Advertisers try to persuade consumers to purchase their

Why are some products

available at competitive

prices? Why are other products

priced higher? In Chapter 7, you

will learn about the various

effects competition and market

structures have on the prices

you pay. To learn more about

competition in a free enterprise

system, view the Chapter 8

video lesson:

Competition and Monopolies

Chapter Overview Visit the Economics: Principlesand Practices Web site at epp.glencoe.com andclick on Chapter 7—Chapter Overviews to previewchapter information.

Advertisers try to persuadeconsumers to purchasetheir products.

Advertisers try to persuadeconsumers to purchasetheir products.

http://epp.glencoe.com

Competition and MarketStructures

Main IdeaMarket structures include perfect competition,monopolistic competition, oligopoly, and monopoly.

Reading StrategyGraphic Organizer As you read the section, completea graphic organizer similar to the one below by iden-tifying five conditions that characterize perfectlycompetitive markets.

Key Termslaissez-faire, market structure, perfect competition,imperfect competition, monopolistic competition,

Perfectcompetition

product differentiation, nonprice competition, oli-gopoly, collusion, price-fixing, monopoly, naturalmonopoly, economies of scale, geographic monop-oly, technological monopoly, government monoply

ObjectivesAfter studying this section, you will be able to:1. Explain the characteristics of perfect competition.2. Understand the nature of monopolistic

competition.3. Describe the behavior and characteristics of the

oligopolist.4. Identify several types of monopolies.

Applying Economic ConceptsProduct Differentiation Think of a popular brand ofshoes or clothing. Read to find out why sellers go tosuch lengths to differentiate their products.

Cover Story

Air fares cut for business travel

N E W Y O R K

(AP)—In a nod to the

importance of corpo-

rate travel to their bot-

tom lines, three of the

nation’s biggest airlines

introduced discounts

on business fares at a

time when planes are

flying half-empty nationwide [after the 9/11 attacks]. . . .

The discounts, available for travel through Dec. 31,

were adopted Tuesday by Houston-based Continental

and Fort-Worth, Texas-based American after Chicago-

based United announced its fare change late Monday.

Other carriers are expected to follow.

—The Columbus Dispatch, October 3, 2001

W hen Adam Smith published An Inquiry intothe Nature and Causes of the Wealth of Nationsin 1776, the average factory was small, and

business was competitive. Laissez-faire, the philosophythat government should not interfere with commerce ortrade, dominated Smith’s writing. “Laissez-faire” is aFrench term that means “allow them to do.” Under lais-sez-faire, the role of government is confined to protect-ing private property, enforcing contracts, settlingdisputes, and protecting businesses against increasedcompetition from foreign goods.

By the late 1800s, however, competition wasweakening. In some markets mergers and acquisi-tions had combined many small firms into a fewvery large businesses. As industries developed, thenature of competitive markets changed. Industryrefers to the supply side of the market, or all pro-ducers collectively. Many modern markets, such asthe one discussed in the cover story, are now domi-nated by a few very large firms.

CHAPTER 7: MARKET STRUCTURES 163

Airlines lower fares

Today, economists classify markets accordingto conditions that prevail in them. They ask ques-tions such as: How many buyers and suppliers arethere? How large are they? Does either have anyinfluence over price? How much competitionexists between firms? What kind of product isinvolved—is everyone trading the exact sameproduct, or are they simply similar? Is it easy ordifficult for new firms to enter the market?

The answers to these questions help determinemarket structure, or the nature and degree ofcompetition among firms operating in the sameindustry. Economists group industries into fourdifferent market structures—perfect competition,monopolistic competition, oligopoly, andmonopoly.

Perfect CompetitionPerfect competition is characterized by a largenumber of well-informed independent buyers

and sellers who exchange identical products. It repre-sents a theoretically ideal situation that is used toevaluate other market structures. Five major condi-tions characterize perfectly competitive markets.

Necessary ConditionsThe first condition is that there are a large num-

ber of buyers and sellers. No single buyer or seller islarge enough or powerful enough to affect the price.

The second condition is that buyers and sellersdeal in identical products. With no difference inquality, there is no need for brand names and noneed to advertise. One seller’s merchandise is just asgood as another’s. The market for table salt sharessome of these features. Because salt is always thesame chemical—sodium chloride—there is no logicalreason to prefer one brand of salt over another.

The third condition is that each buyer and selleracts independently. This ensures that sellers com-pete against one another for the consumer’s dollar,and that consumers compete against one anotherto obtain the best price. This competition is one ofthe forces that keeps prices low.

The fourth condition is that buyers and sellersare reasonably well-informed about products andprices. Well-informed buyers shop at the storesthat have the lowest prices. Well-informed sellersmatch the lowest prices of their competitors toavoid losing customers.

The fifth condition is that buyers and sellers arefree to enter into, conduct, or get out of business.This freedom makes it difficult for producers inany industry to keep the market to themselves.Producers have to keep prices competitive or newfirms can take away some of their business.

Perfect Competition andProfit Maximization

Under perfect or pure competition, each individ-ual firm is too small to influence price. The firmviews demand differently than the market does. In aperfectly competitive market, supply and demand set

Market Structures

Conditions A market is a place where buyersand sellers can exchange products. How doeconomists classify markets?

164 UNIT 2 MICROECONOMICS

the equilibrium price. Then, each firm selects a levelof output that will maximize its profits at that price.

The relationship between an individual firm andthe entire industry under perfect competition isshown graphically in Figure 7.1. In Panel A, the mar-ket forces of supply and demand set the equilibriumprice at $15. This price, as shown in Panel B, nowbecomes a horizontal demand curve facing each per-fectly competitive firm. Because the firm receives $15for every additional unit it makes, the demand curveis the same as the marginal revenue (MR) curve.

Panel B also shows the cost and revenue infor-mation for the firm presented earlier, in Figure 5.6on page 128. This firm, as you may recall, alsoreceived $15 for every unit of output sold—which iswhy the price is the same as the marginal revenueshown in the second-to-last column. When thefirm wanted to maximize its profits, it did so byfinding the level of output that equated its mar-ginal cost with its marginal revenue.

Panel B in Figure 7.1 shows this same informationgraphically. For example, the firm’s marginal cost(MC) for producing the 110th unit of output was$4.50. Because this unit could be sold in the marketfor $15, the firm made a profit of $10.50. When thefirm added the seventh worker, total output rose to129 units, and marginal costs rose to $4.74—therebyearning additional profits for the firm.

The eighth worker helped increase total output to138 units. This was also profitable since the marginalcost of producing 138 units was less than the mar-ginal revenue from the sale of those products. Whenthe firm hired the ninth worker, however, marginalcost was exactly equal to marginal revenue, so at thispoint the firm would stop hiring labor and maintainproduction at 144 units. Had the firm hired thetenth variable input, increasing total output to 148units, total profits would have gone down becausethe $22.50 marginal cost of production was largerthan the $15 marginal revenue.

D S

S

D

Price = $15 = D = MR

AA Market

The equilibriummarket price

MC

Additions to profit

148144129110 138Quantity

B Individual FirmB

E C O N O M I C SA T A G L A N C EE C O N O M I C SA T A G L A N C E Figure 7.1Figure 7.1

Perfect Competition: Market Price and Profit Maximization

Using Graphs Using Graphs Under perfect competition, the market forces of supply and demand establish the equilibrium price. The perfectly competitive firm treats this price as its demand curve and its marginal revenue (MR) because the firm will receive $15 for each and every unit it sells. Is perfect competition always a theoretical situation? Explain.

15.00

5.00

$25.00

Price

$22.50

10.00

4.744.50

Revenue/Cost

Profits aremaximized where

MR = MCSubtractions from profit


The profit maximizing quantity of output is foundwhere the marginal cost of production is equal to themarginal revenue from sales, or where MC = MR.This occurs at 144 units of output, shown in bothFigure 5.6 on page 128 and Panel B of Figure 7.1.Other levels of output may generate the sameamount of profits, but none will generate more.

