Market Structures & Competition

There are several possibilities for

free market competition:
Perfect Competition
Monopolistic Competition
Monopoly
Oligopoly
Inadequate Competition
 Perfect Competition
A large # of buyers and sellers exchange
identical products under 5 conditions:
1. Large # of buyers and sellers
2. Products are identical between suppliers
3. Buyers and sellers act independently
4. Buyers and sellers are well-informed
5. Buyers and seller are free to enter,
conduct, or get out of business. NO
Barriers to entry other than start-up costs
or technology
 Price and Output
One of the primary characteristics of perfectly
competitive markets is that
. they are efficient. In a
perfectly competitive market, price and output reach
their equilibrium levels.

Market Equilibrium in Perfect Competition

Supply
Price

Equilibrium
Price
Equilibrium
Quantity

Demand

Quantity
 Monopolistic Competition
In monopolistic competition, many companies compete in an
open market to sell products which are similar, but not
identical. Best example: OTC pain relievers
1. Many Firms--As a rule, monopolistically competitive
markets are not marked by economies of scale or high start-
up costs, allowing more firms.
2. Few Artificial Barriers to Entry--Firms in a monopolistically
competitive market do not face high barriers to entry.
3. Slight Control over Price--Firms in a monopolistically
competitive market have some freedom to raise prices
because each firm's goods are a little different from everyone
else's. EX: Tylenol, Aleve, and Bayer
4. Differentiated Products--Firms have some control over their
selling price because they can differentiate, or distinguish,
their goods from other products in the market. EX: Excedrin
better for headache than Tylenol
 Non-Price Competition
Nonprice competition is a way to attract
customers through style, service, or location, but
not a lower price

1. Characteristics of Goods--The simplest way for a

firm to distinguish its products is to offer a new
size, color, shape, texture, or taste.
2. Location of Sale--A convenience store in the
middle of the desert differentiates its product
simply by selling it hundreds of miles away from
the nearest competitor.
3. Service Level--Some sellers can charge higher
prices because they offer customers a higher level
of service. EX: Insurance companies
4. Advertising Image--Firms also use advertising to
create apparent differences between their own
 Oligopoly
• Oligopoly describes a market dominated by a few
large, profitable firms through collusion or cartel.
It is further away from perfect competition than
monopolistic competition is. Final prices are
higher for consumers.
• Collusion--an agreement among members of an
oligopoly to set prices and production levels. 2
forms of collusion: Price- fixing is an agreement
among firms to sell at the same or similar prices.
Dividing up the market is another. Collusion is
illegal in the U.S.
Cartel--an association by producers established to
coordinate prices and production.
Oligopolists act independently by lowering prices
soon after the first seller announces the cut, but
Activity: Deciding How Much to
Produce
 Monopoly
Only 1 seller of a particular product.
It’s VERY DIFFICULT to define a true
monopoly
Americans prefer competitive trade; few
monopolies in U.S.
The monopolist is larger than a perfect
competitor, allowing it to be a price
MAKER.
Herfendahl Index used to measure
monopolies; nowadays the trend is to
analyze Barriers to Entry
 Types of Monopolies
Economies of Scale--If a firm's start-up costs are high,
and its average costs fall for each additional unit it
produces, then it enjoys what economists call
economies of scale. An industry that enjoys economies
of scale can easily become a natural monopoly. Good
example: Broadband and Cable TV industries
Natural Monopolies--a market that runs most
efficiently when one large firm provides all of the
output. Sometimes the development of a new
technology can destroy a natural monopoly.
Geographic Monopoly—occurs when a location cannot
support two or more businesses EX: Small-town
drugstore or barbershop
Government Monopoly—see next slide
 Types of Gov’t Monopolies
• Technological Monopolies
The government grants patents, licenses that give the
inventor of a new product the exclusive right to sell
it for a certain period of time, and copyrights, the
exclusive right to protect written or performed work.
EX: Artists get lifetime + 50 yrs.

• Franchises and Licenses

A franchise is a contract that gives a single firm the
right to sell its goods within an exclusive market. A
license is a government-issued right to operate a
business. Local cable companies are frequently
franchised.

