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Spectrum of Market Competition
Perfect Competition Monopolistic Competition Oligopoly Monopoly Most competitive Least competitive
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Perfect Competition
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Conditions for Pure Competition
1.Many buyers and sellers 2. No one buyer or seller has the ability to influence price 3. Products are homogenous (very similar)
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Conditions for Pure Competition
4. Free exit or entry (no barriers to entry) 5. Perfect knowledge 6. Perfect mobility of resources
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Price Takers Both buyers and sellers are “price takers”; both must take the market price No one buyer or seller can change the price by not buying or producing.
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The Purely Competitive firm maximizes profit where MC=MR
Profit Maximization The Purely Competitive firm maximizes profit where MC=MR
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Monopoly Single seller of a product Product has no close substitutes
Single seller is only seller in market, so IS the market.
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Monopoly can be formed by:
Barriers to Entry Monopoly can be formed by: Natural Barriers; distance, population, economies of scale
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Barriers (cont’d) A monopoly can also be formed by artificial barriers
Legal: patents, copyright, tariffs, licenses, franchise Illegal: predatory pricing, violence
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Profit Maximization A monopoly maximizes profit where MC=MR
A monopoly must search for the price on the AR curve See examples on board
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Consumer Surplus The difference between what a consumer was willing to pay and the market clearing price they had to pay.
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Costs of Monopoly
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Price Discrimination A monopoly can charge different customers different prices, taking away Consumer Surplus Airplane example
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Other Costs of Monopoly
Dead weight loss is the loss to consumers from the higher prices and lower production from a monopoly, in the graph
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Costs: Rent Seeking “Rent seeking” is the term for what the monopoly spends to become and stay a monopoly. We could also include the money spent by government, or would be competitors, to fight the monopoly
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X-inefficiency This is the term given to monopoly waste; since they have no competition, the monopoly has no reason to stay “lean and mean” 3 supervisors, 2 teachers
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Controlling a monopoly
Government can require “marginal cost pricing” or “average cost pricing” See board Government could also tax or charge a licensing fee
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Break up a monopoly Create competing firms out of the monopoly: Standard Oil, Bell Telephone… Microsoft?
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Monopolistic Competition
Many firms competing with products which are perceived to be different
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Conditions of MONOCOMP
1. Many firms 2. Differentiated product, perceived to be different 3. Easy entry to market by competitors
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Importance of Elasticity of Demand
See the board
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How to get Inelastic Demand
Achieve Product differentiation Price competition Non price competition Advertising Colors Any edge
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Oligopoly A market with only a few firms
Pure Oligopoly homogenous product with a single price Differentiated Oligopoly goods are perceived to be different, so you end up with “price clusters”
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Price Clusters Autos: GM, Ford, Daimler/Chrysler compete at different price levels Chevy Ford Dodge $ Pontiac Mercury Chrysler $$ Cadillac Lincoln Mercedes $$$$$
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Price Clusters Beer Anheiser Busch, Coors, Miller
Busch, Keystone, Strohs $ Bud, Miller, Coors Michelob, MGD, Fat Tire
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Concentration Ratios Measure the degree of concentration in a market
A four firm concentration ratio greater than 40%, is considered an oligopoly
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Examples Beverages Tobacco Cars Coca Cola Philip Morris GM 45% 49% 29%
Pepsi RJR Ford 31% 24% 25% Schweppes B&W Chrysler 14% 15% 16% From page 252 in text
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Cooperation vs. Competition
“People of the same trade seldom meet together… but the conversation ends in… some conspiracy to raise prices” Adam Smith
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Types of Cooperation Price Matching: ensures high prices, not low.
Price Leadership: all firms look to one firm (biggest) to set prices matched by others Price Fixing: Collusive price setting, or cartel (illegal)
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Game Theory Decision Grid on board
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Kinked Demand Curve On board
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Consequences of Price Fixing
1. Consent Decree, to stop illegal activity 2. Treble Damages (3X the losses) 3. Fines and jail time
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Music CD agreement Music CD agreement $480 million overcharge
- $67.4 million refunds - $74.7 million in free cds to schools =$338 million in profit due to price fixing
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