1. Prices and Decision Making
Chapter 6
Prices and Decision Making

2. Prices
Price—monetary value of a product as established by supply and demand
Prices communicate info to buyers/sellers
High prices=producers produce more, buyers buy less
Low prices=producers produce less, buyers buy more

3. Prices
Prices are the link between producers and consumers

4. Price Adjustment Process
Transactions in a market economy are voluntary, because of that the compromise that eventually takes place must be to the benefit of both parties

5. Economic Model
Helps to analyze behavior and predict outcomes

6. Market Equilibrium
Situation where prices are stable and quantity of goods/services are equal to quantity demanded
The market economy finds this by trial and error

7. Surplus
Situation in which the quantity supplied is greater than the quantity demanded at a given price

8. Surplus
Surplus shows up as unsold products on shelves, sellers know price is too high
Prices tend to go down as a result of surplus

9. Shortage
Situation in which the quantity demanded is greater than the quantity supplied at a given price

10. Shortage
Results in quantity and price both going down

11. Equilibrium Price
Price that “clears the market” by leaving neither a surplus or a shortage
Market will seek its own equilibrium

12. Social Goals vs. Market Efficiency
Gov’t tends to get involved in the market to secure economic goals of equity and security
One of the common ways of achieving social goals involves setting prices at “socially desirable” levels
When this happens, prices are not allowed to adjust to their equilibrium levels

13. Government Intervention
Condition when gov’t sets the prices
Occurs when gov’t feels the market system is not working
Gov’t can set price ceilings and price floors

14. Price Ceilings Maximum legal price that can be charged for a product
Gov’t does then when they feel prices are too high for a product
Will cause shortages

15. Price Floors Lowest legal price that can be paid for a good
Gov’t does then when they feel prices are too low
Minimum wage is an example

16. Agricultural Price Supports
Price supports are most evident in agriculture
US Department of Agriculture tinkers with free market system using target prices, land banking, price supports to alter market forces

17. Chapter 7
Market Structures

18. Bell Ringer 10/17

20. Market Structure
The competition among firms operating in the same industry

21. Market Organization 1. Perfect Competition 2. Monopolistic Competition
3. Oligopoly
4. Monopoly

22. Market Structure Characteristics
1. Number of firms in industry
2. Influence over price
3. Product differentiation
4. Advertising
5. Ease of entering or leaving the market

23. What Is Perfect Competition?
1) In perfect competition, all consumers and producers are price takers.
Equilibrium
Price
Producers
2) This means that neither consumers nor producers can do anything to change price.
3) Consumers rarely affect price, so we will focus on the producer.
4) The supply and demand model is a model of a perfectly competitive market.

24. The Two Main Characteristics
There are two conditions necessary for a perfectly competitive market to exist.
1) Numerous Sellers =
A) Generally there are hundreds or even thousands of sellers. = =
B) No seller can have a large market share. =
C) This means no seller can produce more than a small fraction of the total market supply. = =
2) Standardized Product =
A) Consumers must regard all products to be identical. =
B) They do not have to be identical, consumers just have to think they are. =

25. 2. Monopolistic Competition
Market organization in which many firms produce goods that are similar enough (a little different) to be substitutes
Example: gas stations, fast food industry, soft drink industry

26. Characteristics
Monopolistic competition has characteristics that make it similar to both monopoly and perfect competition.
1) Many Sellers
Each firm has a small amount of market power, but there is no possibility for collusion.
Shampoo is a great example of just how many different firms can exist in a single market, all with differing prices and qualities.

27. Characteristics
Monopolistic competition has characteristics that make it similar to both monopoly and perfect competition.
1) Many Sellers
Each firm has a small amount of market power, but there is no possibility for collusion.
2) Differentiated Products
Firms produce imperfect substitutes, products that are close substitutes but are still distinct.
Cheeseburgers from McDonald’s and Burger King could be considered substitutes, but most consumers consider them to be very different.

28. Characteristics
Monopolistic competition has characteristics that make it similar to both monopoly and perfect competition.
1) Many Sellers
Each firm has a small amount of market power, but there is no possibility for collusion.
2) Differentiated Products
Firms produce imperfect substitutes, products that are close substitutes but are still distinct.
3) Low Barriers to Entry
In the long run, firms are free to enter or exit the industry.
Markets, such as hair salons, can see lots of new entrants in a short time if the market can support them. Likewise, many can fail quickly, too.

29. Product Differentiation
One of the key features of monopolistic competition is product differentiation. Firms can differentiate their products in one of three ways.

