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Market Structures

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Chapter 7: Market Structures

KEY CONCEPT• A market structure is an economic model that helps economists

examine the nature and degree of competition among businesses in the same industry.

WHY THE CONCEPT MATTERS• The level of competition in a market has a major impact on the prices

of products. The more sellers compete for your dollars, the more competitive prices will be.

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The Characteristics of Perfect CompetitionKEY CONCEPTS

• Economists classify markets based on how competitive they are • Market structure—economic model of competition within an industry • Perfect competition—ideal model of a market economy

– economists assess how competitiveness of market by where it falls short

What Is Perfect Competition?

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The Characteristics of Perfect Competition

Characteristic 1: Many Buyers and Sellers • No one buyer or seller has power to control price in the market• Many sellers means buyers can choose a producer with better price• Many buyers means sellers can all sell product at market price

– lack of demand will not cause sellers to lower prices

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Characteristic 2: Standardized Product • Standardized product—one producer’s product is identical to

another’s • Perfect substitutes include

– agricultural products, such as wheat, eggs, milk– basic commodities, such as notebook paper, gold

• Price is only basis for consumer choice

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Characteristic 3: Freedom to Enter and Exit Markets• Producers can enter market when profitable and exit when

unprofitable• Regulations do not restrict businesses from entering or exiting

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Characteristic 4: Independent Buyers and Sellers• Neither buyers nor sellers join together to influence price• Supply and demand set the equilibrium price• Independent action ensures that market stays competitive

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Characteristic 5: Well-informed Buyers and Sellers• Buyers can compare prices• Sellers know what competitors charge, what buyers willing to pay• Price taker—seller that accepts market price set by supply and

demand

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Competition in the Real World

KEY CONCEPTS• No perfectly competitive markets; none meet all conditions• Imperfect competition—market structures that lack one or more of

the conditions• Some markets come close, such as some wholesale farm products

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Example 1: Corn• Thousands of growers; decide only how much to produce at market

price• Many buyers; standardized product; wholesale price easy to

determine• In reality, several factors can interfere:

– government subsidies; farmers or buyers sometimes band together

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Example 2: Beef• Many producers; each cut of beef is standard

– sellers can adjust only their production• Competition somewhat imperfect because

– ranchers may join together to influence price– producers may say products differ due to factors such as feed

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Reviewing Key Concepts

Explain the differences between the terms in each of these pairs:

• market and market structure• perfect competition and imperfect competition

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Characteristics of a MonopolyKEY CONCEPTS

• Monopoly—market structure with one seller, no substitutes for product

• Cartel—organization of sellers that agree to set prices, limit output • Price maker—business without competitors, can set prices • Barrier to entry—obstacle to entering market

– include government regulations, size, resources, technology

The Impact of Monopoly

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Characteristics of a Monopoly

Characteristic 1: Only One Seller • Single business controls supply of product without close substitutes• De Beers cartel controlled diamond market in 20th century because

– produced over half of world’s diamond supply– bought up diamonds from smaller producers to resell

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Characteristic 2: A Restricted, Regulated Market • Government regulations allow single firm to control market• De Beers worked with South African government

– restricted access of other producers– controlled supply of diamonds

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Characteristic 3: Control of Prices• Monopolists can control prices because there are no close

substitutes• During economic downturns, De Beers created artificial shortage

– by withholding diamonds from market, kept prices higher

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Types of Monopolies

KEY CONCEPTS• Natural monopoly—cost of production lowest with only one producer• Government monopoly—government owns and runs or permits only

one producer • Technological monopoly—one firm owns invention, technology,

method • Geographic monopoly—no other sellers within a region

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Types of Monopolies

Example 1: Natural Monopoly: A Water Company• In some markets, inefficient to have companies competing• Example: public utilities that require complex systems

– economies of scale—average production cost falls as production grows

• Government both supports and regulates

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Types of Monopolies

Example 2: Government Monopoly: The Postal Service• Government runs some businesses that provide goods and services

– private firms cannot or do not want to provide because of low profits

• Example: Postal Service has sole right to deliver first-class mail• New services and technologies now compete

