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Economics Chapter 7 Market Structures


  • pg 1
Chapter 7
 Chapter 7
 Section 1

Perfect competition is a market
  structure in which a large
 number of firms all produce
      the same product.
    Sometimes called pure
competition, this market is one
with a large number of firms all
 producing the same product.
  Perfect competition assumes
       that the market is in
 equilibrium and that all firms
  sell at about the same price.

 Because each firm produces a
small part of the total supply, no
 one firm can control the price.
•There are Four
 Conditions for
1. Many Buyers and
Sellers must participate in
the market

There are many participants
on both the buying and
selling sides.
2. Sellers Offer Identical

 There are no differences
 between the products sold by
 different suppliers.
3. Buyer and Sellers are Well
  Informed About Products.

  The market provides the
  buyer with full information
  about the product and its
4. Buyer and Sellers have Free
   Market Entry and Exit

  Firms can enter the market
  when they can make money
  and leave it when they can't.
Only a few industries come
close to meeting these

Two examples are:
 1.the market for farm products
 2.stock traded on the stock
   Barriers to Entry
Factors that make it difficult for
  new firms to enter a market
   are called barriers to entry.
There are two types:
Start-Up Costs and Technology
 Start-up Costs
 • The expenses that a new
   business must pay before the
   first product reaches the
   customer are called start-up
   For example, before starting a new
sandwich shop you would need to rent a
store, buy cooking equipment, and print
 Technology, or Technical Ability
 • Some markets require a high
   degree of technological know-how.
   As a result, new entrepreneurs
   cannot easily enter these markets.

For example, Carpenters, pharmacists,
  or electricians need training before
  they can have the skills they need.
   Price and Output
One of the primary
 characteristics of perfectly
 competitive markets is that
 they are efficient.
In a perfectly competitive
 market, price and output
 reach their equilibrium levels.
Market Equilibrium in Perfect Competition


        Equilibrium Price



Perfectly competitive markets are
The intense competition in these
markets keeps both prices and
production costs low.
A firm that raised its prices higher than
other firms, or had higher production
costs, would not be able to compete.
The illustration above summarizes
the characteristics of a perfectly
competitive market.
Chapter 7
Section 2

Monopoly: More than
 just a board game!
   Defining Monopoly
• A monopoly is a market
  dominated by a single seller.
• Instead of many buyers and
  sellers, as is the case with perfect
  competition, a monopoly has one
  seller and any number of buyers.
•Monopolies form when barriers
prevent firms from entering a market
that has a single supplier.
•Monopolies can take advantage of
their monopoly power and charge high
•For this reason, the United States has
outlawed monopolistic practices in most
Forming a Monopoly

Different market conditions can
     create different types of
  monopolies. Here are several
     ways monopolies form:
   Economies of Scale
If a firm's start-up costs are high,
and its average costs fall for each
additional unit it produces, then it
enjoys what economists call
economies of scale. An industry that
enjoys economies of scale can easily
become a natural monopoly.
 Natural Monopolies
A natural monopoly is a
market that runs most
efficiently when one large
firm provides all of the
Government Monopolies
A government monopoly is a
 monopoly created by the
 government. These take
 several forms:
Technology and Change
 Sometimes the development of
 a new technology can destroy
 a natural monopoly.
• Technological Monopolies
 –The government grants
  patents, licenses that give the
  inventor of a new product
  the exclusive right to sell it
  for a certain period of time.
In the local telephone industry, a
monopoly developed because it
was inefficient for more than one
company to build an expensive
wire network.
In such cases, the government
may give one company the right to
dominate a geographic area.
• Franchises and Licenses
 –A franchise is a contract
  that gives a single firm the
  right to sell its goods within
  an exclusive market. A
  license is a government-
  issued right to operate a
• Industrial Organizations
  –In rare cases, such as sports
   leagues, the government
   allows companies in an
   industry to restrict the
   number of firms in the
 Price Discrimination
Price discrimination is the
 division of customers into
 groups based on how much
 they will pay for a good.
Although price discrimination
 is a feature of monopoly, it
 can be practiced by any
 company with market power.
 Market power is the ability to
 control prices and total
 market output.
Targeted discounts, like
 student discounts and
 manufacturers’ rebate offers,
 are one form of price
• Price discrimination requires
  some market power, distinct
  customer groups, and difficult
    Output Decisions
A monopolist sets output at a
 point where marginal revenue
 is equal to marginal cost.
• Even a monopolist faces a limited
  choice – it can choose to set
  either output or price, but not
• Monopolists will try to maximize
  profits; therefore, compared with
  a perfectly competitive market,
  the monopolist produces fewer
  goods at a higher price.
The illustration above summarizes
the characteristics of a monopoly.
  Chapter 7
  Section 3
And Oligopoly
Perfect competition and monopoly
are the two extremes in the range
of market structures.
Most markets fall into two other