30. Product Differentiation
One of the key features of monopolistic competition is product differentiation. Firms can differentiate their products in one of three ways.
1) By Style or Type
Includes differences in features, design, packaging, or service.
No two hair salons are alike. Each offers different hair styles based on gender, age, culture, income, preference, etc.

31. Product Differentiation
One of the key features of monopolistic competition is product differentiation. Firms can differentiate their products in one of three ways.
1) By Style or Type
Includes differences in features, design, packaging, or service.
2) By Location
Consumers often choose a product based on convenience even if it is more expensive.
Many small hair salons can succeed because people are likely choose one that is close to their house.

32. Product Differentiation
One of the key features of monopolistic competition is product differentiation. Firms can differentiate their products in one of three ways.
1) By Style or Type
Includes differences in features, design, packaging, or service.
2) By Location
Consumers often choose a product based on convenience even if it is more expensive.
3) By Quality
Some professional stylists can charge hundreds of dollars per customer, but most consumers settle for something cheaper than that.
Some consumers are willing to pay more for higher quality products.

33. 3. Oligopoly
Market structure in which very few large firms dominate the industry
Examples: Automobiles, TV companies, cell phone companies

34. What Is Oligopoly?
Oligopolies share many characteristics with monopolies, but the forces that create oligopolies are not as strong as those that create monopolies.
1) A Few Large Firms
Generally, the four-firm concentration is above 50%, meaning together they share significant market power.
Market
Concentration
Largest Firms
Light Bulbs
75.4 %
General Electric, Sylvania, Philips, Westinghouse
Cereals
80.4 %
Kellogg’s, General Mills, Post, Quaker
Batteries
88.0 %
Duracell, Energizer, Panasonic, Rayovac
Different economists use different cut-offs for the four-firm concentration ratio. Above 50% is generally regarded to be a sign of oligopoly. It is fun at this point to see if students can come up with other oligopolistic markets and name the four largest firms.
This means the four largest firms account for at least 50% of all sales. There may be many smaller sellers, but they do not have any market power.

35. What Is Oligopoly?
Oligopolies share many characteristics with monopolies, but the forces that create oligopolies are not as strong as those that create monopolies.
1) A Few Large Firms
Generally, the four-firm concentration is above 50%, meaning together they share significant market power.
2) Identical or Differentiated Products
Oligopolists can either create identical products or varied products.
For example, light bulbs of a similar size are all essentially identical.
The cereal industry, however, has a seemingly endless variety of products to choose from.

36. What Is Oligopoly?
Oligopolies share many characteristics with monopolies, but the forces that create oligopolies are not as strong as those that create monopolies.
1) A Few Large Firms
Generally, the four-firm concentration is above 50%, meaning together they share significant market power.
2) Identical or Differentiated Products
Oligopolists can either create identical products or varied products.
3) High Barriers to Entry
Barriers (usually high start-up costs) prevent competing firms from opening.
Manufacturing industries, such as batteries, require a great deal of technology, machinery, and patents.

37. What Is Oligopoly?
Oligopolies share many characteristics with monopolies, but the forces that create oligopolies are not as strong as those that create monopolies.
1) A Few Large Firms
Generally, the four-firm concentration is above 50%, meaning together they share significant market power.
2) Identical or Differentiated Products
Oligopolists can either create identical products or varied products.
3) High Barriers to Entry
Barriers (usually high start-up costs) prevent competing firms from opening.
The airline industry is a great example of how one oligopolist’s profits are largely determined by his/her competitors’ prices.
4) Interdependence
An individual firm’s profits are highly dependent on its competitors’ prices.

38. 4. Monopoly
Form of market organization in which there is only 1 seller of a product
Example: No perfect example, best is gov’t controlled water companies

39. Characteristics of Monopoly
There are several traits that characterize a monopoly. The four most important ones are described here.

40. Characteristics of Monopoly
There are several traits that characterize a monopoly. The four most important ones are described here.
1) One Seller
Monopolies exist when one firm controls an entire market (or almost all of it).
Microsoft owns over 95% of the operating system market, but it does have competition from Mac and Linux operating systems.

41. Characteristics of Monopoly
There are several traits that characterize a monopoly. The four most important ones are described here.
1) One Seller
Monopolies exist when one firm controls an entire market (or almost all of it).
2) No Substitutes
If there are substitutes to the product supplied by the monopolist, he/she cannot exercise monopoly power.
The National Football League (NFL) has no close substitutes. Yes, there are other similar leagues, but none that compare to the NFL.

42. Characteristics of Monopoly
There are several traits that characterize a monopoly. The four most important ones are described here.
1) One Seller
Monopolies exist when one firm controls an entire market (or almost all of it).
2) No Substitutes
If there are substitutes to the product supplied by the monopolist, he/she cannot exercise monopoly power.
3) High Barriers to Entry
A monopolist remains the single seller in a market only because he/she can keep others from entering the market.
A barrier to having competing electrical companies is that cities are not willing to have more than one set of power lines.