A Theoretical SituationFew, if any, perfectly competitive markets exist,

although local vegetable farming (“truck” farming)comes close to satisfying all five conditions. Inthese markets many sellers offer nearly identicalproducts. Individual sellers are unable to controlprices, and both buyers and sellers have reasonableknowledge of products and prices. Finally, anyonewho wants to enter the business by growing toma-toes, corn, or other products can easily do so.

Although perfect competition is rare, it is impor-tant because economists use it to evaluate othermarket structures. Imperfect competition is thename given to a market structure that lacks one ormore of the conditions of perfect competition.Most firms and industries in the United Statestoday fall into this classification, which has threecategories—monopolistic competition, oligopoly,and monopoly.

Monopolistic CompetitionMonopolistic competition is the marketstructure that has all the conditions of per-

fect competition except for identical products. Bymaking its product a little different, the monopo-listic competitor tries to attract more customersand monopolize a small portion of the market.

Product DifferentiationIn contrast to perfect competition, monopolistic

competition utilizes product differentiation—realor imagined differences between competing prod-ucts in the same industry. Most items producedtoday—from the many brands of athletic footwearto personal computers—are differentiated. The dif-ferentiation may even be extended to store loca-tion, store design, manner of payment, delivery,packaging, service, and other factors.

Sometimes differences between products arereal. For example, some brands of athletic footwearhave special shock-absorbing soles. Others havecertain construction materials to reduce weight.Some are just designed to look more appealing, orare linked to star athletes.

Nonprice CompetitionMonopolistic competitors want to make con-

sumers aware of product differences. Nonpricecompetition—the use of advertising, giveaways, orother promotional campaigns to convince buyersthat the product is somehow better than anotherbrand—often takes the place of price competition.Therefore, monopolistic competitors usually adver-tise or promote heavily to make their productsseem different from everyone else’s.

Can you organize andevaluate data? Can you beimpartial when you com-pile your findings?

The WorkMarket researchers gather,record, and analyze factsabout products and sales.

Information may be gathered from company or govern-ment records, published materials, statistical files, andother sources. Researchers often print and circulate ques-tionnaires, or survey people over the phone or door-to-door. The information is used to prepare forecasts offuture sales trends, offer recommendations on productdesign, and define the market toward which advertisingshould be directed.

QualificationsStrong analytical and writing skills and experience withcomputerized data are essential. Courses in marketing,statistics, English composition, speech, psychology, andeconomics are required.

Market Researcher


This explains why producers of designer jeansspend so much on advertising and promotion. Ifthe seller can differentiate a product in the mind ofthe buyer, the firm may be able to raise the priceabove its competitors’ prices.

Monopolistic Competition and ProfitMaximization

Under monopolistic competition, similar prod-ucts generally sell within a narrow price range. Themonopolistic aspect is the seller’s ability to raisethe price within this narrow range. The competitiveaspect is that if sellers raise or lower the priceenough, customers will forget minor differencesand change brands.

The profit maximization behavior of the monop-olistic competitor is no different from that of otherfirms. The firm produces the quantity of outputwhere its marginal cost is equal to its marginal rev-enue. If the firm convinces consumers that its prod-uct is better, it can charge a higher price. If it cannotconvince them, the firm cannot charge as much.

The monopolistic competitor can enter themarket easily. The possibility of profits draws newfirms, each of which produces a product only alittle different from the ones already on the market.

In time, both the number of firms in an industryand the supply of the product becomes fairly stablewith no great profits or losses.

OligopolyOligopoly is a market structure in which afew very large sellers dominate the industry.

The product of an oligopolist may be differenti-ated—as in the auto industry, or standardized—as inthe steel industry. The exact number of firms in theindustry is less important than the ability of anysingle firm to cause a change in output, sales, and

Competing in the Market On an average shoppingtrip, a consumer’s eye lingers on a product for onlyabout 2.5 seconds. In order to stay competitive,companies experiment with new formulas, alongwith the color and size of the product’s packaging.These research and development costs can rangefrom $100,000 for adding a new color to an existingproduct line to millions of dollars for the creation ofa new product.

MARKETING IN CHINAAn important part of any product is its name. Itmust convey what the producers intend.

Potential exporters must understand culturalcharacteristics when considering brand manage-ment. Because the Chinese continue to favor namesthat convey goodness, luck, happiness, long life,prosperity or historical significance, it is sometimesdifficult to translate a Western brand name intoChinese.

The Coca-Cola Company took 11 years to makea profit, in part due to an ill-advised brand name,after it came back to China in 1979. Today, Coke

dominates the vast soft drink market across theChinese continent after creating an improved namemeaning “delicious, enjoyable and makes youhappy.”

PepsiCo, Inc., came up with “everything makesyou happy” to capture market share for Pepsi. . . .

—Alcinda Hatfield, Foreign Agricultural Service, July 1999

1. Making Generalizations Why is it some-times difficult to translate a brand nameinto a name acceptable to people inanother country?

2. Categorizing Information What part doesthe brand name and labeling of a productplay in product differentiation?

Critical Thinking


prices in the industry as a whole. Because of thesecharacteristics, oligopoly is further from perfectcompetition than is monopolistic competition.

In the United States, many markets are already oli-gopolistic, and many more are becoming so. Pepsiand Coke dominate the soft drink market.McDonald’s, Burger King, and Wendy’s dominatethe fast-food industry. A few large corporations dom-inate other industries, such as the domestic airline,automobile, and long-distance telephone serviceindustries.

Interdependent BehaviorBecause oligopolists are so large, whenever one

firm acts the other firms usually follow. As demon-strated in the cover story on airline pricing, if oneairline announces discount fares, the other airlinesgenerally match the lower prices in a matter ofdays, if not hours. Each oligopolist knows that the

other firms in the industry have considerablepower and influence over consumer choices.Therefore, firms tend to act together.

Sometimes the interdependent behavior takes theform of collusion, a formal agreement to set prices orto otherwise behave in a cooperative manner. Oneform of collusion is price-fixing—agreeing to chargethe same or similar prices for a product. In almostevery case these prices are higher than those deter-mined under competition. The firms also mightagree to divide the market so that each is guaranteedto sell a certain amount. Because collusion usuallyrestrains trade, it is against the law.

Pricing BehaviorThe tendency of oligopolists to act together usu-

ally shows up in their pricing behavior. For example,one firm may try to implement a price increase inhopes that other firms in the industry will follow. Ifthe other firms do not follow, then the oligopolistthat initiated the price change will usually be forcedto take it back—or lose customers to its competitors.

An oligopolist may also try to lower the price ofits product, knowing that other oligopolists arelikely to follow suit. When one firm lowers prices,it can lead to a price war, or a series of price cutsthat result in unusually low prices. Oligopolisticprice wars are usually short but intense——andalmost always provide welcome relief for con-sumers in the form of lower prices.

Because oligopolists usually act together when itcomes to changing prices, most firms tend to com-pete on a nonprice basis by advertising, or byenhancing their products with new or different fea-tures. Nonprice competition has the advantage ofmaking it more difficult for rivals to respondquickly. If an oligopolist finds a new advertisinggimmick or a way to enhance a product, the otherfirms are at a disadvantage for a period of time.After all, it takes longer to develop a better adver-tising campaign or a new physical attribute for aproduct than it does to match a price cut.

Oligopoly and Profit MaximizationThe oligopolist, like any other firm, maximizes

its profits when it finds the quantity of output

Competition

Advertising Advertisers often use celebrities,such as star athletes, to increase the popularity oftheir products. What is the purpose of productdifferentiation?


where its marginal cost is equal to its marginal rev-enue. Having found this level of production, theoligopolist will charge the price consistent with thislevel of sales.

