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Chapter 6
Prices and Decision Making
Prices
Price—monetary value of a product as established by
supply and demand
Prices communicate info to buyers/sellers
High prices=producers produce more, buyers buy less
Low prices=producers produce less, buyers buy more
Prices
Prices are the link between producers and consumers
Price Adjustment Process
Transactions in a market economy are voluntary,
because of that the compromise that eventually takes
place must be to the benefit of both parties
Economic Model
Helps to analyze behavior and predict outcomes
Market Equilibrium
Situation where prices are stable and quantity of
goods/services are equal to quantity demanded
The market economy finds this by trial and error
Surplus
Situation in which the quantity supplied is greater than the
quantity demanded at a given price
Surplus
Surplus shows up as unsold products on shelves, sellers
know price is too high
Prices tend to go down as a result of surplus
Shortage
Situation in which the quantity demanded is greater
than the quantity supplied at a given price
Shortage
Results in quantity and price both going down
Equilibrium Price
Price that “clears the market” by leaving neither a
surplus or a shortage
Market will seek its own equilibrium
Social Goals vs. Market
Efficiency
Gov’t tends to get involved in the market to secure
economic goals of equity and security
One of the common ways of achieving social goals
involves setting prices at “socially desirable” levels
When this happens, prices are not allowed to adjust to
their equilibrium levels
Government Intervention
Condition when gov’t sets the prices
Occurs when gov’t feels the market system is not
working
Gov’t can set price ceilings and price floors
Price Ceilings
Maximum legal price that can be charged for a product
Gov’t does then when they feel prices are too high for a product
Will cause shortages
Price Floors
Lowest legal price that can be paid for a good
Gov’t does then when they feel prices are too low
Minimum wage is an example
Agricultural Price Supports
Price supports are most evident in agriculture
US Department of Agriculture tinkers with free market
system using target prices, land banking, price supports
to alter market forces
Chapter 7
Market Structures
Bell Ringer 10/17
Market Structure
The competition among firms operating in the same
industry
Market Organization
1. Perfect Competition
2. Monopolistic Competition
3. Oligopoly
4. Monopoly
Market Structure
Characteristics
1. Number of firms in industry
2. Influence over price
3. Product differentiation
4. Advertising
5. Ease of entering or leaving the market
What Is Perfect Competition?
1) In perfect competition, all
consumers and producers are price
takers.
2) This means that neither consumers
nor producers can do anything to
change price.
3) Consumers rarely affect price, so we
will focus on the producer.
4) The supply and demand model is a
model of a perfectly competitive
market.
Equilibrium
Price
Producers
The Two Main
Characteristics
There are two conditions necessary for a perfectly competitive market to exist.
1) Numerous Sellers
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A) Generally there are hundreds or even
thousands of sellers.
B) No seller can have a large market share.
C) This means no seller can produce more
than a small fraction of the total market
supply.
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B) They do not have to be identical,
consumers just have to think they are.
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2) Standardized Product
A) Consumers must regard all products to
be identical.
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2. Monopolistic Competition
Market organization in which many firms produce
goods that are similar enough (a little different) to be
substitutes
Example: gas stations, fast food industry, soft drink
industry
Characteristics
Monopolistic competition has characteristics that make it similar to both monopoly and
perfect competition.
1) Many Sellers
Each firm has a small amount of market
power, but there is no possibility for
collusion.
Shampoo is a great example of just how many different
firms can exist in a single market, all with differing prices
and qualities.
Characteristics
Monopolistic competition has characteristics that make it similar to both monopoly and
perfect competition.
1) Many Sellers
Each firm has a small amount of market
power, but there is no possibility for
collusion.
2) Differentiated Products
Firms produce imperfect substitutes,
products that are close substitutes but are
still distinct.
Cheeseburgers from McDonald’s and Burger King could
be considered substitutes, but most consumers consider
them to be very different.
