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Market Structures Market Structures • Perfect Competition • Monopolistic Competition • Oligopoly • Monopoly Perfect Competition • Many buyers and sellers • Each participant sells a homogenous (identical) product • Buyer will not pay extra for one particular company’s goods because they are the same • Buyer always chooses the supplier with the lowest price Perfect Competition • Most consistently meets the criteria of the pure supply and demand model Perfect Competition • Competitors known as “price takers” • No control over the price of their product • Price is set by the laws of supply and demand at market equilibrium • Can sell as much product as they can produce at market price and receive a small profit Perfect Competition • Entry and exit in the market is easy • Buyers and sellers are well-informed by the market about products and prices (presumes perfect information.) Perfect Competition • Example: Share in the stock market – When buying a share of a company’s stock, you are buying a share of ownership in the company that issued the stock – The value of all shares increases and decreases equally – No difference between shares of stock (within the same class of share) Perfect Competition • Example: Share of stock • There are many shares available from any particular corporation • Any adult may buy a share • Entering the market (buying a share) and exiting the market (selling a share) is simple because stock is very liquid • Liquid assets are those that can be easily and quickly sold at their market value for cash Perfect Competition • Example: Share of stock • Buyers have relevant information about a stock • Price • Performance over time • Information about the stock is regularly published and available from: • The stock market itself • Financial media • Print: Wall Street Journal; Financial Times • Television: CNBC, Fox Business News Commodities • Category of products that exists in perfect competition – Often (but not always) substances that come from the earth – The same or virtually the same no matter where produced – Maintain roughly universal price – Fungible = equivalent no matter who produces it Commodities – Examples of Commodities • Notebook paper • Milk • Petroleum • Metals – Primarily traded in the U.S. on the: – Chicago Board of Trade – New York Mercantile Exchange (“The Merc”) Monopolistic Competition • Similar to perfect competition • Biggest exception is the nature of the product itself • Includes most retail markets where there are a number of competing sellers Monopolistic Competition • Many buyers and sellers • Characterized by low economies of scale and low start up costs • Economies of scale – the more a company makes, the less expensive each unit becomes • Start up costs – non-recurring costs associated with setting up a business Monopolistic Competition • Distinguished from perfect competition by product differentiation • Products similar enough to be substitutes but are not identical • Each firm holds a monopoly over its own product • Firms have freedom to make products different enough in some way to attract buyers Monopolistic Competition • Few barriers to entry • No patents, franchises, or legal limitations to enter market • Competitors enter market with ease Monopolistic Competition • Too many producers to coordinate to keep out new competitors • Like perfect competition Monopolistic Competition • Non-price competition allows producers some control over prices • Compete on variables other than price: style, quality, color, etc. • Advertise to try to differentiate goods to attract consumers Non-Price Competition Monopolistic Competition • Example: Shirt industry • Plenty of shirts available on the market • All serve same basic function • However, there is variety demanded by consumers: • Style, Color, Types, Quality, Design Oligopoly • Few sellers in the market • Economists define as when 4 of the largest firms produce 70-80% of the output • Working alone or together, dominant firms set prices for goods Oligopoly • Attempt to avoid price competition, price deflation • Could trigger a downward spiral of competitively lower prices • Companies could lose profits without gaining market share Oligopoly • Market leader is usually also the pricing leader • Market leader – the company with the largest market share • Market share = size of the company/size of the industry Oligopoly • Pricing leader – the company that usually makes pricing changes first, causing other industry participants to adjust their relative prices in response Oligopoly • Significant barriers to entry • Accounts for the fact that few survive the • • • • competition High start-up costs Strong loyalty Long established brands Government regulations customer Oligopoly • Sometimes due to huge economies of scale • Average cost of production decreases as output increases • A few firms reach these economies of scale and levels of efficiency before the market becomes too crowded Oligopoly • Competitors often able to coordinate to not lower prices in ways that avoid breaking government anti-trust laws (press releases) Collusion • An agreement between 2 or more parties made in secret to illegally limit competition Cartel • A formal agreement among “competing” firms to fix prices, marketing, and production Antitrust Laws • A collection of laws which regulates businesses to promote fair competition for the benefit of consumers • Sherman Act of 1890 Differentiated Oligopoly • Products are not exactly alike according to style and design • Work to make their brands and models stand apart • Makes non-price competition the most distinguishing characteristic Differentiated Oligopoly • Each firm must find its own way to win customers without lowering prices • Example: Auto industry • Automobile industry financing incentives • Free service plans • Heavily advertized features of models to make them stand out from others Differentiated Oligopoly • Example: Breakfast cereal industry • Only 4 cereal makers • 100s of brands appealing to wide range of tastes Pure Oligopoly • Products are homogenous (identical) • Cannot be differentiated • Like perfect competition in this respect • Only a few producers • Unlike perfect competition Pure Oligopoly • Non-price competition exists, but difficult • Must build image, but usually without large advertising budgets • Service • Speedy delivery • Quality service Pure Oligopoly • Example industries: • Salt • Sand • Gravel • Glass windows Monopoly • Single seller of goods produces 70-80% of output • Disliked because they are “price makers” • Discouraged by anti-trust laws • AT&T was last true example (1981) • Before cellular communication and Internet • NFL, NBA, MLB all operate under government-sanctioned monopolies Monopoly • Forms when barriers to entry are very high • High start-up costs • Low per-unit operating costs • No substitutes • Little to no non-price competition • Due to unique nature of the good or service being monopolized Monopoly • Government sometimes encourage monopolies • Patents issued by the Congressional Patent Office • Give inventor or developer of a new product or service exclusive operating rights for a set period of time • Guarantee companies can profit from costly research without competition • Encourages firms to develop new products that benefit all, and contribute to higher standard of living • Patents usually expire after a number of years Monopoly • Government licensing • Utilities often have exclusive rights to operate in a certain locality • Water • Electric • Pay a licensing fee to a city, county, or commission Monopoly • Government franchising and licensing (cont’d) • In a competitive market competing utilities would: • Run separate lines • Clutter landscape • Possibly make service unprofitable for both utilities Monopoly • Companies are also franchised to do exclusive business in a government facility • Food concessions at government-built stadiums • Corporate pizza business in school cafeteria Duopoly • A market structure in which two companies control at least 70-80% of the market.