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Chapter 7_ Section 1 Competition and Market Structures


									    Chapter 7, Section 1 Competition and Market Structures
   Laissez-faire is the philosophy that government should not
    interfere with commerce or trade
        o Adam Smith’s Wealth of Nations advocated laissez-faire
        o Under a laissez-faire system, government is limited to
           protecting private property, enforcing contracts, settling
           disputes, and protecting businesses against competition
           form foreign goods
   Industries – the supply side of the market; all producers
   Economists classify markets by asking questions such as
        o How many buyers and sellers are there?
        o How large are they?
        o Does either influence the price?
        o How much competition exists between firms?
        o What kind of product is involved – are they similar or
           exactly the same?
        o Is it easy or difficult for new firms to enter the market?
   The answers determine the market structure – the nature and
    degree of competition among firms operating in the same
   There are four market structures:
        o Perfect competition
        o Monopolistic competition
        o Oligopoly
        o Monopoly

   Perfect Competition
       o Perfect competition is characterized by a large number of
          well-informed independent buyers and sellers who
          exchange identical products
       o Necessary Conditions
             1. large number of buyers and sellers
                     none large enough to affect the price
             2. buyers and sellers deal in identical products
             3. each buyer and seller acts independently
                     ensures that buyers (and sellers) compete with
                      each other
             4. buyers and sellers are reasonably well-informed
             5. buyers and sellers are free to enter into, conduct,
                 and get out of business
                     makes it difficult for producers to exclude new
       o Perfect Competition and Profit Maximization
              1. Supply and demand set the equilibrium price
                 because each individual firm is too small to
                 influence price
              2. Each firm then operates at the level of production
                 that maximizes profit
       o A Theoretical Situation
              1. There are very few, if any, perfectly competitive
              2. Vegetable markets are close
              3. Although it is rare, perfect competition is a good
                 example to evaluate other market structures
              4. Imperfect competition – market structure that lacks
                 one of the five conditions for perfect competition
   Monopolistic Competition
       o Monopolistic competition has all the conditions for perfect
          competition EXCEPT identical products
       o Product Differentiation
              1. monopolistic competition utilizes product
                 differentiation – real or imagined differences
                 between competing products in the same industry
              2. sometimes the differences are imagined by the
                 consumer due to successful branding
   Nonprice Competition
       o Nonprice competition - the use of advertising, giveaways,
          or promotional campaigns to convince buyers that the
          product is somehow better than another brand
       o If the firm is successful in differentiating, it may be able to
          raise the price
   Monopolistic Competition and Profit Maximization
       o Under Monopolistic Competition, similar products sell
          within a narrow price range
       o The firm produces at the point where
          marginal cost = marginal revenue
       o Monopolistic competitors can enter the market easily, but
          over the long run the supply of the product remains stable
          with no great profits or losses
   Oligopoly
       o Oligopoly – market structure in which a few very large
          sellers dominate the industry
              1. products may be differentiated (cars) or
                 standardized (oil)
              2. the number of firms is less important than each
                 individual firm’s ability to influence the price
             o Interdependent Behavior
                   1. Oligopolists are so large that when one firm acts, the
                      other firms generally follow
                   2. sometimes this behavior is collusion – a formal
                      agreement to set prices or behave in a cooperative
                           price-fixing – agreeing to charge the same
                             prices for a product
                           collusion is against the law
             o Pricing Behavior
                   1. One firm may raise prices hoping others will follow
                   2. One firm may lower prices, initiating a price war
                   3. oligopolists usually compete on a nonprice basis to
                      avoid price wars
             o Oligopolies and Profit Maximization
                   1. Marginal cost = marginal revenue
                   2. price is likely to be higher than under perfect
             o The Prisoner’s Dilemma
      Two suspects are arrested by the police. The police have
      insufficient evidence for a conviction, and, having separated both
      prisoners, visit each of them to offer the same deal. If one testifies
      ("defects") for the prosecution against the other and the other
      remains silent, the betrayer goes free and the silent accomplice
      receives the full 10-year sentence. If both remain silent, both
      prisoners are sentenced to only six months in jail for a minor
      charge. If each betrays the other, each receives a five-year
      sentence. Each prisoner must choose to betray the other or to
      remain silent. Each one is assured that the other would not know
      about the betrayal before the end of the investigation. How should
      the prisoners act?

                          You Stay Silent           You Betray
Partner Stays Silent      Each serve 6 months       You go free, partner
                                                    serves 5 years
Partner Betrays           Partner goes free, you    You each serve 15
                          serve 5 years             years

         The prisoner’s dilemma can be applied to the oligopoly and
          helps explain its behavior
                         You Keep Prices           You Drop Prices
They Keep Prices         Each earn normal          You earn
Stable                   profits                   extraordinary profits
                                                   for a short time
They Drop Prices         They earn                 Both earn sub-
                         extraordinary profits     standard profits
                         for a short time

        So each oligopolist feels they are safer keeping prices stable, to
         avoid a price war that could damage profits

        Monopoly
            A market structure with only one seller of a particular
                o An extreme case because Americans dislike and try
                   to outlaw them and because new technologies
                   compete with old monopolies
            Types of Monopolies
                o Natural monopoly – a market situation where the
                   costs of production are minimized by having a
                   single firm produce the product
                       Public utilities are usually given franchise
                          rights (the right to operate without
                       Arguments for the natural monopoly are
                          based on economies of scale – the situation in
                          which the average cost of production falls as
                          the firm gets larger
                o Geographic monopoly – a monopoly is formed
                   because no other sellers exist in the same area
                o Technological monopoly – a monopoly based on
                   ownership of a manufacturing method, process, of
                   other scientific advance
                       Patents – an exclusive right to manufacture,
                          use, or sell any new and useful invention for a
                          specific time period
                o Government monopoly – a monopoly the
                   government owns and operates
                       Water use
                       Some states control alcoholic beverages
                       Weapons-grade uranium
                o Monopoly and Profit Maximization
   Marginal cost = marginal revenue
   Some differences
       The monopolist is much larger than the
         perfect competitor
       The monopolist is a price-maker
             o In every case, the monopolist
                charges higher than equilibrium
                price and creates limited

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