CHAPTER 7 Market Structures

Section 1 Competition and Market Structures

Adam Smith published Wealth of Nations in 1776, based on the philosophy of LAISSEZ-FAIRE; means “allow them to do”. Under laissez-faire, the role of govt. Is confined to protecting private property, enforcing contracts, settling disputes, and protecting businesses against increased competition from foreign goods.

Industry refers to the supply side of the market, or all producers collectively. Economists classify markets according to conditions that prevail in them. How many buyers/sellers? How large are they? Influence over price? Competition? What kind of Product?

The answers to these questions help determine MARKET STR$UCTURE

4 categories PERFECT COMPETITION, MONOPOLISTIC COMPETITION, OLIGOPOLY, MONOPOLY

PERFECT COMPETITION-is characterized by a large number of well-informed buyers/sellers who exchange identical products. 5 major characteristics

  1. Large # buyers/sellers. No 1 buyer/seller has enough power to influence the price.
  2. Identical Products. No difference in quality, no name brands
  3. Buyers/sellers act independently. This keeps prices low.
  4. Buyers/sellers well informed about products/prices.
  5. Easy enter/easy exit.

PERFECT COMPETITION AND PROFIT MAXIMIZATION

Price set by supply and demand. Profit Maximization point is where Marginal revenue equals marginal costs.

Few if any perfectly competitive markets exists, though agriculture is the closest thing.

MONOPOLISTIC COMPETITION- is the market structure that has all the conditions of a perfect competition EXCEPT for identical products. By making its product a little different, the monopolistic competitor tries to attract more customers and monopolize a small portion of the market.

  1. Large # buyers/sellers
  2. Product Differentiation-real or imagine
  3. Limited influence over price
  4. Large Advertising
  5. Easy entry, easy exit.

Nonprice Competition-the use of advertising, giveaway, coupons, promotional campaigns to convince buyers that their product is better.

Profit maximization point is where marginal revenue equals marginal cost.

OLIGOPOLY- is a market structure in which a few large sellers dominate the industry.

  1. Few large firms
  2. Differentiated or Identical products
  3. Some substitutes
  4. Barriers to Entry
  5. Interdependent Behavior-collusion, price-fixing Each oligopolist knows that the other firms in the industry have considerable power and influence over consumer choices. Collusion-a formal agreement to set prices and production in a cooperative manner. Price leadership, one lowers price, others will follow.

NonPrice Competition- A lot of advertising, giveaways, etc.

Profit Maximization is where marginal revenue equals marginal cost. Final price will be higher for the consumers.

MONOPOLY- market structure with only one seller.

1.One seller

2. No close substitutes

3. Barriers to Entry

4. Extensive influence over price.

TYPES OF MONOPOLIES-

  1. Natural-a market situation where the costs of production are minimized by having a single firm. They can provide services more cheaply than 2 or more companies competing for the same area. Govt. often gives public utilities a FRANCHISE, the exclusive right to do business in a certain area without competition. By accepting such franchises, the company accepts a certain amount of govt. regulation. The justification for the natural monopoly is ECONOMIES OF SCALE- a situation in which the average cost of production falls as the firm gets larger. When this happens, it makes sense for the firm to be as large as is necessary to lower production costs.
  2. GEOGRAPHIC MONOPOLY-a monopoly based on the absence of other sellers in a certain geographic area.
  3. TECHNOLOGICAL MONOPOLY- is a monopoly that is based on ownership or control of a manufacture method, process, or other sceintic advance. PATENT- an exclusive right to manufacture, use, sell any new and useful invention for a specific period. Inventions are covered for 20 years, COPYRIGHT-the exclusive right of authors or artists to publish, sell, or reproduce their work for their lifetime plus 50.
  4. GOVERNMENT MONOPOLY-a monopoly the govt. owns and operates. National, state, local levels. In most cases they involve products or services that private industry cannot provide.

PROFITMAXIMIZATIONPOINT- marginal revenue equals marginal costs. They are a PRICE MAKER, not a PRICE TAKER>

Chapter 7 Section 2 Market Failures

A competitive free enterprise economy works best when 4 conditions are met:

  1. Adequate competition must exist in all markets
  2. Buyers and sellers must be reasonably well-informed about conditions and opportunities in these markets.
  3. Resources must be free to move from one industry to another.
  4. Prices must reasonably reflect the costs of production, including rewards to entrepreneurs.

A MARKET FAILURE can occur when any of these 4 conditions are significantly altered.