  1. monopolistic competition
  2. oligopoly
Monopolistic Competition
 In monopolistic competition,
  many companies compete in
    an open market to sell
  products which are similar,
      but not identical.
  Four Conditions of
Monopolistic Competition
Many Firms
 As a rule, monopolistically
 competitive markets are not
 marked by economies of scale
 or high start-up costs, allowing
 more firms.
Few Artificial Barriers to
 Firms in a monopolistically
 competitive market do not face
 high barriers to entry.
Slight Control over Price
 Firms in a monopolistically
 competitive market have some
 freedom to raise prices because
 each firm's goods are a little
 different from everyone else's.
Differentiated Products
 Firms have some control over
 their selling price because they
 can differentiate, or distinguish,
 their goods from other products
 in the market.
•For example, jeans can differ in
brand, style, and color.
•Ice cream differs in taste and flavors.
These markets are called monopolistic
competition because each firm has a
kind of monopoly over its own
particular product.
Monopolistic competition exists in
industries where there are low barriers
to entry.
   Nonprice Competition
Firms that are monopolistically
 competitive have slight control over
 their prices, because they offer
 products that are slightly different
 from any other company’s.
Nonprice competition is a way to
 attract customers through style,
 service, or location, but not a lower
They may offer new colors, textures,
 or tastes in their products

They may also try to find the best
 location for their services.
Four Conditions:

Characteristics of Goods
 The simplest way for a firm to
 distinguish its products is to
 offer a new size, color, shape,
 texture, or taste.
Location of Sale
 A convenience store in the
 middle of the desert
 differentiates its product simply
 by selling it hundreds of miles
 away from the nearest
Service Level
 Some sellers can charge higher
 prices because they offer
 customers a higher level of
Advertising Image
 Firms also use advertising to
 create apparent differences
 between their own offerings and
 other products in the
 Prices, Profits, and Output
• Prices
  –Prices will be higher than they
    would be in perfect competition,
    because firms have a small
    amount of power to raise prices.
 Prices, Profits, and Output
• Profits
  –While monopolistically
    competitive firms can earn profits
    in the short run, they have to work
    hard to keep their product distinct
    enough to stay ahead of their
 Prices, Profits, and Output
• Costs and Variety
  – Monopolistically competitive firms
    cannot produce at the lowest average
    price due to the number of firms in
    the market. They do, however, offer
    a wide array of goods and services to
 Oligopoly describes a market
  dominated by a few large,
  profitable firms.
 It can form when significant
   barriers to entry exist.
Examples of oligopolies in the United
 States include air travel, cola, breakfast
 cereals, and household appliances.
Oligopolistic firms sometimes use
 illegal practices to set prices or to
 reduce competition.
They may engage in price fixing, an
 agreement among forms to sell at
 the same or very similar prices.
 Price fixing is illegal in the United
  States and can lead to heavy
Two types:

• Collusion is an agreement among
  members of an oligopoly to set
  prices and production levels.
  Price- fixing is an agreement
  among firms to sell at the same or
  similar prices.
• A cartel is an association by
  producers established to coordinate
  prices and production.
Comparison of Market Structures

 • Markets can be grouped into
   four basic structures: perfect
   competition, monopolistic
   competition, oligopoly, and
Comparison of Market Structures

                       Perfect     Monopolistic      Oligopoly    Monopoly
                     Competition   Competition

                    Many Many                     Two to four     One
Number of firms
Variety of goods    None Some                      Some          None
Control over        None           Little          Some
Barriers to entry   None           Low              High
and exit

                     Wheat,        Jeans,           Cars,        Public
                    shares of      books
                                                   movie         water
 Chapter 7
 Section 4
      Market Power
Market power is the ability of a
 company to control prices and
Monopoly and oligopoly can
 sometimes have negative effects
 on consumers and the economy.
• Markets dominated by a few
  large firms tend to have
  higher prices and lower
  output than markets with
  many sellers.
• To control prices and output
  like a monopoly, firms
  sometimes use predatory
  pricing. Predatory pricing sets
  the market price below cost
  levels for the short term to
  drive out competitors.
Another way firms try to reduce
 competition is by buying out
 their competitors.
Since the late 1800’s, the United
 States has enacted various laws
 to prevent companies from
 reducing competition.
      Government and
Government policies keep firms
 from controlling the prices and
 supply of important goods.
 Antitrust laws are laws that
 encourage competition in the
It is the job of the Federal Trade
  Commission and the
  Department of Justice’s
  Antitrust Division to enforce
  these laws.
The government also tries to prevent
 companies from joining together, that
 might reduce competition and lead to
 higher prices.
   Regulating Business

The government has the power
to regulate business practices if
these practices give too much
power to a company that
already has few competitors.
Breaking Up Monopolies

The government has used anti-
trust legislation to break up
existing monopolies, such as
the Standard Oil Trust and
    Blocking Mergers

A merger is a combination of
two or more companies into a
single firm. The government
can block mergers that would
decrease competition.
  Preserving Incentives

In 1997, new guidelines were
introduced for proposed
mergers, giving companies an
opportunity to show that their
merging benefits consumers.
In the 1970’s and 1980’s, Congress
  passed laws leading to the
  deregulation of some industries.
Deregulation is the removal of
 some government controls over a
Markets experiencing deregulation
 included the airline, trucking ,
 banking, railroad, natural gas,
 and television broadcasting
When it is successful, deregulation
 increases competition and leads to
 lower prices for consumers.
But deregulation often caused
 hardship for employees of
 companies driven out of business by
 increased competition.

• Antitrust laws strengthen
  government control over a market.
• Deregulation loosens government
• Deregulation and anti-trust laws are
  both used to promote competition.
• Many new competitors enter a
  market that has been deregulated.
  This is followed by an economically
  healthy weeding out of some firms
  from that market, which can be hard
  on workers in the short term.
  The table above lists four very
important government actions that
were taken to promote competition.

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