11-1 copyright © 2008 thomson south-western, a part of the thomson corporation. thomson, the star...
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11-1COPYRIGHT © 2008 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license.
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Competition• Market structure in which seller cannot
influence price• Protects consumers from potentially
unreasonable prices and prohibits any supplier market power– Ability of individual firm to influence market price of
its product
• Competitive market has three characteristics:1. Many small buyers and sellers2. Standardized product3. No barriers to entry or exit
• Important implication of characteristics is that competitive firm will be a price taker
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Competition (cont.)
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Monopoly• Market in which only one firm (monopolist) produces
product with no close substitutes– Historical examples:
• Long-distance phone service (AT&T)• U.S. postal service
• Monopolist is not a price taker (firm unable to influence market price of its product) but a price maker (firm able to influence market price of its product)– Does not mean firm will simply set highest possible price; firm
can raise price by decreasing quantity it supplies
• Characteristics of monopolies:1. Single firm2. Offers for sale a unique product with no close substitutes3. Market has strong barriers to entry
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Monopoly (cont.)
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Oligopoly
• Market in which only a few large firms dominate (oligopolists)– Examples:
• Automobile companies• Ready-to-eat cereal companies
• Produce large enough share of total market supply of product so that each of these large firms can influence market price
• If oligopoly firms agree to get together and cooperate on output levels, they can set price as high as if they were a monopoly
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Concentration Ratio• Percentage of output produced by four largest firms in
an industry– If four or fewer firms, concentration ratio will be 100– If industry contains many small firms, concentration ratio will be
very low
• Many economists consider concentration ratio above 60 to indicate tight oligopoly in which firms have significant market power
• Although concentration ratios are useful indicators of possible market power, they are not perfect measures of market power1. Concentration ratios based only on domestic (U.S.) production
and exclude foreign competition2. Many markets are regional
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Concentration Ratios for Selected Manufacturing Industries
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Barriers to Entry• Market characteristic that prevents new firms from
entering market• Seven common barriers to entry:
1. Economies of scale• Large amount of product can be produced at lower cost per unit
than small amount of product• Arise from technology used in manufacturing product, as well as
organization of labor and any discounts that producer may receive on large purchases of inputs
2. Exclusive franchises• Permission by government (often local government) for monopoly
firm to exist• Often case when there is a natural monopoly
– Market with significant economies of scale– Examples:
» Local telephone companies» Natural gas companies» Electric companies
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Barriers to Entry (cont.)• Seven common barriers to entry (cont.):
3. Control of essential raw materials
4. Patents• Legal protections that allow inventor to be sole provider of
product for period of time
• Government gives patents for new products and new processes to encourage innovation and invention– Although patents encourage invention, also encourage
development of market power:1. Holder of patent will be sole producer of product for many
years2. Patents can be misused3. Common practice of aggressively defending patents with
patent infringement lawsuits discourages would-be competitors from producing close substitutes
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Barriers to Entry (cont.)• Seven common barriers to entry (cont.):
5. Product differentiation• Creation of image that one firm’s product is different from
or somehow superior to other similar products– May be real (style, quality, or color) or artificial (created solely
by advertising)
6. Licensing• Government requires new entrants to obtain license
(permit) before beginning operation in many professions and trades
7. Behavior of established firms• Price-cutting is example
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Competition vs. Monopoly
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Collusion
• Better known as price-fixing
• Occurs when firms cooperate to restrict total market output and thereby obtain higher price
• More likely in markets with relatively few firms and substantial entry barriers
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Types of Collusion• Cartel agreements
– Group of producers that has explicit agreement to limit output and charge price higher than competitive price
• Examples:– Organization of Petroleum Exporting Countries (OPEC)– DeBeers diamond company
• Price leadership– Charging different groups of buyers different prices– Occurs in markets in which firms never explicitly agree to
collude, but instead somehow come to realization that it is in their best interests to charge similar prices and to restrict output to maintain higher prices
– One firm emerges as price leader and other firms adjust price whenever leader changes its price
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Inefficiency
• Firms in concentrated markets tend to have less incentive to be efficient than do firms in competitive markets– Competitive firm must minimize cost of
product in order to survive, but firm in concentrated market protected by entry barriers has no such incentive
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Price Discrimination• Charging different groups of buyers different