The product’s final price is likely to be higherthan it would be under monopolistic competi-tion, and much higher than it would be underperfect competition. Even when oligopolists donot collude formally, they still tend to act conser-vatively and seldom protest price hikes by theirrivals.

MonopolyAt the opposite end of the spectrum fromperfect competition is the monopoly. A

monopoly is a market structure with only one sellerof a particular product. This situation—like that ofperfect competition—is an extreme case. In fact, theAmerican economy has very few, if any, cases of

pure monopoly—although the local telephonecompany or cable TV operator may come close.

Even the telephone company, however, facescompetition from other communication compa-nies, from the United States Postal Service, andfrom Internet providers that supply E-mail andvoice-mail services. Local cable providers facecompetition from video rental stores, satellite cablesystems, and the Internet. Consequently, whenpeople talk about monopolies, they usually meannear monopolies.

One reason we have so few monopolies is thatAmericans traditionally have disliked and tried tooutlaw them. Another reason is that new tech-nologies often introduce products that competewith existing monopolies. The development ofthe fax machine allowed businesses to send elec-tronic letters that compete with the United StatesPostal Service. Later, E-mail became even morepopular than the fax.


Using Tables Using Tables The term market structure refers to the nature and degree of competition among firms operating in the same industry. Individual market structures—perfect competition, monopolistic competition, oligopoly, and monopoly—are determined by the five characteristics listed in the columns above. In which market structure does nonprice competition play a major role?

Number ofFirms inIndustry

InfluenceOver Price

Product Differentiation Advertising Entry Into

Market Examples

Perfect Competition

Characteristics of Market Structures

Pure Monopoly

MonopolisticCompetition

Oligopoly

Many None EasyNone None

Many FairAmount

FairAmount Easy Gas Stations

Women’s ClothingLimited

Few FairAmount Some Difficult Automobiles

AluminumSome

One None None AlmostImpossibleExtensive

Perfect: Near:

NoneTruckFarming

Perfect: Near:

NoneWater


Types of MonopoliesSometimes the nature of a good or service dictates

that society would be served best by a monopoly.One such case is a natural monopoly—a market situ-ation where the costs of production are minimizedby having a single firm produce the product.

Natural monopolies can provide services morecheaply as monopolies than could several compet-ing firms. For example, two or more competingtelephone companies serving the same area wouldbe inefficient if they each needed their own tele-phone poles and lines. Public utility companiesfall into this category because it would be wastefulto duplicate the networks of pipes and wires thatdistribute water, gas, and electricity throughout acity. To avoid these problems, the governmentoften gives a public utility company a franchise, theexclusive right to do business in a certain areawithout competition. By accepting such fran-chises, the companies also accept a certain amountof government regulation.

The justification for the natural monopoly is thata larger firm can often use its personnel, equipment,and plant more efficiently. This results ineconomies of scale, a situation in which the averagecost of production falls as the firm gets larger. Whenthis happens, it makes sense for the firm to be aslarge as is necessary to lower its production costs.

Sometimes a business has a monopoly becauseof its location. A drugstore operating in a town thatis too small to support two or more such businessesbecomes a geographic monopoly, a monopolybased on the absence of other sellers in a certaingeographic area. Similarly, the owner of the onlygas station on a lonely interstate highway exit alsohas a type of geographic monopoly.

A technological monopoly is a monopoly thatis based on ownership or control of a manufac-turing method, process, or other scientificadvance. The government may grant a patent—anexclusive right to manufacture, use, or sell anynew and useful invention for a specific period.Inventions are covered for 20 years; however, theproduct’s designs can be patented for shorter peri-ods, after which they become public propertyavailable for the benefit of all. Art and literaryworks are protected through a copyright, the exclu-sive right of authors or artists to publish, sell, orreproduce their work for their lifetime plus 50years.

Still another kind of monopoly is the governmentmonopoly—a monopoly the government ownsand operates. Government monopolies are foundat the national, state, and local levels. In mostcases they involve products or services that privateindustry cannot adequately provide.

Competition

Nonprice Competition If advertisers can make you believe their product is better than others, you mightpay more for it. How has nonprice competition affected your buying habits?


Many towns and cities have monopo-lies that oversee water use. Some statescontrol alcoholic beverages by requiringthat they be sold only through statestores. The federal government controlsthe processing of weapons-grade uraniumfor military and natural security purposes.

Monopoly and Profit MaximizationMonopolies maximize profits the same

way other firms do: they equate marginalcost with marginal revenue to find theprofit-maximizing quantity of output. Evenso, there are differences between themonopolist and other profit-maximizingfirms—especially the perfect competitor.

First, the monopolist is very much largerthan the perfect competitor. This is becausethere is only one firm—the monopolist—supplying the product, rather than thousands ofsmaller ones. Second, this large size, along with thelack of meaningful competition, allows the monop-olist to behave as a price maker—as opposed to theperfect competitor who is a price taker.

Because there are no competing firms in theindustry, there is no equilibrium price facing the

monopolist. Instead, the monopolist determinesthe price that will equate its marginal revenue withits marginal cost, and then produces the quantity ofoutput consistent with that price. In every case, themonopolist will charge more for its product—hencethe term price maker—and then limit the quantity forsale in the market.

Checking for Understanding1. Main Idea Describe the four basic market

structures. Explain how they differ from oneanother.

2. Key Terms Define laissez-faire, market struc-ture, perfect competition, imperfect competi-tion, monopolistic competition, productdifferentiation, nonprice competition, oligop-oly, collusion, price-fixing, monopoly, naturalmonopoly, economies of scale, geographicmonopoly, technological monopoly, govern-ment monopoly.

3. List the five characteristics of perfect competition.

4. Describe monopolistic competition.

5. Explain why the actions of one oligopolistaffect others in the same industry.

6. Identify the types of monopolies.

Applying Economic Concepts7. Product Differentiation Make a list of as

many clothing stores in your community aspossible. Describe how each store tries to dif-ferentiate itself from the others.

8. Synthesizing Information Provide at leasttwo examples of oligopolies in the UnitedStates today.

Practice and assess key social studies skills withthe Glencoe Skillbuilder Interactive Workbook,Level 2.

Geographic MonopolyA lone general storein an isolated areaenjoys a geographicmonopoly. How does ageographic monopolydiffer from a naturalmonopoly?

Monopoly


“I Love the Challenge”:

Charles Wang(1944–)

“There are CEOs who bragabout never having touched a PC,”says Charles Wang, chairman ofComputer Associates International.“I say to them, ‘Get your head outof the sand, kid.’” Wang’s aggres-sive approach has helped him growhis firm from a four-person opera-tion to one that earns more than$5 billion in computer softwaresales a year. Today, it is the largestindependent supplier of softwarefor business computing.

A DIFF ICULT START

Born in Shanghai, China, in1944, Charles Wang and his familyfled the communist regime in 1952to settle in the United States. Wangattended Queens College in NewYork and then opened an Americansubsidiary of Swiss-owned ComputerAssociates in New York City in1976. Wang began his operationswith just one product.

STRATEGY FOR GROWTH

Wang believed that the bestgrowth strategy for the fledglingcompany was to purchase existingsoftware firms and market theirproducts. This would spare his

company the risk of developing its own products and enable it to get products to market sooner. The strategy paid off. ComputerAssociates purchased a number offirms throughout the 1980s, andincreased its sales more than ten-fold, from $85 million in 1984 to$1 billion in 1989.

The recession of 1990–1991 puta damper on business, but Wanglaunched a campaign to purchaseeven more companies. His effortswere amply rewarded, andComputer Associates soonrebounded. “I love it when peoplesay it can’t be done,” Wang says. “Ilove the challenge.”

