7-1: What is Perfect Competition?

Competition Economists classify markets based on how competitive they are Market structure: Describes the level of competition found in an industry. Perfect Competition Monopolistic Competition Oligopoly Monopoly

Perfect Competition Perfect Competition Definition: ideal model of a market economy Note: Ideal is a model, not a reality in most cases.

5 Characteristics of Perfect Competition 1. Numerous buyers and sellers No single buyer or seller has the power to control the prices. Buyers have lots of options Sellers are able to sell their products at market price

5 Characteristics of Perfect Competition (continued) 2. Standardized product A product that consumers see as identical regardless of the producer Example: milk, eggs, etc.

5 Characteristics of Perfect Competition (continued) 3. Freedom to enter and exit markets Producers enter the market when it is profitable and exit when it is unprofitable

5 Characteristics of Perfect Competition (continued) 4. Independent buyers and sellers This allows supply and demand to set the equilibrium price

5 Characteristics of Perfect Competition (continued) 5. Well-informed buyers and sellers Buyers compare prices Sellers know what consumers are willing to pay for goods

Perfect Competition Examples of markets that are close to perfect competition: Corn Beef

Imperfect Competition Market structures that lack one of the conditions needed for perfect competition are examples of imperfect competition This means there are only a few sellers and/or products are not standardized

7-2: Monopoly – More than a Game

Definition of a Monopoly A market structure in which only one producer sells a product for which there are no close substitutes Pure monopolies are rare

Definition of a Monopoly A cartel is close to a monopoly Cartel: a group of sellers that act together to set prices and limit output Example: OPEC—11 nations hold more than 2/3 of the world’s oil reserves

Definition of Monopoly Why do monopolies have no competition? Other firms struggle to enter the market due to a barrier to entry— something that stops the business from entering a market

3 Characteristics of Monopolies 1. Only One Seller Supply of product has no close substitutes

3 Characteristics of Monopolies 2. A Restricted or Regulated Market In some cases, government regulations allow a single firm to control a market (think utilities)

3 Characteristics of Monopolies 3. Control of Prices Prices are controlled since there are no close substitutes

Types of Monopolies First, not all monopolies are harmful When monoplies are harmful to consumers the government has power to regulate them or break them up Sherman Anti-Trust Act of 1890

Questions 1. Suppose that you went to a farmers’ market and found several different farmers selling cucumbers. Would you be likely to find a wide range of prices for cucumbers? Why or why not?

2. What would happen to a wheat farmer who tried to sell his wheat for $2.50 per bushel if the market price were $2.00 per bushel? Why?

3. In 2003, 95% of the households on the U. S 3. In 2003, 95% of the households on the U.S. had access to only 1 cable TV company in their area. What type of monopoly did cable TV companies have? Explain your answer.

4. In 2002 the patent on the antihistamine Claritin expired 4. In 2002 the patent on the antihistamine Claritin expired. Using the 3 characteristics of a monopoly, explain what happened to the market for Claritin when the patent expired.

7-3: Other Market Structures

Definition of Monopolistic Competition when many sellers offer similar, but not standardized products

Definition of Monopolistic Competition Monopolistic competition is based on product differentiation and non-price competition Product differentiation: attempt to distinguish a product from similar products

Characteristics of Monopolistic Competition (continued) Non-price competition: using factors other than low price to convince consumers to buy their products. Our car is better quality Our burger tastes better Our jeans are hipper Our purse is a status symbol

4 Characteristics of Monopolistic Competition 1. Many sellers and many buyers Meaningful competition exists Example: there are many restaurants where you can buy a hamburger

4 Characteristics of Monopolistic Competition (continued) 2. Similar but differentiated products Sellers try to convince consumers that their product is different from that of the competition

4 Characteristics of Monopolistic Competition (continued) 3. Limited control of prices Product differentiation gives producers limited control over price Consumers will buy substitute goods if the price goes too high

4 Characteristics of Monopolistic Competition (continued) 4. Freedom to enter or exit the market No huge barriers to enter a monopolistically competitive market When firms make a profit, other firms enter the market and increase competition

Oligopoly Definition Oligopoly: market structure in which only a few sellers offer a similar product Few large firms have a large market share: percent of total sales in a market

4 Characteristics of Oligopolies 1. Few sellers and many buyers Generally where the 4 largest firms control 40% of the market Example: breakfast cereal industry

4 Characteristics of Oligopolies (continued) 2. Standardized or differentiated products Products can be standard such as steel They try to differentiate themselves based on brand name, service, or location Or, products can be differentiated such as cereal and soft drinks They use marketing strategies to separate them from competitors

4 Characteristics of Oligopolies (continued) 3. More control of prices Each firm had a large enough share of the market that its decisions about price and supply affect one another

4 Characteristics of Oligopolies (continued) 4. Little freedom to enter or exit market Set-up costs are high Firms have established brands, making it hard for new firms to enter the market successfully

7-4: Regulation and Deregulation Today

Definition of Regulation set of rules or laws designed to control business behavior to promote competition and protect consumers

Antitrust Legislation Definition Antitrust Legislation: laws that define monopolies and give government the power to control them and break them up Example – Sherman Antitrust Act

Example: Standard Oil Company Trust Trust: when a group of firms are combined to reduce competition in an industry Example: Standard Oil Company

Definition of Merger: Merger when 2 firms join together to become 1 If a merger will eliminate competition it will be denied by the government Example – Google and Motorolla

Enforcing Antitrust Legislation The FTC and the Department of Justice are responsible for enforcing antitrust laws

Definition deregulation: Reducing or removing government control of a business Results in lower prices for consumers and more competition Example: airline industry was deregulated in 1978

Questions 1. In 2005, a major U.S. automaker announced a new discount plan for its cars for the month of June. It offered consumers the same price that its employees paid for new cars. When the automaker announced in early July that it was extending the plan for another month, the other 2 major U.S. automakers announced similar plans. What market structure is exhibited in this story and what specific characteristics of that market structure does it demonstrate?

2. Why do manufacturers of athletic shoes spend money to sign up professional athletes to wear and promote their shoes rather than differentiating their products strictly on the basis of physical characteristics such as design and comfort?

3. The Telecommunications Act of 1996 included provisions to deregulate the cable industry. In 2003, consumers complained that cable rates had increased by 45% since the law was passed. Only 5% of American homes had a choice of more than 1 cable provider in 2003. Those homes paid about 17% less than those with no choice of cable provider. How effective had deregulation been in the cable industry by 2003? Explain your reasoning.