– private delivery companies, fax, e-mail, online bill paying

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Types of Monopolies

Example 3: Technological Monopoly: Polaroid• Patent—legal registration of invention; gives inventor sole rights

– enables businesses to recover costs of development• Monopoly lasts for time limit of patent or until substitute invented• Patent let Polaroid keep Kodak out of instant-photography market

– simpler cameras, digital cameras, quick processing reduced its market

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Types of Monopolies

Example 4: Geographic Monopoly: Professional Sports• Sports leagues tie teams to cities, regions; limit number of teams

– owners can charge high ticket prices, sell team merchandise• Physical isolation—no other supplier in area—lets owner control

prices• Very small market may not support two businesses of same type

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Profit Maximization by Monopolies

KEY CONCEPTS• Monopoly cannot set prices too high

– faces downward-sloping demand curve– raises equilibrium price by producing less than competitive market

would • Most countries have laws to prevent monopolies

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Profit Maximization by Monopolies

EXAMPLE: Drug Manufacturer • Drug companies maximize profits during patent period

– afterwards, others market cheaper generic versions• Schering-Plough strongly marketed non-drowsy antihistamine Claritin

– made up to $3 billion per year worldwide with patent– after patent ended sales dropped to about $1 billion per year

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• monopoly and cartel• natural monopoly and geographic monopoly• technological monopoly and government monopoly

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Characteristics of Monopolistic CompetitionKEY CONCEPTS

• Most real markets fall between perfect competition and monopoly • Monopolistic competition—many sellers offer similar products

– one of most common market structures – product differentiation—sellers try to distinguish their products

from similar ones– nonprice competition—use factors other than price to attract

customers

Other Market Structures

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Characteristics of Monopolistic Competition

Characteristic 1: Many Sellers and Many Buyers • Many sellers and many buyers

– fewer sellers than perfect competition but enough for true competition

• Each seller chooses product to make, amount to make, price to charge– examples include T-shirts, batteries, hamburger restaurants

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Characteristic 2: Similar but Differentiated Products • Consumer loyalty gained with unique product or apparent difference• Sellers use market research to decide how to differentiate product• Chains use sophisticated techniques—learn consumer lifestyles,

tastes– focus groups—moderated discussions with small groups of

consumers– survey large numbers of consumers

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Characteristic 3: Limited Control of Prices• Differentiation gives producers limited control of prices

– low price distinguishes some products– name brands or better quality priced higher

• Consumers pay extra if they perceive important enough difference– will switch to substitute if price goes too high

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Characteristic 4: Freedom to Enter or Exit Market• No great barriers to entry in monopolistically competitive markets

– when firms earn profit, other firms enter and increase competition– competition can be difficult for small businesses against large

ones• Some firms start to take losses

– signal that it is time to exit the market

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Characteristics of an Oligopoly

KEY CONCEPTS• Oligopoly—market structure with only a few sellers offering similar

product • Less competitive than monopolistic competition

– each firm has large market share—percent of total sales in the market

• Few firms due to high start-up costs—expenses of entering market

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Characteristic 1: Few Sellers and Many Buyers• A few firms dominate market

– industry is oligopoly if four firms control 40 percent of market• About half of manufacturing industries in United States are oligopolies

– include breakfast cereals, soft drinks, movies, industrial products

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Characteristic 2: Standardized or Differentiated Products• Many industrial products standardized such as flat glass, aluminum

– firms differentiate by brand name, service, location• Many consumer goods are differentiated

– use marketing strategies, such as focus groups, surveys– create brand-name products that can be marketed widely

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Characteristic 3: More Control of Prices• Each firm’s decisions about supply and price affect entire market • If one firm lowers prices, others probably will too

– no firm gains market share from price drop; all risk losing profits• If one raises prices, others may not in order to gain market share• Anticipate competitors’ response to price, output, marketing changes

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Characteristic 4: Little Freedom to Enter or Exit Market• High start-up costs—such as factories, warehouses—make entry

hard– new firm may sell on small scale; hard to compete with established

ones• Established firms have resources, patents, economies of scale• High investment by firms in oligopoly make exit difficult