prices when price differentials are not justified by differences in costs
• Only possible when firms have significant price-making power
• Extremely common in United States
• Examples:– Automobile companies charging different prices for
different models of cars– Drug industry charging different prices for drugs
consumed by hospital patients rather than by retail buyers
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Forces That Decrease Market Power
• Technological change
• Antitrust activity
• Deregulation of unwisely regulated sectors
• Import competition
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Technological Change
• Economies of scale often eroded by forces of technological changes
• Examples:– Phone industry– Railroads
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The U.S. Antitrust System• Set of weapons designed to combat market power
• Consists of laws passed by Congress, agencies empowered to administer laws, and court system to try cases under laws
• Examples of federal antitrust laws:– Sherman Act (1890)– Clayton Act (1914)– Celler-Kefauver Act (1950)
• Principal agencies charged with administering law are Antitrust Division of Justice Department and Federal Trade Commission (FTC)
• Examples of antitrust cases:– Ticketmaster (1993)– McDonnell Douglas and Boeing (1997)– Sprint and WorldCom (2000)– Microsoft (2000)
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Regulation and Deregulation• Natural monopolies that exhibit substantial economies of
scale are generally regulated by state or federal government agencies
• Regulation involves limitation of market entry by granting exclusive franchises to firms– Natural monopoly is regulated with respect to rates charged and
level of service offered
• Major problem with regulation occurs when public utility-type of regulation is imposed on industries that are not natural monopolies because they do not have substantial economies of scale– Regulation shelters firms from competition and actually causes
inefficiency
• Deregulation simply means lessening regulatory restrictions
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Import Competition
• Import quotas and tariffs that limit competition from foreign imports are often called upon to protect American firms
– Powerful firms that lobby Congress to limit imports are often in concentrated markets
• Restricting imports protects market power in concentrated industries, but does not benefit American worker or consumers
– By protecting market power in concentrated industries, ultimately cause lower output levels, lower employment, and higher prices to consumers
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Wal-Mart• World’s largest privately owned company,
employing 1.7 million workers and earning profits of $11.2 billion in 2005
• Center of controversy as critics charge that its business practices are unethical– Among these charges are that:
• It does not pay employees a living wage• It does not allow workers to form unions• It does not provide adequate health care insurance for
employees• It discriminates by failing to promote women to management
positions
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Wal-Mart (cont.)• Effect on local communities is controversial
– Critics argue that prices charged by Wal-Mart will drive local establishments out of business, and that lower prices may disappear when local businesses fail and Wal-Mart utilizes enhanced market power
– Others argue that Wal-Mart enhances competition, thereby bringing lower prices to consumers
– Also maintain that increased traffic resulting from large numbers of Wal-Mart shoppers visiting local communities will actually increase business of downtown merchants
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International Aspects of Market Power
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The Economic Left and the Economic Right
• THE ECONOMIC RIGHT (Conservative)
– Feel market power is seldom serious problem
– Believe barriers to entry are seldom so high as to eliminate threat of competition from new firms entering industry
– Believe technological change erodes established monopoly positions
– Seldom see need for antitrust or economic regulation, and believe such policies create inefficiency
– Argue that any increased market power created when firms merge is controlled by potential competition from new entrants into industry and by technological change
– Argue that government actually creates monopoly power by granting utility companies exclusive franchises
• THE ECONOMIC LEFT (Liberal)– Believe competition creates
efficiency, and government must act to reduce market power that impedes competition
– Support antitrust policy and government regulatory authority
– Feel antitrust system is needed to control excessive market power and that proposed mergers should be scrutinized closely before allowed to take place
– Believe public utilities should be regulated to protect consumer from monopolistic excesses
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Appendix: Elasticity and Monopoly Profits
• Since monopolist supplies unique product, likely that demand for product is inelastic
– When demand is inelastic, consumers do not alter quantities they purchase very much when price of product changes
• Monopolists take advantage of situation by recognizing that even small reduction in quantity supplied will be associated with much higher price
– Monopolist can increase profits by restricting output
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Appendix: Elasticity and Price Discrimination
• Two different groups of consumers of long-distance phone service:– One group of businesspeople must phone
clients during business hours and have few alternatives to making phone calls
• Inelastic demand– Supplier can increase revenue by raising price
– One group of nonbusiness consumers can use e-mail and make calls during the evenings or weekends
• Elastic demand– Supplier can increase revenue by reducing price
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