydroelectric power, coal, wood, solar and nuclear sources.

10 Courts and Markets In many cases the courts are called upon to determine what the market is.

11 Courts and Markets Example: DuPont’s relevant market. In 1953 the government filed suit against DuPont, charging it illegally dominated the cellophane market because it produced over 80 percent of all cellophane.

12 Courts and Markets Example: DuPont’s relevant market. DuPont countered that its relevant market was not cellophane, but the broader market of flexible packaging materials.

13 Courts and Markets Example: DuPont’s relevant market. By that definition, DuPont controlled less than 20 percent of the market.

14 Courts and Markets Example: DuPont’s relevant market. The court decided in favor of DuPont.

15 Courts and Markets The decision of the courts is not revealed truth, but rather an impartial judgment concerning the issue of what constitutes a relevant market.

16 Courts and Markets One tool the courts use to identify the relevant market is cross elasticity of demand.

17 Cross Elasticity Defines the Market The relevant market can be delineated by comparing the cross elasticities among goods within the set and outside the set.

18 Cross Elasticity Defines the Market It has been suggested that when the cross elasticity (e) between two goods is greater than or equal to three, the goods can be regarded as belonging to the same market.

19 EXHIBIT 1DELINEATING THE MARKET

20 Exhibit 1: Delineating the Flower Market In Exhibit 1, what is the market for each zone? Zone A is the Peace rose market. The cross elasticity for goods within the set is infinite – any Peace rose will be a good substitute. The cross elasticity for goods outside the set is zero – nothing but a Peace rose will substitute.

21 Exhibit 1: Delineating the Flower Market In Exhibit 1, what is the market for each zone? Zone A and B are the rose market. The cross elasticity of goods within the set is relatively high (e=25) – for most people, any rose will be a good substitute. The cross elasticity of goods outside the set is relatively low – for most people, only a rose will make a good substitute.

22 Exhibit 1: Delineating the Flower Market In Exhibit 1, what is the market for each zone? Zone A, B and C are the flower market. The cross elasticity of goods within the set is still relatively high (e=10) – for most people, any kind of flower will be a good substitute. The cross elasticity of goods outside the set is relatively low – for most people, nothing but flowers will make a good substitute.

23 Exhibit 1: Delineating the Flower Market In Exhibit 1, what is the market for each zone? Zone D lies outside these markets. The cross elasticity of goods within the set is zero (e=0) – fish do not substitute for flowers.

24 Markets and Market Structure Market structure A set of market characteristics such as number of firms, ease of firm entry, and substitutability of goods.

25 Markets and Market Structure The most important characteristic that distinguishes one market structure from another is the number of producers selling in the market.

26 Markets and Market Structure The number of producers within a market determines: The control an individual producer has in the market. How producers respond to decisions consumers make.

27 Markets and Market Structure The number of producers within a market determines: How producers respond to decisions other producers in their market make. How producers respond to the the market prices they face.

28 EXHIBIT 2THE MARKET STRUCTURE SPECTRUM

29 Exhibit 2: The Market Structure Spectrum 1. How is the monopoly market structure characterized? Only one firm is producing goods. The goods have no substitutes. No other firm can enter the market.

30 Exhibit 2: The Market Structure Spectrum 2. How is the perfectly competitive market structure characterized? A considerable number of firms are producing goods. The goods are perfect substitutes. Firms can easily enter the market.

31 Exhibit 2: The Market Structure Spectrum 3. How is the monopolistic competition market structure characterized? Greater than a few, but fewer than a considerable number of firms are producing goods. Firms can enter the market, but without the ease allowed in perfectly competitive markets.

32 Exhibit 2: The Market Structure Spectrum 4. How is the oligopoly market structure characterized? Only a few firms are producing goods. Entry into the market is relatively difficult.

33 Markets and Market Structure Mutual interdependence Any price change made by one firm in the oligopoly affects the pricing behavior of all other firms in the oligopoly.

