1. Chapter 10 IDENTIFYING MARKETS AND MARKET STRUCTURES Gottheil — Principles of Economics, 7e © 2013 Cengage Learning 1

2. Economic Principles © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 2 The use of cross elasticity to define markets The relationship between firms, industries, and markets Market structures The characteristics of monopoly

3. Economic Principles © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 3 The characteristics of monopolistic competition The characteristics of perfect competition The role of advertising

4. Defining the Relevant Market © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 4 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 © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 5 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 © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 6 Example: Automobiles and transportation. A relevant market can be narrowly defined as just the automobile industry.

7. Defining the Relevant Market © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 7 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 © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 8 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 © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 9 2.What makes up the relevant market for energy ? Oil, hydroelectric power, coal, wood, solar and nuclear sources.

10. Courts and Markets © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 10 In many cases the courts are called upon to determine what the market is.

11. Courts and Markets © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 11 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 © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 12 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 © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 13 Example: DuPont’s relevant market. By that definition, DuPont controlled less than 20 percent of the market.

14. Courts and Markets © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 14 The court decided in favor of DuPont. Example: DuPont’s relevant market.

15. Courts and Markets © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 15 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 © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 16 One tool the courts use to identify the relevant market is cross elasticity of demand.

17. Cross Elasticity Defines the Market © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 17 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 © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 18 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. © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 19 EXHIBIT 1DELINEATING THE MARKET

20. Exhibit 1: Delineating the Flower Market © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 20 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. In Exhibit 1, what is the market for each zone?

21. Exhibit 1: Delineating the Flower Market © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 21 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. In Exhibit 1, what is the market for each zone?

22. Exhibit 1: Delineating the Flower Market © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 22 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. In Exhibit 1, what is the market for each zone?

23. Exhibit 1: Delineating the Flower Market © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 23 Zone D lies outside these markets. The cross elasticity of goods within the set is zero ( e = 0)—fish do not substitute for flowers. In Exhibit 1, what is the market for each zone?

24. Markets and Market Structure © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 24 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 © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 25 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 © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 26 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 © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 27 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. © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 28 EXHIBIT 2THE MARKET STRUCTURE SPECTRUM

29. Exhibit 2: The Market Structure Spectrum © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 29 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 © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 30 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 © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 31 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 © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 32 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 © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 33 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 © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 34 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 © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 35 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 © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 36 Complete this sentence: _____ is the most important characteristic defining a monopoly. i.The size of the firm. ii.Being the only firm.

37. The World of Monopoly © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 37 Industry A collection of firms producing the same good.

38. The World of Monopoly © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 38 If only one firm firm produces a good, then the firm is the industry.

39. © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 39 EXHIBIT 3A MONOPOLY’S DEMAND CURVE

40. Exhibit 3: A Monopoly’s Demand Curve © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 40 How does the market demand curve compare to the monopoly demand curve? The curves are identical.

41. The World of Monopoly © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 41 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 © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 42 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. © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 43 EXHIBIT 4THE NATURAL MONOPOLY

44. Exhibit 4: The Natural Monopoly © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 44 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 © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 45 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 © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 46 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 © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 47 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 © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 48 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 © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 49 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 © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 50 Buying out all of the competition is another way to create a monopoly market structure. Andrew Carnegie, the first U.S. steel mogul, built his empire by consuming the competition.

51. Monopolistic Competition and Oligopoly © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 51 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 © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 52 Oligopoly A market structure consisting of only a few firms producing goods that are close substitutes.

53. Monopolistic Competition and Oligopoly © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 53 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. © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 54 EXHIBIT 5RELATIONSHIP BETWEEN FIRMS, INDUSTRIES, AND MARKETS

55. Exhibit 5: Relationship Between Firms, Industries, and Markets © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 55 1.How many firms are depicted in Exhibit 5? i.1 ii.3 iii.15

56. Exhibit 5: Relationship Between Firms, Industries, and Markets © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 56 1.How many firms are depicted in Exhibit 5? i.1 ii.3 iii.15—Each box represents one firm.

57. Exhibit 5: Relationship Between Firms, Industries, and Markets © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 57 2.How many industries are depicted in Exhibit 5? i.1 ii.3 iii.15

58. Exhibit 5: Relationship Between Firms, Industries, and Markets © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 58 2.How many industries are depicted in Exhibit 5? i.1 ii.3—The steel industry, the concrete industry and the aluminum industry. iii.15

59. Exhibit 5: Relationship Between Firms, Industries, and Markets © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 59 3.How many markets are depicted in Exhibit 5? i.1 ii.3 iii.15

60. Exhibit 5: Relationship Between Firms, Industries, and Markets © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 60 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. ii.3 iii.15

61. Monopolistic Competition and Oligopoly © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 61 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 © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 62 As more firms enter a market, firm demand curves become more elastic.

63. © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 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 © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 64 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 © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 65 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 © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 66 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 © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 67 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.

68. Monopolistic Competition and Oligopoly © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 68 Market share The percentage of total market sales produced by a particular firm in a market.

69. © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 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 © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 70 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 © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 71 Complete this sentence: After advertising, Coke’s demand curve shifts to the _____. i.Right ii.Left

72. Perfect Competition © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 72 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 © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 73 Characteristics of perfect competition: Goods are perfect substitutes. Firms have insignificant market share. Firms have free entry. Firms cannot influence price.

74. © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 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 © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 75 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 © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 76 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. © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 77 EXHIBIT 9SUMMARY SKETCH OF MARKET STRUCTURES

78. Exhibit 9: Summary Sketch of Market Structure © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 78 Type of Market Number of Firms Type of Products Entry Influence over Price? Perfect Competition ManyIdenticalFullNo

79. Exhibit 9: Summary Sketch of Market Structure © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 79 Type of Market Number of Firms Type of Products Entry Influence over Price? Monopolistic Competition ManyDifferentiated Difficult /Easy Yes

80. Exhibit 9: Summary Sketch of Market Structure © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 80 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 © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 81 Type of Market Number of Firms Type of Products Entry Influence over Price? MonopolyOne—ImpossibleYes