PROGRESSIVEMANAGEMENT

Despite its enormous growth,the company still remains focusedon its people. Wang supplies on-site fitness facilities and childdevelopment centers for employ-

ees. He brought together 2,000members of Computer Associates’development staff for “NerdWeekend”—a celebration for thepeople who fueled ComputerAssociates’ growth. Wang alsosponsors “Technology Boot Camps”to help chief executives get overtheir fear and ignorance of com-puters. In 1994, he wrote a bookurging business people to startthinking like technology people,and vice versa.

Wang’s success recalls theAmerican dream. In 2002, how-ever, the firm’s accounting prac-tices were investigated, and CharlesWang stepped down as chairman.

Examining the Profile1. Identifying Cause and Effect What

business strategy helped Wang’s fledg-ling company become successful?

2. Evaluating Information How impor-tant do you think Wang’s “NerdWeekend” and similar activities are tohis company’s success?


Market Failures

Cover Story

Mum’s the WordWe live in increasingly

intolerant times. . . . Mobile

telephones are the latest tar-

get: some trains, airline

lounges, restaurants and

even golf courses are being

designated “no phone” areas.

The Economist would like to suggest restrictions on

another source of noise pollution: children. . . .

Smoking, driving and mobile phones all cause what

economists call “negative externalities” . . . [the] costs

of these activities to other people tend to exceed the

costs to the individuals [who are doing it].

For children, just like cigarettes or mobile phones,

clearly impose a negative externality on people who are

near them. Anybody who has suffered a 12-hour flight

with a bawling baby in the row immediately ahead or a

bored youngster viciously kicking their seat from

behind, will grasp this quickly. . . .

—The Economist, December 5, 1998

Woman on cell phone

T he writer of the article cited in the coverstory went on to suggest that airlines shouldcreate “child-free zones” by seating children

in the back of the aircraft—and by charging parentsmore. This “rare outbreak of humor at TheEconomist,” according to London’s Daily Telegraph,was a hit with readers, resulting in bulging mailbagsand publicity.

The cover story, however, reminds us of another,more serious, fact of economic life—that marketssometimes fail. How they fail, and how the failurescan be remedied, is a concern for economists. Wenow want to take a look at how markets fail. Ways todeal with these failures will be discussed in the nextsection of this chapter.

A competitive free enterprise economy worksbest when four conditions are met. Adequatecompetition must exist in all markets. Buyers andsellers must be reasonably well-informed aboutconditions and opportunities in these markets.Resources must be free to move from one indus-try to another. Finally, prices must reasonably

Main IdeaInadequate competition, inadequate information, and immobile resources can result in market failures.

Reading StrategyGraphic Organizer As you read the section, thinkabout why maintaining adequate competition is a worthwhile goal. Use a graphic organizer like the one below to list effects of competition.

Key Termsmarket failure, externality, negative externality,positive externality, public goods

EffectsIf markets arecompetitive . . .

ObjectivesAfter studying this section, you will be able to:1. Discuss the problems caused by inadequate

competition.2. Understand the importance of having adequate

information.3. Describe the nature of resource immobility.4. Explain the nature of positive and negative

externalities.

Applying Economic ConceptsMarket Failure Have you ever felt that the perfectpart-time job is waiting for you—but you just can’tseem to find it? If so, you are experiencing marketfailure. A market failure usually occurs when wedon’t have adequate information about the market.The result is that productive resources—includingyou—do not reach their maximum potential.



reflect the costs of production, including therewards to entrepreneurs. Accordingly, a marketfailure can occur when any of these four condi-tions are significantly altered.

The most common market failures involve casesof inadequate competition, inadequate informa-tion, resource immobility, external economies, andpublic goods. These failures occur on both thedemand and supply sides of the market.

Inadequate CompetitionOver time, mergers and acquisitions haveresulted in larger and fewer firms dominat-

ing various industries. The decrease in competitionhas several consequences.

Inefficient Resource AllocationInadequate competition tends to curb efficient

use of scarce resources—resources that could beput to other, more productive uses if they wereavailable. For example, why would a firm with fewor no competitors have the incentive to useresources carefully? If a firm is free to do as itpleases, it likely will spend its profits on bonusesand extras like executive jets, lucrative salaries,and generous retirement benefits. This is one ofthe reasons that public utilities such as electricityare regulated by the government—to make surethat they do not use their monopoly status towaste or abuse resources.

Higher Prices and Reduced OutputAn imperfect competitor such as a monopoly

can use its position to prevent competition andrestrict production. This situation brings about arti-ficial shortages that cause higher prices than underother market structures.

Economic and Political PowerInadequate competition may enable a business

to influence politics by wielding its economicmight. In the past, many firms have used their hugecapital resources to further the political careers ofowners and their relatives and friends.

A large corporation does not even have to be amonopoly for its economic power to translate topolitical power. A large corporation, for example,may demand tax breaks from the state or local gov-ernment. If the government refuses, the corpora-tion may threaten to move elsewhere, causingeconomic loss to the community. Because thecommunity does not want to risk the loss, the cor-poration may get its way.

Both Sides of the MarketIf we consider the supply side of the market, it is

clear that perfectly competitive or monopolisticallycompetitive markets usually have enough firms toensure competition. When it comes to oligopoly,however, we know that the temptation to collude isstrong. No competition exists if a monopolist dom-inates the supply side of the market.

Inadequate competition may occur on thedemand side of the market as well. In most cases,such as in the consumer goods and services markets, many buyers can be found. How manybuyers are there, though, for space shuttles,hydroelectric dams, super computers, M-1 tanks,and high technology fighter jets? While failureson the demand side of the market do occur, theyare more difficult to correct than failures on the supply side.

Inadequate InformationIf resources are to be allocated efficiently,everyone—consumers, businesspeople, and

government officials—must have adequate informa-tion about market conditions. A secretary or anaccountant may receive a competitive wage in theautomobile industry, but are wages for the sameskills higher in the insurance industry, or in thebanking industry? Even the treasurer of a smallcommunity needs to know if the town’s surplusfunds can earn a higher return if invested in Dallas,New York, Indianapolis, or Seattle. Informationabout conditions in many markets is needed beforethese questions can be answered.

Some information is easy to find, such as want-ads or sale prices found in the local newspaper.Other information is more difficult to obtain. If this

knowledge is important to buyers, and is difficult toobtain, then it is an example of a market failure.

Resource ImmobilityOne of the more difficult problems in anyeconomy is that of resource immobility.

This means that land, capital, labor, and entrepre-neurs do not move to markets where returns are thehighest. Instead they tend to stay put and some-times remain unemployed.

What happens, for example, when a large autoassembly plant, steel mill, or mine closes, leavinghundreds of workers without employment? Certainlysome workers can find jobs in other industries, butnot all can. Some of the newly unemployed may notbe able to sell their homes. Others may not want tomove away from friends and relatives to find newjobs in other cities.

Consider the problems caused when the federalgovernment closed military bases to save taxpay-ers’ dollars. Thousands of workers were laid off incommunities that had no immediate means ofemploying them. Resource mobility, an ideal inthe competitive free enterprise economy, is muchmore difficult to accomplish in the real world.When resources are immobile or refuse to move,markets do not always function efficiently.

ExternalitiesMany activities generate some kind ofexternality, or unintended side effect that

either benefits or harms a third party not involvedin the activity that caused it.

A negative externality is the harm, cost, or incon-venience suffered by a third party because of actionsby others. The classic case of a negative externality is

Externalities

Positive and Negative Most economic activities generate externalities. Do you think the nearby airportexpansion was a positive or a negative externality for the people living in this neighborhood? Why?


the noise and inconvenience some people sufferwhen an airport expands.

A positive externality is a benefit received bysomeone who had nothing to do with the activitythat generated the benefit. For example, peopleliving on the other side of town may benefit fromthe additional jobs generated by the airportexpansion, or a nearby restaurant may sell moremeals, make a greater profit, and hire more work-ers. Both the owners of the restaurant and the newworkers gain from the airport expansion eventhough they had nothing to do with the expan-sion in the first place.