34 The World of Monopoly Monopoly A market structure consisting of one firm producing a good that has no close substitutes. Firm entry is impossible.

35 The World of Monopoly Complete this sentence: _____ is the most important characteristic defining a monopoly. i. The size of the firm. ii. Being the only firm.

36 The World of Monopoly Complete this sentence: _____ is the most important characteristic defining a monopoly. ii. Being the only firm.

37 The World of Monopoly Industry A collection of firms producing the same good.

38 The World of Monopoly If only one firm firm produces a good, then the firm is the industry.

39 EXHIBIT 3A MONOPOLY’S DEMAND CURVE

40 Exhibit 3: A Monopoly’s Demand Curve How does the market demand curve compare to the monopoly demand curve? The curves are identical.

41 The World of Monopoly In a monopoly market structure, it is impossible for other firms to enter the market. Factors that contribute to impossible entry include the nature of the market, exclusive access to resources, the patent system, and acquisition.

42 The Natural Monopoly Natural monopoly The result of a combination of market demand and firm’s costs such that only one firm is able to produce profitably in a market.

43 EXHIBIT 4THE NATURAL MONOPOLY

44 Exhibit 4: The Natural Monopoly 1. What happens before the Blues enter the baseball market in Exhibit 4? The Reds charge $7 per person and draw a crowd of 40,000. The ATC is $5. The Reds’ profit = $(7-5)*40,000 = $80,000.

45 Exhibit 4: The Natural Monopoly 2. What happens after the Blues enter the baseball market and each team charges $7 per person? Attendance is split between the Blues and Reds. With an attendance of only 20,000, the ATC climbs to $11. Losses for each team = $(7-11)*20,000 = -$80,000.

46 Exhibit 4: The Natural Monopoly 3. What happens when the Blues and the Reds lower the price per person to $4? At $4 per person, attendance climbs to 35,000 per team. The ATC is $5.50. Losses for each team = $(4-5.50)*35,000 = -$52,500.

47 Exclusive Access to Resources Some firms, by chance or by design, acquire exclusive access to a nonreproducible good. New discoveries of the resource or the creation of alternatives to the resource destroy the monopoly.

48 Exclusive Access to Resources How might a monopoly on coal power as a source of energy be destroyed? A new producer finds a new source of coal and is able to enter the market. Alternatives to coal, such as solar and wind power, are developed.

49 The Patent System Patent A monopoly right on the use of a specific new technology or on the production of a new good. The monopoly right is awarded to and safeguarded by the government to the firm who introduces the new technology or good.

50 Acquisition Buying out all of the competition is another way to create a monopoly market structure. Andrew Carnegie, the first US steel mogul, built his empire by consuming the competition.

51 Monopolistic Competition and Oligopoly Monopolistic competition A market structure consisting of many firms producing goods that are close substitutes. Firm entry is possible but less open and easy than in perfect competition.

52 Monopolistic Competition and Oligopoly Oligopoly A market structure consisting of only a few firms producing goods that are close substitutes.

53 Monopolistic Competition and Oligopoly The real extent of competition in an oligopoly market must be measured by the number of firms in all the industries producing close substitutes.

54 EXHIBIT 5RELATIONSHIP BETWEEN FIRMS, INDUSTRIES, AND MARKETS

55 Exhibit 5: Relationship Between Firms, Industries, and Markets 1. How many firms are depicted in Exhibit 5? i. 1 ii. 3 iii. 15

56 Exhibit 5: Relationship Between Firms, Industries, and Markets 1. How many firms are depicted in Exhibit 5? iii. 15. Each box represents one firm.

57 Exhibit 5: Relationship Between Firms, Industries, and Markets 2. How many industries are depicted in Exhibit 5? i. 1 ii. 3 iii. 15

58 Exhibit 5: Relationship Between Firms, Industries, and Markets 2. How many industries are depicted in Exhibit 5? ii. 3. The steel industry, the concrete industry and the aluminum industry.