43. Characteristics of Monopoly
There are several traits that characterize a monopoly. The four most important ones are described here.
1) One Seller
Monopolies exist when one firm controls an entire market (or almost all of it).
2) No Substitutes
If there are substitutes to the product supplied by the monopolist, he/she cannot exercise monopoly power.
3) High Barriers to Entry
A monopolist remains the single seller in a market only because he/she can keep others from entering the market.
De Beers, a company that controls most of the world’s supply of diamonds, artificially increases price by limiting its output.
4) Control Over Price
A true monopolist can change price and quantity to maximize profits.

44. Barriers to Entry
A monopolist’s profits do not go unnoticed. So why don’t other firms enter the market? One of the following barriers keeps others from entering the market.

45. Barriers to Entry 1) Control of a Resource
If a firm controls all or most of a scarce resource, it is easy to keep other firms from obtaining it.
De Beers controls most of the world’s diamond supply, making entry into the market very difficult.

46. Barriers to Entry 1) Control of a Resource
If a firm controls all or most of a scarce resource, it is easy to keep other firms from obtaining it.
2) Technological Superiority
Firms can gain a technological advantage over competitors that can lead to a monopoly.
Intel produces the chips that run computers. For many years no other firms were able to match their microprocessor technology.

47. Barriers to Entry 1) Control of a Resource
If a firm controls all or most of a scarce resource, it is easy to keep other firms from obtaining it.
2) Technological Superiority
Firms can gain a technological advantage over competitors that can lead to a monopoly.
3) Government Involvement
The government can restrict firms from entering a market through patents, copyrights, and laws.
Sometimes government will actually run a monopolistic business, or it can issue patents and copyrights.

48. Barriers to Entry 1) Control of a Resource
If a firm controls all or most of a scarce resource, it is easy to keep other firms from obtaining it.
2) Technological Superiority
Firms can gain a technological advantage over competitors that can lead to a monopoly.
3) Government Involvement
The government can restrict firms from entering a market through patents, copyrights, and laws.
The enormous upfront costs of power companies makes it very difficult to start a competing business.
4) Economies of Scale
A monopoly can exist if one company has a cost advantage over new firms.

49. Types of Monopoly
There are four types of monopolies. Each one gets its market power from the way in which it bars entry into the market.

50. Types of Monopoly 1) Geographic Monopoly
If there is only one store in a location, it acts as a monopoly since it has no local competition.
Notice how the type of monopoly matches the way in which it bars other firms from entering the market. The student note sheet is set up to show that each one of these notes matches with the notes from the Barriers to Entry slides. Unfortunately, the geographic monopoly does not correspond very well to “Control of a Resource.” But the other ones correspond perfectly. “Technological Superiority” goes with “Technological Monopoly.” “Government Involvement” goes with “Legal Monopoly.” And “Economies of Scale” goes with “Natural Monopoly.”
A single gas station along a lonely road in the desert is an example of a geographic monopoly.

51. Types of Monopoly 1) Geographic Monopoly 2) Technological Monopoly
If there is only one store in a location, it acts as a monopoly since it has no local competition.
2) Technological Monopoly
Although firms can enjoy a technological edge in the short run, other firms will soon copy it.
Despite Intel’s early success, it now experiences a tremendous amount of competition.

52. Types of Monopoly 1) Geographic Monopoly 2) Technological Monopoly
If there is only one store in a location, it acts as a monopoly since it has no local competition.
2) Technological Monopoly
Although firms can enjoy a technological edge in the short run, other firms will soon copy it.
3) Legal Monopoly
Sometimes the government deems it necessary to create a monopoly.
By allowing drug companies to patent their discoveries for 20 years, it encourages heavy investment in research and development.

53. Types of Monopoly 1) Geographic Monopoly 2) Technological Monopoly
Economies of Scale
Diseconomies of Scale D
ATC
If there is only one store in a location, it acts as a monopoly since it has no local competition.
2) Technological Monopoly
Although firms can enjoy a technological edge in the short run, other firms will soon copy it.
3) Legal Monopoly
Economies of scale exist when Average Total Cost (ATC) is decreasing. Diseconomies of scale exist when ATC is increasing. If this lesson is being used with the entire Unit Plan for “Market Structure,” this graph should make sense to the students. Natural monopolies include things like the electric company, natural gas company, sewer, and to some degree cable and internet services. Natural monopolies usually exist when there are large upfront fixed costs.
Sometimes the government deems it necessary to create a monopoly.
4) Natural Monopoly
If Average Total Cost (ATC) is still decreasing at the output level, the firm is still in the economy of scale portion of the graph.
Exist when 1 company can produce items cheaper than 2 competing firms.