  1. INADEQUATE COMPETITION- Mergers and acquisitions have resulted in larger/fewer firms dominating various industries.
  2. INEFFICIENT RESOURCE ALLOCATION-Inadequate competition tends to curb efficient use of scarce resources. Why would a firm with no competition use resources carefully? If a firm is free to do as it pleases, it likely will spend its profits on executive bonuses, jets, salaries/retirement benefits. This is the reason that public utilities are regulated by the govt.
  3. HIGHER PRICES AND REDUCED OUTPUT-A monopoly can use its position to prevent competition and restrict production which results in shortages and higher prices.
  4. ECONOMIC AND POLITICAL POWER-In the past, many firms have used their capital resources to further political careers of owners/relatives/friends. A large corporation may demand tax breaks and threatened to move elsewhere.
  5. BOTH SIDE OF THE MARKET- Supply side-perfect competition and monopolistic have enough firms to ensure competition Oligopolies can collude, monopolies are the only seller. Demand side may occur because there are not many buyers for space shuttles, tanks fighter jets,etc.
  6. INADEQUATE INFORMATION-If resources are to be allocated efficiently, everyone, consumers, businesses, govt. must have adequate information about market conditions. Information is needed about wages, investments, etc.
  7. RESOURCES IMMOBILITY-One of the most difficult problems-land, labor, capital, and entrepreneurs must be willing to move to markets where returns are the highest. Problems are created when automobile plants close, military bases close.
  8. EXTERNALITIES-an unintended side effect that either benefits or harms a third party not involved in the activity that caused it.
  9. NEGATIVE EXTERNALITY-is the harm, cost, or inconvenience suffered by a 3rd party because of actions caused by others. Examples: Airport expansion, highway/road repairs, chemical plants.
  10. POSITIVE EXTERNALITY-is a benefit received by someone who had nothing to do with the activity that generated the benefit. Workers on the airport expansion, highways/roads, businesses.

Externalities are classified as market failures because their costs and benefits are not reflected in the market prices that buyers/sellers pay for the original products.

  1. PUBLIC GOODS-are products that are collectively consumed by everyone, and whose use by one individual does not diminish the satisfaction or value available to others, highways, flood control, National Defense, Police/Fire Protection. People do not want to pay for these things, so private firms cannot efficiently produce them and govt. usually has to provide for them.

THE ROLE OF GOVERNMENT Section 3

Government has the power to encourage competition and to regulate monopolies that exist for the public welfare. In some cases, govt. has taken over certain economic activities and runs them as government-owned monopolies.

  1. ANTITRUST LEGISLATION-late 1800’s govt passed laws to restrict monopolies, combinations, and TRUSTS-legally formed combinations of corporation or companies. Since then, a number of key laws have been passed that allow govt. to prevent or break up monopolies designed to prevent market failures due to inadequate competition.
  2. SHERMAN ANITRUSTS-1890 “to protect trade and commerce against unlawful restraint and monopoly”. First significant law against monopolies. Law was not specific enough .
  3. CLAYTON ANTITRUST-1914 gave govt. greater power against monopolies. Outlawed PRICE DISCRIMINATION-the practice of charging customers different prices for the same product.
  4. FEDERAL TRADE COMMISSION ACT-1914-enforce Clayton and set up Federal Trade Commission-gave it authority to issue CEASE AND DESIST ORDER-to stop unfair business practices, such as price-fixing, that reduces competition among firms.
  5. ROBINSON-PATMAN ACT-1936-effort to strengthen Clayton Act particularly price fixing. Companies could no longer offer special discounts to some customers while denying them to others. Primarily affected national organizations and chain stores that were offering goods/service at lower prices than those paid by small independent businesses.
  6. GOVERNMENT REGULATION- Not all monopolies are bad. Natural monopolies allowed to exists to take advantage of lower production cost-then have govt regulate them.

A.EXAMPLES OF REGULATION-Local/State- regulate cable, electric, phone, water companies. Must approve their prices and approve rate increases. National level-FDA, DEA,FTC,SEC, etc.

  1. INTERNALIZING EXTERNALITIES-Govt. can also use the tax system to lessen some of the negative externalities in the economy. Firms causing pollution, using the environment as a giant waste-disposal, their costs of production are lower than they should be. If govt. taxes them, several things happen, cost of production goes up, causing them to produce less and the supply curve to sift to the left and product prices rise. Consumers buy less, govt uses the tax proceeds to clean up the pollution. Economists call this “internalizing the externalities” because it forces the polluting firms and its customers, rather than innocent third parties, to pay for the cost of pollution.
  1. PUBLIC DISCLOSURE- The purpose of public disclosure is to provide the market with enough data to prevent market failure due to inadequate information. There are some cost to the businesses and some prefer not to disclose anything, the benefits to society outweigh the costs. Public disclosure is the requirement that businesses reveal information to the public. FDA, SEC. Banks must disclose interest rates on loans, credit cards, savings. etc. “truth-in-advertising” prevent sellers from making false claims about their products.
  2. INDIRECT DISCLOSURE-Govt. support of the Internet, providing low costs access to public schools, not taxing e-commerce sales. Virtually every govt. document, study, report, is available on the Internet.
  3. MODIFIED FREE ENTERPRISE- Concern over the costs of imperfect competition is the one reason the govt. intervenes in the economy. Historically, the freedom to pursue self-interests led some people/businesses to seek economic gain at the expense of others, large firms taking advantages of smaller ones, and monopolies replacing competition. Because of these conditions, Congress passed laws to prevent “evil monopolies” and to protect the right of workers, consumers. Government takes part in economic affairs for several reasons:
  4. To promote and to encourage competition for the benefit of society.
  5. To prevent monopolies and reduce the cost of imperfect competition whenever possible.
  6. To regulate industries in which a monopoly is clearly in the best interest of the public.