59 Exhibit 5: Relationship Between Firms, Industries, and Markets 3. How many markets are depicted in Exhibit 5? i. 1 ii. 3 iii. 15

60 Exhibit 5: Relationship Between Firms, Industries, and Markets 3. How many markets are depicted in Exhibit 5? i. 1. All of the firms and all of the industries are part of the construction market.

61 Monopolistic Competition and Oligopoly Product differentiation The physical or perceived differences among goods in a market that make them close, but not perfect, substitutes for each other.

62 Monopolistic Competition and Oligopoly As more firms enter a market, firm demand curves become more elastic.

63 EXHIBIT 6THE DEMAND CURVE FOR COCA-COLA: BEFORE AND AFTER SUBSTITUTES APPEAR ON THE MARKET

64 Exhibit 6: The Demand Curve for Coca-Cola: Before and After Substitutes Appear on the Market 1. How can Coke’s demand curve be described before substitute goods appear on the market? Coke’s demand curve equals the market demand curve.

65 Exhibit 6: The Demand Curve for Coca-Cola: Before and After Substitutes Appear on the Market 2. How does Coke’s demand curve change after substitute goods appear on the market? Coke’s demand curve shifts to the left, while the market demand curve remains at D 1.

66 Monopolistic Competition and Oligopoly Brand loyalty The willingness of consumers to continue buying a good at a price higher than the price of its close substitutes.

67 Monopolistic Competition and Oligopoly Market share The percentage of total market sales produced by a particular firm in a market.

68 Monopolistic Competition and Oligopoly Firms in both the monopolistic competition and oligopoly market structures have strong incentives to advertise. Advertising is a way to increase market share and make demand more inelastic.

69 EXHIBIT 7THE EFFECT OF ADVERTISING ON THE FIRM’S DEMAND CURVE

70 Exhibit 7: The Effect of Advertising on the Firm’s Demand Curve Complete this sentence: After advertising, Coke’s demand curve shifts to the _____. i. Right. ii. Left.

71 Exhibit 7: The Effect of Advertising on the Firm’s Demand Curve Complete this sentence: After advertising, Coke’s demand curve shifts to the _____. i. Right.

72 Perfect Competition Perfect competition A market structure consisting of a large number of firms producing goods that are perfect substitutes. Firm entry is open and easy.

73 Perfect Competition Characteristics of perfect competition: Goods are perfect substitutes. Firms have insignificant market share. Firms have free entry. Firms cannot influence price.

74 EXHIBIT 8MARKET DEMAND CURVE AND THE DEMAND CURVE FACING A FIRM IN PERFECT COMPETITION

75 Exhibit 8: Market Demand Curve and the Demand Curve Facing a Firm in Perfect Competition 1. Why is the demand curve for a perfectly competitive firm horizontal? The perfectly competitive firm cannot influence price. Therefore, it can produce any quantity it desires and price will always remain the same.

76 Exhibit 8: Market Demand Curve and the Demand Curve Facing a Firm in Perfect Competition 2. What would happen if a firm decided to charge $0.66 for potatoes in Exhibit 8? The quantity demanded would fall to zero.

77 EXHIBIT 9SUMMARY SKETCH OF MARKET STRUCTURES

78 Exhibit 9: Summary Sketch of Market Structure Type of Market Number of Firms Type of Products Entry Influence over Price? Perfect Competition ManyIdenticalFullNo

79 Exhibit 9: Summary Sketch of Market Structure Type of Market Number of Firms Type of Products Entry Influence over Price? Monopolistic Competition Many Differentiated Difficult /Easy Yes

80 Exhibit 9: Summary Sketch of Market Structure Type of Market Number of Firms Type of Products Entry Influence over Price? OligopolyFew Usually Differentiated DifficultYes

81 Exhibit 9: Summary Sketch of Market Structure Type of Market Number of Firms Type of Products Entry Influence over Price? MonopolyOne--ImpossibleYes