Externalities are classified as market failuresbecause their costs and benefits are not reflectedin the market prices that buyers and sellers pay forthe original product. For example, does the airlineor the air traveler compensate the homeowner forthe diminished value of the property located nearthe new runway extension? Does the restaurantowner share the additional good fortune derivedfrom the new business with the airport or the airtraveler? In both cases the answer is no. As aresult, the prices that travelers pay for air travelwill not reflect the external costs and benefits thatthe airport expansion generates.

Public GoodsAnother form of market failure shows up inthe need for public goods. Public goods are

products that are collectively consumed by every-one, and whose use by one individual does notdiminish the satisfaction or value available to oth-ers. Examples of public goods are uncrowded high-ways, flood control measures, national defense,and police and fire protection.

The market, however, when left to itself, does notsupply these items—or only supplies them inade-quately. This is because a market economy pro-duces only those items that can be withheld ifpeople refuse to pay for them. It would be difficult,for example, to deny one person the benefits ofnational defense while supplying it to others.Because it is so difficult to get everyone to pay fortheir fair share of a public good, private marketscannot efficiently produce them and will thereforeproduce other things.

The case of public goods illustrates that while themarket is very successful in satisfying individual wantsand needs, it may fail to satisfy them on a collectivebasis. If public goods are to be supplied, the govern-ment usually has to provide them.

Checking for Understanding1. Main Idea Using your notes from the graphic

organizer activity on page 173, explain whymaintaining adequate competition is a worth-while goal.

2. Key Terms Define market failure, externality,negative externality, positive externality, pub-lic goods.

3. Define “adequate competition” in your ownwords and explain why markets need ade-quate competition.

4. Explain the importance of having adequateinformation.

5. Explain why resources are not always mobileand willing to move.

6. Describe the similarities and differencesbetween positive and negative externalities.

Applying Economic Concepts7. Market Failures Cite at least two examples

of situations in your community in whichresources did not move from one market orindustry to another because they were eitherunable or unwilling to move.

8. Understanding Cause and Effect Identifyone possible positive externality and onepossible negative externality from the clos-ing of a military base.



Coca-Cola and Pepsi are competing forcontrol of the U.S. beverage market. Thecola giants are experimenting with newmarketing strategies in New York City,where the consumer market is consideredone of the toughest in the country.

Cola WarsWith $30 billion in beverage sales between

them, Coca-Cola Co. and Pepsico Inc. have longbattled each other with multimillion dollar adcampaigns and country-by-country marketingcoups. . . .

But to make sure all that marketing moneytranslates into bottles sold, both Coke and Pepsiare intensifying their efforts at the locallevel. . . . And nowhere is the fighting moreheated than in the intensely competitive,intensely difficult New York market. “Many soft-drink executives think New York is the toughestmarket in the country,” says John Sicher, editorof industry newsletter Beverage Digest. “The traf-fic is huge, the population is dense, and theneighborhoods are complicated.”

But it’s also a huge price—and one PepsiCo,headquartered in Purchase, N.Y., would be loathto lose. Pepsi has always spent big to stay aheadon its home turf. New Yorkis one of only four U.S.markets where Pepsi-Cola outsells Coca-ColaClassic. . . .

The showdown over theBig Apple began . . . whenCoke’s largest bottler, Coca-Cola Enterprises Inc.(CCE), moved into the NewYork market. CCE has sinceadded 600 more marketingpeople and 60 new trucks toits delivery fleet. . . .

. . . Each marketing representative visits up to120 small stores a week,[where they are] pushingfor snazzier displays, bet-ter placement, and morepromotions. . . .

. . . Pepsi is pushing its own New York cam-paign to the hilt. But rather than send out freshnew troops, Pepsi is relying heavily on its bot-tler’s local distribution force to boost its pres-ence in stores, with new racks, coolers, andgiveaways. It is also making a big push to get themost from its sponsorships of Lincoln Center,Radio City Music Hall, and the Bronx Zoo withticket giveaways and advertising tie-ins. . . .

. . . In this hard-fought battle, Coke and Pepsiare doing everything they can to come out on top.—Reprinted from August 3, 1998 issue of Business Week, by special

permission, copyright © 1998 by The McGraw-Hill Companies, Inc.

Examining the Newsclip1. Finding the Main Idea Explain how the

cola companies are trying to dominate theNew York consumer markets.

2. Making Predictions What might youexpect to happen to Pepsi and Coke prices as the companies try to dominate the NewYork City market?

AUGUST 3, 1998 N e w s c l i p


The Role of Government

Main IdeaOne of the economic functions of government in a market economy is to maintain competition.

Reading StrategyGraphic Organizer As you read the section, give threereasons government takes part in economic affairs.Complete an organizer similar to the one below tohelp you organize your answer.

Key Termstrust, price discrimination, cease and desist order,public disclosure

Government ineconomic affairs

ObjectivesAfter studying this section, you will be able to:1. Discuss major antitrust legislation in the United

States.2. Understand the need for limited government

regulation.3. Explain the value of public disclosure.4. Discuss the modifications to our free enterprise

economy.

Applying Economic ConceptsPublic Disclosure Do you have a credit card or a carloan? Do you know the size of the monthly payments,the computation of the interest, and other importantterms of the agreement? Did someone take the timeto explain all these details? Disclosing this informationis not merely an act of kindness on the part of thebusiness: it is required by a federal public disclosurelaw to assure that you are a well-informed consumer.

T oday, government has the power to encour-age competition and to regulate monopoliesthat exist for the public welfare. In some

cases, government has taken over certain economicactivities and runs them as government-ownedmonopolies. In other cases, the United States gov-ernment even makes estimates—such as thosedescribed in the cover story—in order to carry out itslegal and social obligations.

Antitrust LegislationIn the late 1800s, the United States passedlaws to restrict monopolies, combinations,

and trusts—legally formed combinations of corpo-rations or companies. Since then, a number of keylaws have been passed that allow the governmentto either prevent or break up monopolies.Collectively, this legislation is designed to preventmarket failures due to inadequate competition.

178

Cover Story

GM recalls 254,000 Saturns

NEW YORK–About 254,000 Saturn L-Series cars

are being recalled because of ignition and spark plug

problems that could

cause a fire, General

Motors said Tuesday.

The world’s largest

automaker said there

have been seven re-

ports of fires related to the problems but no crashes,

serious injuries or fatalities. The necessary replace-

ments and reprogramming will be performed at no

cost to the customers, the company said.

GM stock sank nearly 2 percent in afternoon trad-

ing on the New York Stock Exchange.

—CNN/Money, June 24, 2003

Saturn L-Series

178_GLENEPP 10/3/03 7:11 PM Page 178

In 1890 Congress passed the Sherman AntitrustAct “to protect trade and commerce againstunlawful restraint and monopoly.” The ShermanAct, described in Figure 7.3, was the country’s firstsignificant law against monopolies. It sought todo away with monopolies and restraints that hin-dered competition. By the early 1900s, a numberof business organizations had been convictedunder the Sherman Act.

The Sherman Act laid down broad foundationsfor maintaining competition. The act was not spe-cific enough, however, to stop many practices thatrestrained trade and competition. In 1914Congress passed the Clayton Antitrust Act to givethe government greater power against monopo-lies. Among other provisions, this act outlawedprice discrimination—the practice of chargingcustomers different prices for the same product.

The Federal Trade Commission Act was passedin the same year to enforce the Clayton AntitrustAct. The act set up the Federal Trade Commission(FTC) and gave it the authority to issue cease anddesist orders. A cease and desist order is an FTCruling requiring a company to stop an unfair busi-ness practice, such as price-fixing, that reduces orlimits competition among firms.