54. Advertising
Advertising is a controversial economic subject, but it is generally considered that it does affect the demand curve and increases revenue.

55. Advertising 1) Why do firms advertise?
A) It helps differentiate their products from other firms.
B) Differentiated products give firms more market power, allowing them to charge higher prices.

56. Advertising 1) Why do firms advertise? 2) Why Can They Charge More?
A) It helps differentiate their products from other firms.
B) Differentiated products give firms more market power, allowing them to charge higher prices.
2) Why Can They Charge More?
A) Demand increases since consumer tastes and brand loyalty are affected.
B) Demand also increases since the perceived utility of the item increases.
Remember, whenever demand increases, it means more output is being sold at a higher price.

57. Branding
Branding refers to the distinctive identity that a particular name, phrase, or symbol bestows on a firm and its products.

58. Branding 1) It provides quality assurance.
A) Consumers are willing to pay for a brand name for its quality.
Consumers are often willing to spend more on a pricey brand name television simply because of its reputation for quality.

59. Branding 1) It provides quality assurance.
A) Consumers are willing to pay for a brand name for its quality.
B) If a brand name fails in its quality, it will be punished by the market.
When the E. coli bacteria was found in some Jack-in-the-Box hamburger meat in 1993, its sales and stock plummeted.

60. Branding 1) It provides quality assurance. 2) It provides information.
A) Consumers are willing to pay for a brand name for its quality.
B) If a brand name fails in its quality, it will be punished by the market.
2) It provides information.
A) Especially in new situations, consumers turn to known brands.
Imagine you are in an unfamiliar town and need a hotel for the night. You are much more likely to stay at a brand name hotel even if it costs more.

61. Branding 1) It provides quality assurance. 2) It provides information.
A) Consumers are willing to pay for a brand name for its quality.
B) If a brand name fails in its quality, it will be punished by the market.
2) It provides information.
A) Especially in new situations, consumers turn to known brands.
B) Consumers are more likely to purchase new products if it has a familiar brand name.
Suppose you have a favorite shampoo brand. If you are in need of face wash, hand lotion, or sunscreen, you may use the same brand.

62. Market Failures
The allocation of goods and services by a free market that is not efficient…there is a better way for participants to be better-off and not make someone else worse-off
Most common market failures involve:
1.inadequate competition
2. inadequate information
3. externalities

63. 1. Inadequate Competition
A decrease in competition has several consequences:
1. inefficient resource allocations (waste of resources)—why would a firm with few competitors have incentive to use resources carefully?
2. higher prices
3. may enable a business to influence politics—example: big company to demand tax breaks or move elsewhere

64. 2. Inadequate Information
Information is needed to make economic decisions, if not available to buyers than it is an example of a market failure

65. 3. Externalities Unintended side effects
Negative externality—harm, cost, or inconvenience suffered by a 3rd party because of actions of another (example: pollution of steel plant, traffic congestion due to plant)

66. Role of Government In the Market
The marketplace usually keep businesses competitive with one another
The Government has the power to regulate markets when needed by establishing rules and laws to protect consumers
The most important laws are called antitrust legislation which give them the power to control and break up monopolies
The government can also keep trusts from forming and can regulate business mergers as needed

67. Role of Government In the Market
In the late 1800s, U.S. government passed laws to restrict monopolies and trusts (to prevent market failures due to inadequate competition)
The U.S. government has created several agencies to monitor and restrict markets/companies

68. Federal Trade Commission (FTC)1914
Administers antitrust laws forbidding unfair competition
They monitor unfair business practices, including deceptive advertising

69. Food and Drug Administration (FDA)1906
Protects consumers from unsafe foods, drugs, or cosmetics; requires truth in labeling of these products

70. Securities and Exchange Commission (SEC) 1934
Regulates and monitors the stock market to protect investors

71. Occupational Safety and Health Administration (OSHA) 1970
Enforces regulations to protect employees at work
Investigates accidents at the workplace

72. Federal Communications Commission (FCC)
Regulates the communications industry, including radio, television, cable, and telephone services

73. Environmental Protection Agency (EPA)
Protects human health by enforcing environmental laws regarding pollution and hazardous materials

74. Role of Government In the Market
The government also tries to make sure that businesses do not engage in practices that would reduce competition
Price fixing occurs when businesses agree to set prices for competing products
The government can issue a cease and desist order that requires a firm to stop an unfair business practice