• Industrial Organizations
In rare cases, such as sports leagues, the government
allows companies in an industry to restrict the
 Interesting Thoughts
About Monopolies…
Anti-trust lawyers try to expand the definition of
monopoly; corporate attorneys try to narrow it.
Even if there is no competition, you must act as
if there are other competitors, or you will
provide an incentive to compete
Efficiency is NOT a barrier to entry.
EX: Microsoft wins because its software is
compatible with everything. Apple screwed up.
Don’t like Microsoft? Try Linux, or try to beat
Microsoft.
Large companies can spring up to take on large
 Predatory Pricing
The concept: Drive your competitors out of business by
charging less than cost for a good or service. Once your
opponents are gone, raise prices and screw consumers.
How do you define it? Grocery stores often sell some
items under cost to entice consumers. Is that wrong?
Predatory pricing cannot work in the long-term.
German Bromine Cartel existed around 1910. Sold
bromine for 45¢. Dow in the U.S. sold for 36¢.
Germans got mad, sold bromine for 15¢. Dow bought
up all the bromine and sold it in Europe at 27¢!
Germans eventually gave up.
 More on Efficiency
John D. Rockefeller led Standard Oil
At one point, he owned 90% of the refineries
in the U.S.
Company was broken up when he only
owned 64%.
Yet, under Rockefeller, the price of kerosene
had DROPPED!!!
1869– 30 cents/gal.
1880—9 cents/gal.
1897—5.9 cents/gal. (cheaper than
electricity)
 Inadequacies in the Market
Inadequate competition—decreases in
competition due to mergers/acquisitions can
create market failure
Resource problems: Inefficient resource
allocation occurs when there’s no incentives to
use resources wisely. Resources must also avoid
immobility (in case a market tanks)
Companies may not market products properly,
even if they are cheaper and better (Sony
Betamax loses to JVC VHS)
Monopolies can reduce supply, raise prices
A large business can exert political power (USX)
Market failures on the demand side are harder to
correct than failures on the supply side.
Consumers, businesspeople, and government
officials must be able to obtain market conditions
 Price Discrimination
Price discrimination is the division of customers into
groups based on how much they will pay for a good.
Although price discrimination is a feature of
monopoly, it can be practiced by any company with
market power. Market power is the ability to
control prices and total market output.
Targeted discounts, like student discounts and
manufacturers’ rebate offers, are one form of price
discrimination.
Price discrimination requires some market power,
distinct customer groups, and difficult resale.
 Comparison of Market Structures

Markets can be grouped into four basic structures: perfect

competition, monopolistic competition, oligopoly, and
monopoly.

Comparison of Market Structures

Perfect Monopolistic Oligopoly Monopoly

Competition Competition

Number of firms Many Many Two to four dominate One

Variety of goods None Some Some None

Control over prices None Little Some Complete

Barriers to entry and exit None Low High Complete

Examples Wheat, Jeans, Cars, Public water

shares of stock books movie studios
 Section 3 Review
The differences between perfect competition and monopolistic
competition arise because
 (a) in perfect competition the prices are set by the
government.
 (b) in perfect competition the buyer is free to buy from
any seller he or she chooses.
 (c) in monopolistic competition there are fewer sellers
and more buyers.
 (d) in monopolistic competition competitive firms sell
goods that are similar enough to be substituted for one
another.

An oligopoly is
 (a) an agreement among firms to charge one price for the
same good.
 (b) a formal organization of producers that agree to
coordinate price and output.
 (c) a way to attract customers without lowering price.
 (d) a market structure in which a few large firms
 Deregulation
Deregulation is the removal of some government
controls over a market
Deregulation is used to promote competition.
Many new competitors enter a market that has been
deregulated. This is followed by an economically
healthy weeding out of some firms from that market,
which can be hard on workers in the short term.
EX: Telecommunications sector in U.S. Effects have
been mixed.
 Government and
Competition
Government policies keep firms from controlling
the prices and supply of important goods.
Antitrust laws are laws that encourage
competition.
Sherman Antitrust Act (1890) was the 1st U.S. law
against monopolies
Clayton Antitrust Act (1914) outlawed price
discrimination
Federal Trade Commission (1914) was empowered
to issue cease and desist orders to companies
practicing unfair business practices
Robinson-Patman Act (1936) outlawed special
discounts to some consumers
Government also taxes to regulate businesses with
negative externalities (Chemical manufacturers)
Government also requires public disclosure
 Section Review—Role of
Gov’t
Antitrust laws allow the U.S. government to do all
of the following EXCEPT
 (a) regulate business practices.
 (b) stop firms from forming monopolies.
 (c) prevent firms from selling new
experimental products.
 (d) break up existing monopolies.

The purpose of both deregulation and antitrust

laws is to
 (a) promote competition.
 (b) promote government control.
 (c) promote inefficient commerce.