In 1936 Congress passed the Robinson-PatmanAct in an effort to strengthen the Clayton Act,particularly the provisions that dealt with price

discrimination. Under this act, companies couldno longer offer special discounts to some customerswhile denying them to others. This law primarilyaffected national organizations and chain storesthat were offering goods and services at lower pricesthan those paid by small independent businesses.

Government RegulationNot all monopolies are bad, and for that rea-son not all should be broken up. In the case

of a natural monopoly, it makes sense to let the firmexpand to take advantage of lower productioncosts—then regulate its activities so that it cannottake advantage of the consumer. Ideally, the regula-tor’s goal is to set the same level of price and ser-vice that would exist under competition.


Anti-Monopoly Legislation

Using Charts The federal government enacted four major legislative acts to curb monopolistic practices. What is the purpose of the Federal Trade Commission?Using Charts The federal government enacted four major legislative acts to curb monopolistic practices. What is the purpose of the Federal Trade Commission?

Sherman

Antitrust

Act

1890

Outlawed all contracts“in restraint of trade”to halt the growth of trusts and monopolies

Clayton

Antitrust

Act

1914

Federal

Trade

Commission

Act

1914

Strengthened the ShermanAct by outlawing pricediscrimination

Established the Federal TradeCommission to regulate unfair methods of competition in interstate commerce

Robinson-

Patman

Act

1936

Forbade rebates and dis-counts on the sale of goodsto large buyers unless therebate and discount wereavailable to all

Consumer ProtectionAccurate and reliable information about prod-ucts helps consumers determine which onesare the best buys. Consumer information isavailable on many online sites. Included arestudies and tests about products and services,personal finance, health and nutrition, andother consumer concerns.


Food and Drug Administration(FDA), 1906

Federal Trade Commission(FTC), 1914

Federal Communications Commission(FCC), 1934

Securities and Exchange Commission(SEC), 1934

National Labor Relations Board(NLRB), 1935

Federal Aviation Administration(FAA), 1958

Equal Employment Opportunity Commission(EEOC), 1964

Environmental Protection Agency(EPA), 1970

Occupational Safety and Health Administration(OSHA), 1970

Consumer Product Safety Commission(CPSC), 1972

Nuclear Regulatory Commission(NRC), 1974

Federal Energy Regulatory Commission(FERC), 1977


Federal Regulatory Agencies

Using Charts Using Charts The government has created a number of federal regulatory agencies to oversee the economy. Because of government’s involvement in the economy, we have a modified free enterprise system. With which of the agencies listed in the table are you familiar? Which affect you directly? Why?

Enforces laws to ensure purity, effectiveness, and truthfullabeling of food, drugs, and cosmetics; inspects productionand shipment of these products

Administers antitrust laws forbidding unfair competition,price fixing, and other deceptive practices

Licenses and regulates radio and television stations andregulates interstate telephone, telegraph rates and services

Regulates and supervises the sale of listed and unlistedsecurities and the brokers, dealers, and bankers who sell them

Administers federal labor-management relations laws; settles labor disputes; prevents unfair labor practices

Oversees the airline industry

Investigates and rules on charges of discrimination byemployers and labor unions

Protects and enhances the environment

Investigates accidents at the workplace; enforcesregulations to protect employees at work

Develops standards of safety for consumer goods

Regulates civilian use of nuclear materials and facilities

Supervises transmission of the various forms of energy


Examples of RegulationLocal and state governments regulate many

monopolies, such as cable television companies,water and electric utilities, and even telephonecompanies. A public commission or other govern-ment agency usually approves prices for their ser-vices. If a company wants to raise rates, it mustargue and prove its case before the commission.

Agencies of the national government, such asthose listed in Figure 7.4, regulate many busi-nesses. Privately owned agencies, such as theFederal Reserve System, have certain regulatorypowers, including the power to regulate themoney supply, some daily bank operations, andeven bank mergers.

Internalizing ExternalitiesThe government can also use the tax system to

lessen some of the negative externalities in theeconomy. Suppose, for example, that firms in a cer-tain industry are causing pollution, which is flow-ing into a nearby river or even affecting theatmosphere. Because they are using the environ-ment as a giant waste-disposal system, their costs ofproduction are lower than they should be.

If government taxes these producers, severalthings happen. First, every firm’s cost of produc-tion goes up, causing each to produce a little lessat every possible price. This causes the marketsupply curve to shift and the price of the productto rise. Consumers of the product react pre-dictably by buying less of the product.Meanwhile, the government uses the tax proceedsto clean up the pollution.

Figure 7.5 shows how this works. First, a $1 taxis placed on every unit of output that a firm pro-duces. This shifts the supply curve up by exactly$1. The new intersection of supply and demandtakes place at $15.60—indicating that the firmpaid 40¢ of the tax and passed 60¢ on to the consumer.

Economists call this “internalizing an external-ity” because it forces the polluting firm and its cus-tomers, rather than innocent third parties, to payfor the cost of pollution. Consequently, the gov-ernment uses policies like this to prevent marketfailures due to negative externalities.

Public DisclosureThe purpose of public disclosure is to pro-vide the market with enough data to prevent

market failures due to inadequate information. Whilethere is some cost involved, and while some busi-nesses might prefer to not disclose anything, thebenefits to society far outweigh the costs.

One of the more potent weapons available tothe government is public disclosure, or therequirement that businesses reveal information tothe public. The degree of disclosure is more exten-sive than most people realize, going beyond thecontent labels that the Food and DrugAdministration requires on foods and medicines.

For example, the government requires that allcorporations selling stock to the public must dis-close financial and operating information on aregular basis to both its shareholders and to theSecurities and Exchange Commission (SEC). The

5 6Quantity


Effects of a Pollution Tax

Using GraphsUsing Graphs A pollution tax shifts the cost of the negative externality back to the producer and the user of the product. In the example, how much of the $1 tax does the producer pay?

$15.60$15.00

DS + tax

S + tax

S

S

D

Pric

e

$1 per unitpollution taxraises cost ofproduction.


SEC retains this data electronically in itsElectronic Data Gathering Analysis and Retrieval(EDGAR) system, which can be accessed by any-one over the Internet. Access is free, and you neednot be an owner to see the extremely detailedfinancial and operating information for any firm.

Banks are required to file periodic reports tothe Federal Reserve System and other federalagencies such as the Federal Deposit InsuranceCorporation (FDIC) that insures the nation’s

banks. Most of this information is available to thebank’s competitors as well as to its shareholders,and it is highly sought after by almost all firms inthe industry.

There are also disclosure regulations for busi-nesses that lend to consumers. If you obtain acredit card or borrow money to buy a car, thelender will take considerable time to explain howthe monthly interest is computed, the length of theloan, the size of the payments, and other importantterms of the agreement. This is not an act of kind-ness on the lender’s part—federal law requires thatlenders make these disclosures so that consumersknow what they are getting into. Finally, there are“truth-in-advertising” laws that prevent sellers frommaking false claims about their products.

Indirect DisclosureThe government has also worked indirectlyto improve the quality of information avail-

able to consumers. One example is the govern-ment’s support for the Internet, and its attempt toprovide low-cost access to all public schools.Government has also agreed to not collect somefees, such as taxes on e-commerce sales, in order tohelp the Internet grow.

INFOBYTEINFOBYTE

The SEC The Securities and Exchange Commission(SEC) is a regulatory agency that is responsible foradministering federal securities laws. The purposeof these laws is to protect investors from improperpractices in securities markets and to ensure thatthey have access to disclosure of all material infor-mation concerning publicly traded securities. Thecommission also regulates firms engaged in thepurchase or sale of securities, people who provideinvestment advice, and investment companies.

Consumer Protection

The Role of Government Truth-in-advertising laws are one way the federal government tries to improvethe quality of information in the economy. How do these laws protect consumers?

King Features Syndicate. All rights reserved.