– operations too vast, complex to sell and reinvest easily

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Comparing Market Structures

KEY CONCEPTS• Each market structure has benefits, problems

– each creates different balance of power between producers and consumers

• Consumer has most influence, little choice in perfect competition • Consumer has some influence, most choice in monopolistic

competition• Consumer has limited influence, some choice in oligopolies• Producers have the most control in a monopoly

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Joan Robinson: Challenging Established IdeasExplaining Real-World Competition

• In 1933, Robinson published The Economics of Imperfect Competition

• Described oligopoly, monopsony (market with many sellers, one buyer)

• Her theory reflected modern market economies in which– firms compete through product differentiation and advertising– many industries are controlled by oligopolies

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Explain the relationship between the terms in each of these pairs:

• product differentiation and nonprice competition• focus group and market share• oligopoly and start-up costs

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Promoting CompetitionKEY CONCEPTS

• Government regulation—rules or laws that control business behavior– promotes competition and protects consumers

• Antitrust legislation—define monopolies, allow government to control or break them up

• Trust—group of firms combined to reduce competition • Merger—joining of firms or purchase of one firm by another

Regulation and Deregulation Today

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Promoting Competition

Origins of Antitrust Legislation • Late 1800s, trusts dominated oil, steel, railroad industries• 1890 Sherman Antitrust Act enabled government to control

monopolies– regulate practices that might reduce competition

• Standard Oil Company had 90 percent of industry; set output, prices– forced to give up control of 33 companies

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Promoting Competition

Antitrust Legislation Today • Federal Trade Commission, Justice Department enforce antitrust

legislation– tend to support mergers that benefit consumers– tend to block mergers that concentrate market in hands of few

firms• To evaluate potential merger, look at how market is defined

– market share before and after merger; if competitors get eliminated

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Ensuring a Level Playing Field

KEY CONCEPTS• Government ensures business practices do not reduce competition

– with less competition, prices go up, supply goes down• In United States, laws prohibit most of these practices

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Ensuring a Level Playing Field

Prohibiting Unfair Business Practices• Price fixing—competing businesses collaborate to set prices

– alternatively, they might agree to restrict output to drive up prices• Market allocation—businesses divide up market, control own territory

• Predatory pricing—set prices below cost to drive out small producers

– used by cartels or large producers

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Protecting Consumers

KEY CONCEPTS• Cease and desist order—requires firm to stop unfair business

practice– issued when business behavior is unfair to competitors or

consumers • Public disclosure—requires businesses to reveal product information

– enables consumers to make informed buying decisions

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Protecting Consumers

Consumer Protection Agencies• Government protects consumers by regulating different aspects of

business• Federal Trade Commission promotes competition, prevents unfair

practices• Other agencies regulate specific industries, protect consumers

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Deregulating Industries

KEY CONCEPTS• 20th century regulation focused on public service industries • Deregulation—reduces or removes government oversight and

control • Deregulation may lead to fewer consumer protections• Usually results in lower prices since markets become more

competitive– with regulated prices, firms have no incentive to reduce costs

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Deregulating Industries

Deregulating the Airlines• Airline Deregulation Act of 1978 removed control of routes and rates• Benefits

– New carriers entered market: greater efficiency, lower prices– More people chose plane travel

Problems– Quality of service declined; airports became crowded – Multiple bankruptcies resulted: layoffs, lower wages, lost pensions

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• trust and merger• price fixing and predatory pricing• regulation and deregulation

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Competition in Gadgets and Gizmos

Background• Billions of people around the world own cell phones. As the market

becomes saturated, manufacturers are adding new gadgets and gizmos to increase sales.

What’s the Issue?• What affects your selection of a cell phone?

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Competition in Gadgets and Gizmos {continued}Thinking Economically

1. Compare the product described in document A and the one illustrated in B. Are cell phones likely to become more or less complex? Explain why or why not.

2. Which of the four market structures best fits the market for cellular phones? Use evidence from documents A and C to explain your answer.

3. In documents A and C, compare the role that market research plays in the development of new products. Use evidence from the documents.

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