Characteristics
Monopolistic competition has characteristics that make it similar to both monopoly and
perfect competition.
1) Many Sellers
Each firm has a small amount of market
power, but there is no possibility for
collusion.
2) Differentiated Products
Firms produce imperfect substitutes,
products that are close substitutes but are
still distinct.
3) Low Barriers to Entry
In the long run, firms are free to enter or
exit the industry.
Markets, such as hair salons, can see lots of new entrants in
a short time if the market can support them. Likewise,
many can fail quickly, too.
Product Differentiation
One of the key features of monopolistic competition is product differentiation. Firms
can differentiate their products in one of three ways.
Product Differentiation
One of the key features of monopolistic competition is product differentiation. Firms
can differentiate their products in one of three ways.
1) By Style or Type
Includes differences in features, design,
packaging, or service.
No two hair salons are alike. Each offers different hair styles
based on gender, age, culture, income, preference, etc.
Product Differentiation
One of the key features of monopolistic competition is product differentiation. Firms
can differentiate their products in one of three ways.
1) By Style or Type
Includes differences in features, design,
packaging, or service.
2) By Location
Consumers often choose a product based
on convenience even if it is more
expensive.
Many small hair salons can succeed because people are likely
choose one that is close to their house.
Product Differentiation
One of the key features of monopolistic competition is product differentiation. Firms
can differentiate their products in one of three ways.
1) By Style or Type
Includes differences in features, design,
packaging, or service.
2) By Location
Consumers often choose a product based
on convenience even if it is more
expensive.
3) By Quality
Some consumers are willing to pay more
for higher quality products.
Some professional stylists can charge hundreds of dollars per
customer, but most consumers settle for something cheaper
than that.
3. Oligopoly
Market structure in which very few large firms
dominate the industry
Examples: Automobiles, TV companies, cell phone
companies
What Is Oligopoly?
Oligopolies share many characteristics with monopolies, but the forces that create
oligopolies are not as strong as those that create monopolies.
1) A Few Large Firms
Generally, the four-firm concentration is
above 50%, meaning together they share
significant market power.
Market
Concentration
Largest Firms
Light
Bulbs
75.4 %
General Electric,
Sylvania, Philips,
Westinghouse
Cereals
80.4 %
Kellogg’s, General
Mills, Post, Quaker
Batteries
88.0 %
Duracell, Energizer,
Panasonic, Rayovac
This means the four largest firms account for at least 50% of
all sales. There may be many smaller sellers, but they do not
have any market power.
What Is Oligopoly?
Oligopolies share many characteristics with monopolies, but the forces that create
oligopolies are not as strong as those that create monopolies.
1) A Few Large Firms
Generally, the four-firm concentration is
above 50%, meaning together they share
significant market power.
2) Identical or Differentiated Products
Oligopolists can either create identical
products or varied products.
For example, light bulbs of a similar size are all essentially
identical.
The cereal industry, however, has a seemingly endless variety
of products to choose from.
What Is Oligopoly?
Oligopolies share many characteristics with monopolies, but the forces that create
oligopolies are not as strong as those that create monopolies.
1) A Few Large Firms
Generally, the four-firm concentration is
above 50%, meaning together they share
significant market power.
2) Identical or Differentiated Products
Oligopolists can either create identical
products or varied products.
3) High Barriers to Entry
Barriers (usually high start-up costs)
prevent competing firms from opening.
Manufacturing industries, such as batteries, require a great
deal of technology, machinery, and patents.
What Is Oligopoly?
Oligopolies share many characteristics with monopolies, but the forces that create
oligopolies are not as strong as those that create monopolies.
1) A Few Large Firms
Generally, the four-firm concentration is
above 50%, meaning together they share
significant market power.
2) Identical or Differentiated Products
Oligopolists can either create identical
products or varied products.
3) High Barriers to Entry
Barriers (usually high start-up costs)
prevent competing firms from opening.