Businesses have joined the rush to the Web byposting extensive information about their activi-ties. The Internet provides other information toconsumers as well. The savvy user can talk to oth-ers in chat rooms, participate in user forums, orread product reviews to find out more about agood or service before making a purchase. Otherservices allow consumers to search for the bestprices.

Finally, virtually every government document,study, and report is available in some fashion onthe Internet. This includes the annual budget ofthe U.S. government, and reports by thePresident’s Council of Economic Advisors. Alsoavailable online are information from the StatisticalAbstract of the United States, bulletins by the Bureauof Labor Statistics, reports by the Census Bureau,and almost every other publication that you canfind in the government documents section of amajor research library.

Modified Free EnterpriseConcern over the costs of imperfect competi-tion is one reason the government intervenes

in the economy. Historically, the freedom to pursueself-interests led some people and businesses to seekeconomic gain at the expense of others. Under thelabel of competition, some larger firms used theirpower to take advantage of smaller ones. In somemarkets, monopoly replaced competition.

Because of such conditions, Congress passed lawsto prevent “evil monopolies” and to protect therights of workers. Its support of labor unions gaveworkers more bargaining power. New food and druglaws protected people from false claims and harmfulproducts. Government strictly regulated some indus-tries, such as public utilities. All these actions led toa modification of free enterprise.

In summary, government takes part in economicaffairs for several reasons. One is to promote and toencourage competition for the benefit of society.Another is to prevent monopolies and reduce thecosts of imperfect competition wherever possible. Athird is to regulate industries in which a monopoly isclearly in the best interest of the public. A fourth isto fulfill the need for public goods. As a result,today’s modified private enterprise economy is amixture of different market structures, different kindsof business organizations, and varying degrees ofgovernment regulation.

8. Synthesizing Information Identify fiveexamples of how government has inter-vened in your community.

Checking for Understanding1. Main Idea Using your notes from the graphic

organizer activity on page 178, explain why thegovernment is involved in economic affairs.

2. Key Terms Define trust, price discrimination,cease and desist order, public disclosure.

3. Describe four important antitrust laws.

4. Explain why there is a need for limited gov-ernment regulation within the economy.

5. Describe the value of public disclosure.

6. Explain why the United States has a modifiedfree enterprise economy.

Applying Economic Concepts7. Public Disclosure Visit a bank in your commu-

nity and ask for literature describing the com-putation of interest and conditions for with-drawal on various savings accounts. Why doyou think the bank is so forthcoming on theseissues?


Student Web Activity Visit the Economics: Principles andPractices Web site at epp.glencoe.com and click onChapter 7—Student Web Activities for an activity on thegovernment’s role in promoting fair business practices.



Finding the Main IdeaFinding the main idea will help you see the “big picture.” Organizing infor-mation will help you understand and assess the most important concepts.

Increases in economic growth need not mean increases inpollution. Pollution is not so much a by-product of growthas it is a “problem of the commons.” Much of theenvironment—streams, lakes, oceans, and the air—istreated as “common property,” with no restrictions on itsuse. The commons have become our dumping grounds; wehave overused and debased them. Environmentalpollution is a case of spillover or external costs, andcorrecting this problem involves regulatory legislation orspecific taxes to remedy misuse of the environment.

There are serious pollution problems. But limitinggrowth is the wrong solution. Growth has allowedeconomies to reduce pollution, be more sensitive toenvironmental considerations, set aside wilderness, andclean up hazardous waste, while still enabling risinghousehold incomes.

—Alice M. Rivlin, Reviving the American Dream Washington Brookings Institutions, 1992

1. Who wrote this passage?

2. When was it written?

3. What was the purpose of this article?

4. What is the main idea that the author of the article is expressing?

5. What additional details in the excerpt support themain idea?

6. Do you find the article persuasive? Explain yourresponse.

Learning the SkillTo find the main idea, follow these steps:

• Find out the setting of the article.

• As you read the material, ask “What is the purposeof this article?”

• Skim the material to identify its general subject.Look at headings and subheadings.

• Identify any details that support a larger idea orissue.

• Identify the central issue. Ask “What part of theselection conveys the main idea?”

Practicing the SkillRead the excerpt below, then answer the

questions that follow.

Does [economic] growth threaten theenvironment? The connection between growth andenvironment is tenuous, say growth proponents.

Bring to class a news article that deals withcompetition in the marketplace. Identify themain idea and explain why it is important.

Practice and assess key social studies skills with theGlencoe Skillbuilder Interactive Workbook, Level 2.

Chimneys obscured by smoke at coal-firedpower plant


S e c t i o n 1

Competition and MarketStructures (pages 163–171)

• Perfect competition is a market structure with alarge numbers of buyers and sellers, identical eco-nomic products, independent action by buyers andsellers, reasonably well-informed participants, andfreedom for firms to enter or leave the market.

• Perfect competition is a largely theoretical situationused as a benchmark to evaluate other market struc-tures. Market situations lacking one or more of theseconditions are called imperfect competition.

• Monopolistic competition has all the characteristicsof perfect competition except for identical products.

• Oligopoly is a market structure dominated by a fewvery large firms, and the actions by one affects thewelfare of others.

• The monopolist is a single producerwith the most control over sup-ply and price. Various formsof monopoly include thenatural monopoly, thegeographic monopoly,the technologicalmonopoly, and thegovernment monopoly.

• All private firms,regardless of marketstructure, maximize prof-its by producing at the levelof output where marginal costis equal to marginal revenue.

S e c t i o n 2

Market Failures (pages 173–176)

• Market failures occur when sizable deviations fromone or more of the conditions required for perfectcompetition take place.

• Three of the five commonmarket failures includeinadequate competition,inadquate information, andresource immobility.

• Externalities, or economicside effects to third parties,are a fourth market failure.A negative externality is a harmful side effect and a positive externality is abeneficial side effect.

• Externalities are regarded as market failures becausethey are not reflected in the market prices of theactivities that caused the side effects.

• Finally, a market economy often fails to providepublic goods such as national defense and publiceducation because it cannot withhold supply fromthose who refuse to pay.

S e c t i o n 3

The Role of Government (pages 178–183)

• The Sherman Antitrust Act of 1890 was enacted toprohibit trusts, monopolies, and other arrangementsthat restrain competition. The Clayton Antitrust Actwas passed in 1914 to outlaw price discrimination.The Robinson-Patman Act of 1936 was passed tostrengthen the price discrimination provisions of theClayton Antitrust Act.

• Public disclosure is used as a tool to promote com-petition. Any corporation that sells its stock publiclyis required to supply periodic financial reports toboth its investors and to the SEC.

• Banks are covered by additional disclosure laws andreport to various federal agencies.

• Today, government takes part in economic affairs topromote and encourage competition. As a result, themodern economy is a mixture of different marketstructures, different forms of business organizations,and some degree of government regulation.


Identifying Key TermsUse all the terms below in four paragraphs, with each para-graph describing one of the major types of market structures.

collusiongeographic monopolyimperfect competitionmonopolistic competitionnatural monopolyoligopolyproduct differentiationtechnological monopolyprice-fixingmonopolynonprice competitionperfect competition

Reviewing the FactsSection 1 (pages 163–171)

1. Describe the five characteristics of perfect competition.

2. Explain the main characteristics of the monopolisticcompetitor.

3. Contrast the oligopolist and the perfect competitor.

4. Describe the four types of monopolies.

Section 2 (pages 173–176)

5. Explain what happens when markets do not haveenough competition.

6. Provide two examples of inadequate information ina market.

7. Explain what is meant by resource immobility.

8. Explain what is meant by positive and negativeexternalities.

9. Account for the reluctance of the private sector toproduce public goods.

Section 3 (pages 178–183)

10. Identify four major antitrust laws.

11. List 10 major federal government regulatory agencies.

12. Explain how public disclosure is used as a tool toprevent market failures.

13. Describe a modified free enterprise economy.

Thinking Critically1. Drawing Inferences Do you think there would

be any advantages to making monopolies or nearmonopolies break up into smaller, competingfirms? If so, what are they? If not, why wouldthere not be? Use a chart like the one below tohelp you organize the answers to these questions.

