Chapter 7 A Spectrum of Markets

Economics 11

April 2012

• pure competition and pure monopoly represent opposite poles along a spectrum of markets, these situations rarely exist

PERFECT (PURE) COMPETITION

Perfectively competitive markets:

• are ones in which uniform goods are bought and sold and where prices are generally known; where there is competition in the market between buyers and sellers; and where no group of buyers or sellers attempts to fix prices

• in a purely competitive market, companies (firms) are known as “price-takers” because they have to accept the prevailing price (they cannot change it by their actions)

characteristics of perfectly competitive markets:

• there are many buyers and sellers, no single one of whom is able to influence the price of the product

• each firm produces the same product, so buyers have no reason to buy from one seller rather than another

• buyers and sellers know the prices at which goods are sold in the market

• workers are able to move into the industry easily

• there are no barriers preventing firms from entering

• business people can easily set up new firms

MONOPOLY

• a market situation in which there is only one producer of a good or service and many buyers

• monopoly is the opposite of pure competition

• in a monopoly a sole supplier is known as a “price-maker” – they have considerable control over price

MONOPOLY• there are two types of monopolies: natural monopolies and legal

monopolies

- NS Power Corporation is an example of a natural monopoly it is more efficient to have a single supplier

Legal Monopolies – legal monopolies exist when government makes it illegal for more than one company to supply a good or service

for example: Metro Transit

• many municipal transit systems have a legal monopoly on public transit in their area

MONOPOLIES IN CANADA

• monopolies obviously have a great deal of power to fix prices or output in their own interest

• local electrical service is essential, there is no real substitute, and demand for the service is inelastic

NS Power is free to set their own prices, which is why it must be regulated by the government

• government monitors the quality of service and control the prices of the goods and services they produce in order to protect the consumer

OLIGOPOLY • a kind of market in which a few firms supply most of

the goods or services

a good example is the cellular providers

• in some oligopolies, the products are so similar they are virtually identical

this type of market is called a homogeneous oligopoly

Homogeneous oligopoly - production of an identical product is concentrated in a few firms. Price differences among the firms are typically quite small.

Example: pencils, sheet metal.

OLIGOPOLY

• however sometimes oligopolies might strive to make their products distinctive

this type of market is called a differentiated oligopoly

• Firms operating in a differentiated oligopoly attempt to differentiate their products in order to be able to charge consumers a higher price.

Example: Cigarette manufacturing

why are some markets oligopolies?

• one main reason is that certain products require large scale operations to manufacture their product

• for example the automobile industry:– to build an assembly plant requires a huge capital

investment – therefore the entry of new auto firms into the car

market is extremely limited – also the number of firms necessary to supply the car

market is small

Monopolistic Competition

• monopolistic competition is a market situation in which there are many sellers providing a similar but not identical good or service

Monopolistic Competition• the sit down restaurant business is a great example of

monopolistic competition – there are many suppliers (lots of restaurateurs out there) – the products they sell are similar but not identical, this gives

suppliers some measure of control over price– entry into the business is relatively easy (most buildings can be

converted into restaurants without a large capital investment)

• the restaurant industry is monopolistically competitive because each restaurant competes with all the others in the area, but each restaurant has a monopoly over the food it serves and the way it is served.

• monopolistic competition is frequently found in service industries such as hair cutting, auto repair, retail trade and restaurants

Concentration in Canadian Industry

a concentration ratio is used to measure the extent to which an industry is controlled by a few firms

the concentration ratio measures the proportion of an industry’s sales made by its four largest and eight largest firms

– in the tobacco industry, the four largest firms control 99% of sales of domestic tobacco products in Canada (8 largest 100%)

– construction, clothing and furniture industries are markets not dominated by a few firms

Restricting Competition unfortunately sometimes competition among companies can be

diminished, this usually happens in one of five ways:

1. through unfair competition

• sometimes firms use cut throat pricing to drive out their competitors

• with cut throat (predatory) pricing, goods are priced well below the cost of production

• this practice drives smaller companies out of the market

• once the small competitors have been forced out of business, the cut throat competitor can raise prices and increase its share of the market

Example: Walmart

Restricting Competition

2. by establishing a cartel

• a cartel is an organization of independent producers that enter into an agreement to fix output or prices

• this is illegal

Restricting Competition

3. through interlocking directorates

• when a person is on a board of directors of a number of competing companies

Restricting Competition

4. through mergers

• a merger is the combining of assets of two companies into a single company

• usually the result of one company taking over another

• this diminishes competition

Restricting Competition

5. by establishing a holding company

• -a holding company is set up to hold (or own) a significant proportion of the shares of other companies

• this diminishes competition

• horizontal combinations – when companies of the same type combine by merging or by setting up a holding company

• vertical combination (integration) - is the control by a company of the various stages of production

• conglomerate – formed when companies in unrelated industries combine

conglomerates are organized on the principle that is smart to spread business risks over several unrelated industries

– there are two main advantages of large-scale operations:

• ability to engage in research • large scale production

Government Regulation

governments protect the interests of consumers in three main ways:

1. by government ownership of the businesses that provide the goods and services

natural monopolies like water, electricity, public transit, sewage treatment

2. by laws that are intended to ensure the competition between companies is maintained

making it illegal to fix prices or limit output

3. by government regulation of the prices charged and services provided

provincial governments regulate the rates charged for water, electricity, and natural gas

the federal government has jurisdiction over broadcasting, and air and rail transportation

WHAT’S ON CHAPTER 7 TESTThursday April 19th 2012

• The three ways governments protect the interests of consumers

• the two main advantages of large-scale operations

• horizontal combinations

• Vertical combinations

• Conglomerates

• The five ways competition is restricted

• Concentration ratio

• Monopolistic competition

• Monopoly (natural monopoly, legal monopoly)

• Oligopoly (differentiated and homogeneous)