© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko “The Economic Way of Thinking” 11 th Edition Chapter 8: Competition and Monopoly

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 2 of 34 Chapter 8 Outline Introduction Who Qualifies as a Monopolist? Alternatives, Elasticity and Market Power Privileges and Restrictions Price Takers and Price Searchers

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 3 of 34 Chapter 8 Outline Price Takers’ Markets and “Optimal” Resource Allocation Competition as a Process

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 4 of 34 Introduction Reality –Sellers set the majority of the prices. –Buyers set most of the rest. –A few are set by negotiations between buyers and sellers.

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 5 of 34 Introduction Market transactions are an activity. –Scarcity is a logical condition, not a material one. –Making choices involves rationing and prioritizing. –In our interactions with others we engage in competition.

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 6 of 34 Who Qualifies as a Monopolist? Monopoly –One seller Question –Was telephone service a good example prior to cellular phones? Answer –No - If phone service is broadly defined as “communication services”

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 7 of 34 Who Qualifies as a Monopolist? Question –Is a grocer a monopolist? Answer –Yes – If their services are narrowly defined as a provider to people with no alternative source of groceries. The word “monopoly” is extraordinarily ambiguous. – Everyone or no one is a sole seller depending on how we define the commodity being sold.

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 8 of 34 Alternatives, Elasticity and Market Power Question –What problems result from a single seller? Single sellers face no competition Buyers have no substitutes –Can be taken advantage of more easily

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 9 of 34 Alternatives, Elasticity and Market Power Price Elasticity of Demand –Helps explain how much control suppliers have over price.

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 10 of 34 Alternatives, Elasticity and Market Power P Q Does not exist

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 11 of 34 Alternatives, Elasticity and Market Power P Q Less than perfectly elastic demand

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 12 of 34 Alternatives, Elasticity and Market Power P Q Less elastic demand

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 13 of 34 Alternatives, Elasticity and Market Power More substitutes – more elastic the demand Market Power –A matter of degree –Inversely related to elasticity of demand

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 14 of 34 Privileges and Restrictions Monopolies may result from acts of the state. –Allow some to engage in an activity but not others –Tax and restrict some sellers but not others –Grant protection or assistance to some but not others

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 15 of 34 Privileges and Restrictions Governments impose restrictions on entry in the name of: –Public safety –Fair competition –Stability –National security –Efficiency

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 16 of 34 Privileges and Restrictions Questions –Who benefits from these restrictions? –Any losers? Monopolist (a possible definition) –Any individual or organization operating with the advantage of special privileges granted by the government

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 17 of 34 Privileges and Restrictions Question –What firms would be a monopolist using this definition? Oligopolies –Few sellers Questions –Few sellers of what? –How do you define the commodity?

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 18 of 34 Price Takers and Price Searchers Questions –Does US Steel establish the price for its product? –Does a farmer establish the price for his/her product?

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 19 of 34 Price Takers and Price Searchers Question –What would happen if a farmer tried to sell his product above the current market price of $3.38 ¾?

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 20 of 34 Price Takers and Price Searchers P Q / Won’t sell any D Sell all he wants

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 21 of 34 Price Takers and Price Searchers The farmer is a price taker. –He cannot affect the price –He can sell all he wants at the market price –He will probably not sell any at a price above the market price

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 22 of 34 Price Takers and Price Searchers Normal Seller –Sells more at a lower price –Sells less at a higher price These firms are price searchers –They search for the price that is most advantageous to them –They have some market power Inversely related to elasticity of demand

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 23 of 34 Price Takers and Price Searchers P Q Demand curves faced by price searchers

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 24 of 34 Price Takers’ Markets and “Optimal” Resource Allocation Questions –Are monopolists price searchers? –Do they face competition?

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 25 of 34 Price Takers’ Markets and “Optimal” Resource Allocation Scenario –Let’s look at the demand and supply curves for house painters during a summer. –This will be used to illustrate the advantages of the price takers assumption.

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 26 of 34 Price Takers’ Markets and “Optimal” Resource Allocation Remember: –Supply curves are marginal opportunity cost curves. –Marginal opportunity cost curves for any individual will slope upward to the right.

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 27 of 34 Price Takers’ Markets and “Optimal” Resource Allocation Price per Hour Thousands of Hours of House Painting D S= MC Sometimes called the “optimal allocation of resources”

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 28 of 34 Price Takers’ Markets and “Optimal” Resource Allocation Gain from trade foregone Price per Hour Thousands of Hours of House Painting D S= MC

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 29 of 34 Price Takers’ Markets and “Optimal” Resource Allocation Prices fixed above marginal cost rule out some mutually advantageous exchange opportunities.

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 30 of 34 Price Takers’ Markets and “Optimal” Resource Allocation In a price takers’ market: –No seller can set and keep price above marginal cost In a price searchers’ market: –They can do so.

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 31 of 34 Competition as a Process In economics, competition means a state of affairs. A competitive market is said to exist when… –There are a large number of buyers and sellers, and nobody possesses market power –Market participants possess full and complete information of alternatives –Sellers produce a homogeneous product –There is costless mobility of resources –The economic actors are price takers

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 32 of 34 Once Over Lightly Monopoly means one seller. Narrowly defined, every seller is a monopolist. The word monopoly is ambiguous. No seller has unlimited power over buyers. Elasticity of demand reflects the number of substitutes.

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 33 of 34 Once Over Lightly The more substitutes a product has the more elastic the demand for a product. Some companies are granted special privileges that restrict their competition. Competition makes some sellers price takers while others with less competition are price searchers.

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 34 of 34 End of Chapter 8