2. Understanding Cause and Effect How are natu-ral monopolies prevented from practicing monop-olistic practices?

3. Making Generalizations To what extent do youthink government should be involved in the freeenterprise economy? Defend your answer.

4. Finding the Main Idea What problems do theFederal Trade Commission, the Securities andExchange Commission, and the ConsumerProduct Safety Commission address?

5. Summarizing Information Why do private pro-ducers fail to provide public goods?

Monopolies shouldbe broken up Reasons

ReasonsMonopolies shouldnot be broken up

Self-Check Quiz Visit the Economics: Principlesand Practices Web site at epp.glencoe.com andclick on Chapter 7—Self-Check Quizzes to preparefor the chapter test.



Applying Economic Concepts1. Market Failures Explain how your newspaper,

with its help-wanted ads and weekly sale prices,helps prevent market failures.

2. Market Structures Identify a fast-food productthat you consume regularly. Count the number of firms in your community that supply a similarproduct, and then identify the market structurefor that product in your community.

3. Free Enterprise How does the federal governmentattempt to preserve competition among businessenterprises?

Math PracticeThe table below shows the price, market demand, mar-ket supply, and the surplus and shortage for a firm pro-viding a product under perfect competition. Study theinformation in the table, then answer the questions.

1. Some of the information is missing from the table.Calculate the correct information.

2. What is the equilibrium price? How can you tell?

3. What price(s) will produce a surplus?

4. What price(s) will produce a shortage?

Thinking Like an EconomistProfit Maximization Economists like to analyzedecisions incrementally—taking small steps and

analyzing the costs and benefits of the steps as theyare made. How is this way of thinking similar to theprofit maximization logic illustrated in Figure 7.1on page 165?

Technology SkillDeveloping Multimedia Presentations Choose aproduct offered by several producers that is adver-tised in newspapers or magazines. For one week,clip and save at least three different advertisementsabout your product. Keep a journal in which youevaluate each advertisement and summarize whyyou would or would not buy a particular brand.Use your evaluations and a video camera to developa commercial advertising a product of your choice.Have other students evaluate your commercial forits effectiveness.

600-----850990-----1300147016501840

1098765432

15501500145014001350----------12001150

950780----------210

0–220-----

–690

PriceMarketDemand

MarketSupply

Surplus/Shortage


Finding the Main Idea Read the excerptbelow, then answer the questions thatfollow.

Monopolistic competition occurs whenthere are many producers of productsthat are almost the same. Firms in sucha market try to make customers believethat the similar products are actuallydifferent. Each producer uses advertis-ing to persuade the customer that hisor her brand is superior. Firms that aresuccessful have a monopoly on theirname and reputation more than ontheir product. Customers are willing topay more for the product because theyassociate its name with quality or value.Many beauty products, soaps, house-hold cleaners, and over-the-countermedicines fall into this group.

1. What is monopolistic competition?

2. What main idea is expressed?

3. What details support the main idea?


Issues in FreeIssues in FreeIssues in FreeIssues in Free

Issues in FreeIssues in Free

Social Security Is Secure

During the 21st century, when all theBoomers have put work behind them,20 percent of all Americans will beelderly—a larger percentage than everbefore in our history. And theseretirees will get Social Securitybenefits from taxes collectedfrom a much smaller pool ofworking people. . . .

While it’s true that in 2030there will be fewer workersper retiree than there aretoday, a more reliable mea-sure is to look at workers per

dependent—which means not just the elderly butalso those too young to work. Why is this impor-tant? Because it allows us to point out, reassuringly,that in 1965, the last year of the Baby Boom, therewere 95 dependents for every 100 workers, com-pared to 71 today and 79 in 2030. If society could

handle the massive needs (education,health care, for example) of our

generation in our pre-productive years, it canmanage to see us throughour post-productive yearsas well. . . .

Social Security worksbecause it offers universalcoverage. . . . Certainlysome people would rakein more money underprivatization than theywould under the current

P R O

THE FUTURE OF SOCIAL SECURITYThe Social Security Act of 1935 and its later amendments created a social insurance system to

help America’s most needy: elderly, ill, and unemployed citizens. The core of the program wasretirement benefits, funded by taxes on workers and employers, that people could collect whenthey stopped working at age 65. For decades the system, though criticized, was largely recog-nized as fundamentally sound.

But in the 1980s the system faced a severe cash shortage: outgoing payments rose faster thanincoming taxes. The federal government responded with some changes (such as raising theretirement age from 65 to 67 by the year 2027) that forestalled the problem. But as the babyboomer generation ages, Social Security may be facing another crisis.

Many experts fear that the system will be drained of funds in the twenty-first century, leav-ing whole generations bereft of benefits. The solution, they say, is the privatization of the sys-tem. Others maintain that the problems facing Social Security are overstated and that, whilesome fine-tuning may be necessary, a fundamental change like privatization is uncalled for, anddangerous.

Who is right? As you read the selections, ask yourself: Is SocialSecurity working, or does the United States need a new system?


EnterpriseEnterprise

Enterprisesystem. But others would get less and some wouldlose everything. . . . If that doesn’t make youuneasy, try this: these privatization schemes wouldincrease taxes and add considerably to the adminis-trative costs of Social Security (which today stand atan almost unbelievable 1 percent compared to12–14 percent for private sector insurance). SocialSecurity isn’t without problems. Quite simply, peo-ple are living longer and so there will have to beadjustments like a higher retirement and maybesomewhat lower benefits phased in gradually overdecades so no one gets a surprise they can’t plan for.But Social Security ain’t broke—in the fiscal orstructural sense. . . .

—John Shure, Vice President of the Twentieth Century Fund

A New System Is Needed

Back in 1940, when the Social Security programwas just getting under way, average life expectancywas less than 64 years. The program’s designersexpected that many people would contribute tothe program most of their lives and die before col-lecting a dime in retirement benefits. . . . Today,average life expectancy in the United States ismore than 75 years. More important, the popula-tion that reaches age 65 is also living longer. Anaverage person that lives to 65 will live for approx-imately another 17 years. . . .

As life expectancy has soared, birthrates havedeclined, leaving fewer and fewer workers to sup-port the ballooning number of retirees. In 1950,this pyramid scheme was solidly supported with16 workers paying for each retiree; today, there arejust over three workers per beneficiary. The [SocialSecurity Administration’s] own estimates indicatethat the ratio of workers to beneficiaries will con-tinue to decrease, reaching just two workers perbeneficiary by 2030.

Moreover, those projections ignore one of themost promising facts of our time: Not only does lifeexpectancy continue to grow; the rate of growth isaccelerating. From 1940 to 1965, life expectancy formen over age 65 increased by one year; during thenext quarter century it grew by 2.1 years. . . .

Social Security needs fundamental reform if itis to cope with our increasing longevity. . . . [A]llworkers should be given the option of redirectingtheir payroll taxes to personal retirement accounts.

Those accounts, which will be invested in pro-ductive enterprises, will grow and all workers willaccrue a substantial asset of far greater value than thebenefits promised—but not yet paid for—by the cur-rent Social Security system. . . . As the savings rateincreases, young innovative companies . . . will haveeasier access to investment capital and will flourish.

—Carrie Lips, Cato Institute’s Project on Social Security Privatization

C O N

Analyzing the Issue 1. How does Shure’s discussion of the “workers-

per-dependent” ratio suggest that the SocialSecurity system is not in crisis? Why does heoppose privatization of the system?

2. What evidence does Lips use to support herargument that “Social Security needs funda-mental reform”? Why does she supportprivatization?

3. With which opinion do you agree? Explainyour reasoning.

UNIT 2 MICROECONOMICS 189

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