Chapter 7Market Structures

Competition and Market Structure

Laissez-faire – according to Adam Smith, the government’s role in the economy was to:

• Protect private property• Enforce contracts• Settle disputes• Protect domestic industry from

foreign competitionOtherwise, the free market

economy should run on its own

Industry refers to the supply side of the market (all producers collectively)

Consumers create the demand

A market is a place where buyers and sellers can exchange products

Market structures are classified based on:

• How many buyers and suppliers are there?

• How large are they?• Does either have influence over the

price?• How much competition exists?• Are the products exactly the same

or only similar?• Is it easy or difficult to enter and

leave the market?

We will look at 4 kinds of markets:

• Perfect competition• Monopolistic competition• Oligopoly• Monopoly

Perfect Competition:• Large # of buyers and sellers (no single one large enough to

affect price)• Identical products – no need for

much advertising• Each buyer and seller operates

independently and competition keeps prices low

• Buyers and sellers are well-informed• Free to enter or leave the market

• Most markets are not perfectly competitive markets.

• Farmer’s market• Eggs• SaltThese markets come close to

meeting the five conditions that define a perfectly competitive market.

Most firms and industries fall under the category of “imperfect competition” and include:

• Monopolistic competition• Oligopoly• Monopoly

Monopolistic competition • Has all the features of perfect

competition except for identical products

• Product differentiation – real or imagined differences between competing products

Nonprice competition – (advertising)• Monopolistic competitors advertise

and promote their products heavily to make their product seem different from everyone else’s

• Often spend a large portion of their budget on advertising

• If the firm can convince consumers that their product is better, they might be able to charge a higher price.

Examples of monopolistic competition would include:

• Gas stations• Blue jeans• Athletic footwear• Grocery stores• Department stores

Oligopoly – A few large sellers dominate the

industry and have more influence over price

• Pepsi and Coke• McDonald’s and Burger King• Breakfast food industry• Razors and blades• Cameras and film• Automobile industry

Each firm in an oligopoly has considerable power over price and consumer choice so most have to follow the lead on pricing.

• Collusion – a formal agreement to set prices or to behave in a cooperative manner

• Price-fixing – agreeing to charge the same or similar price for a product

Monopoly – only one sellerThe U.S. has discouraged to the

point that what we have today is more accurately described as “near monopolies”

Cable companies have competition from video stores, satellite systems and the internet

Types of monopolies:• Natural monopoly – the costs of

production are minimized by having a single producer of the product

• Electric companies• Cable companiesThese are often given a franchise

by the government to operate in a certain location and are subject to government regulation

Larger firms can use its personnel, equipment, and plant more efficiently resulting in economies of scale. This is where the average cost of production falls as the firm gets larger.

Geographic monopolies occur when the location is not large enough to support more than one firm.

Small towns may only have one drugstore or one gas station

Technological monopolies – when a firm has ownership or control of a manufacturing method or process.

They may have gotten a government patent which gives them the exclusive right to manufacture, use or sell any new and useful invention for a specific period. Inventions are covered for 20 years

Art and literary works are protected by a copyright which gives the author or artist the exclusive right to publish, sell, or reproduce their work for their lifetime plus 50 years.

Government monopoly – the government owns and operates the business which is usually something that private industry cannot adequately provide.

• Water usage• Alcoholic beverages• Processing of weapon grade

uranium• U.S. postal service (although

this has some competition today.)

Because there is little or no competition with a monopoly, they have more power to be a price maker instead of a price taker.

Causes of Market Failure:• Inadequate competition• Inadequate information for

consumers, business people and government officials

• Resource immobility• Externalities – unintended side

effect that either harms or benefits a third party

(airport expansion)

• The need for public goods is a market failure

• Public goods are collectively consumed by everyone

• It would be impossible to divide up the cost according to how much benefit each person received

• Interstate highways, flood control measures, national defense, schools, police and fire protection

The role of the Government:• 1890 – Sherman Antitrust Act -

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

• 1914 - Clayton Antitrust Act – strengthened the Sherman Act by outlawing the practice of charging customers different prices for the same product

1914 – Established the Federal Trade Commission to regulate unfair methods of competition in interstate commerce

1936 – Robinson-Patman Act – forbade rebates and discounts on the sale of goods to large buyers unless the rebate and discount were available to all

(page 180 – Federal Regulatory Agencies)