Chapter 7

Perfect Competition (theoretical)

• Large # of buyers and sellers (B/S) exchange identical products under five conditions:

1. There should be a large # of B/S2. The products should be identical

Perfect Competition, continued

3. B/S should act independently

4. B/S should be well-informed

5. B/S should be free to enter, conduct, or get out of business

Perfect v. Imperfect Competition

• Under perfect competition, supply and demand set the equilibrium price, and each firm sets a level of output that will maximize its profits at that price.

• Imperfect competition refers to market structures that lack one or more of the five conditions of perfect competition

Monopolistic Competition• Meets all the requirements of perfect

competition minus the identical products• NONPRICE COMPETITION: public relations,

giveaways, advertising, promotional campaigns

• Use product differentiation-real or imagined. Ex?

• How do cell phone, fragrance, or junk food companies differentiate their products?

Oligopoly

• Few very large sellers dominate the industry. Ex?

• Further away from perfect competition than monopolistic competition

• Act interdependently by lowering prices soon after the first seller announces the cut. **Prefer non-price competition

• May all agree formally to set prices (collusion), which is illegal

Two forms of Collusion

1. Price-fixing-an agreement to set a price that is often above market price

2. Dividing the market for guaranteed sales

-price wars-Pushing prices lower than the cost of production (short run)

Final prices are likely to be higher than under Mon-Comps and much higher under Per-Comp

• Only one seller in a particular market. Ex?

• Four types: Natural, Geographical, Technological, Government

• The monopolist is larger than a perfect competitor, allowing it to be the price maker versus the price taker.

Monopoly

Natural Monopoly

• Single firm or business produces a product or provides a service because it minimizes the overall costs (public utilities)

Geographic Monopoly

• The location cannot support two or more such business (small town drugstore)

Technological Monopoly

• Producer has exclusive rights through patents or copyrights to produce or sell a particular product

Government Monopoly

• Government provides products or services that private industry cannot adequately provide (uranium processing)

Market Failures and Government Response

•Inadequate CompetitionDecreases in competition can lead to several consequences that create market failures

• Inefficient resource allocation– Where is

the incentive to use resources carefully?

• Higher prices and Reduced Output– Artificial

shortages cause higher prices.

Market Failures

• Economic and Political Power– Many firms use $$ to

further the political careers of relatives and friends.

– Revolving Door…

• Both sides of the Market– Failures on the

demand side are harder to correct than failures on the supply side.

Inadequate Information• To redistribute product and $$ where it

needs to be, everyone must have adequate, reliable, easy-to-find information…

otherwise the market fails!!

Resource Immobility

• The FOP cannot move to a new market where returns are higher = market failure

• Ex?

• Steel mills, auto assembly plants, military bases

ExternalitiesCosts (-) or benefits (+) of production or

consumption of a good spill over onto non-

producers or consumers. Positive or Negative?

• New airport expansion

• Both. Why?

• New sports stadium

• Both. Why?

• The costs and benefits are not reflected in the market prices that buyers and sellers pay for the original product. Thus, it is a market failure

Public Good

• While the market is successful in satisfying individual wants and needs, it may fail to provide for the collective.

…so the government has to provide these services.

Where Does Government Fit In?

Antitrust Legislation

• Prevent market failures due to inadequate competition

• Remember Sherman (1890) and Clayton (1914) Anti-trust Acts?

Government Regulation

Internalizing Externalities

• A firm causes pollution The Gov taxes firms

• 1st: As firm’s production costs ↑, supply ↓• 2nd: Price ↑ = Demand ↓• Taxes are used to clean pollution

Thus, polluting firms and their customers, rather than innocent third parties, are forced to pay for the cost of the pollution clean-up

Public DisclosureDirect Indirect

• Provide the market with data to prevent market failures due to inadequate information

• Businesses are required by federal law, to reveal information to the public

• “Truth in Advertising” laws prevent sellers from making false claims about products.

• Includes gov’t support of the Internet and availability of government documents on Web sites.

• Businesses post information about their own activities on their company websites.

Modified Free Enterprise

Government intervention keeps ‘em honest by:

• Promoting competition• Preventing monopolies• Regulating industry• Fulfilling the need for public goods• U.S. economy is mixture of different market

structures, business organizations, and government regulation