4) Interdependence
An individual firm’s profits are highly
dependent on its competitors’ prices.
The airline industry is a great example of how one
oligopolist’s profits are largely determined by his/her
competitors’ prices.
4. Monopoly
Form of market organization in which there is only 1
seller of a product
Example: No perfect example, best is gov’t controlled
water companies
Characteristics of Monopoly
There are several traits that characterize a monopoly. The four most important ones are
described here.
Characteristics of Monopoly
There are several traits that characterize a monopoly. The four most important ones are
described here.
1) One Seller
Monopolies exist when one firm controls
an entire market (or almost all of it).
Microsoft owns over 95% of the operating system
market, but it does have competition from Mac and
Linux operating systems.
Characteristics of Monopoly
There are several traits that characterize a monopoly. The four most important ones are
described here.
1) One Seller
Monopolies exist when one firm controls
an entire market (or almost all of it).
2) No Substitutes
If there are substitutes to the product
supplied by the monopolist, he/she cannot
exercise monopoly power.
The National Football League (NFL) has no close
substitutes. Yes, there are other similar leagues, but
none that compare to the NFL.
Characteristics of Monopoly
There are several traits that characterize a monopoly. The four most important ones are
described here.
1) One Seller
Monopolies exist when one firm controls
an entire market (or almost all of it).
2) No Substitutes
If there are substitutes to the product
supplied by the monopolist, he/she cannot
exercise monopoly power.
3) High Barriers to Entry
A monopolist remains the single seller in a
market only because he/she can keep
others from entering the market.
A barrier to having competing electrical companies
is that cities are not willing to have more than one
set of power lines.
Characteristics of Monopoly
There are several traits that characterize a monopoly. The four most important ones are
described here.
1) One Seller
Monopolies exist when one firm controls
an entire market (or almost all of it).
2) No Substitutes
If there are substitutes to the product
supplied by the monopolist, he/she cannot
exercise monopoly power.
3) High Barriers to Entry
A monopolist remains the single seller in a
market only because he/she can keep
others from entering the market.
4) Control Over Price
A true monopolist can change price and
quantity to maximize profits.
De Beers, a company that controls most of the
world’s supply of diamonds, artificially increases
price by limiting its output.
Barriers to Entry
A monopolist’s profits do not go unnoticed. So why don’t other firms enter the
market? One of the following barriers keeps others from entering the market.
Barriers to Entry
1) Control of a Resource
If a firm controls all or most of a scarce
resource, it is easy to keep other firms from
obtaining it.
De Beers controls most of the world’s diamond
supply, making entry into the market very difficult.
Barriers to Entry
1) Control of a Resource
If a firm controls all or most of a scarce
resource, it is easy to keep other firms from
obtaining it.
2) Technological Superiority
Firms can gain a technological advantage
over competitors that can lead to a
monopoly.
Intel produces the chips that run computers. For
many years no other firms were able to match their
microprocessor technology.
Barriers to Entry
1) Control of a Resource
If a firm controls all or most of a scarce
resource, it is easy to keep other firms from
obtaining it.
2) Technological Superiority
Firms can gain a technological advantage
over competitors that can lead to a
monopoly.
3) Government Involvement
The government can restrict firms from
entering a market through patents,
copyrights, and laws.
Sometimes government will actually run a
monopolistic business, or it can issue patents and
copyrights.
Barriers to Entry
1) Control of a Resource
If a firm controls all or most of a scarce
resource, it is easy to keep other firms from
obtaining it.
2) Technological Superiority
Firms can gain a technological advantage
over competitors that can lead to a
monopoly.
3) Government Involvement
The government can restrict firms from
entering a market through patents,
copyrights, and laws.
4) Economies of Scale
A monopoly can exist if one company has a
cost advantage over new firms.
The enormous upfront costs of power companies
makes it very difficult to start a competing business.
Types of Monopoly
There are four types of monopolies. Each one gets its market power from the way in
which it bars entry into the market.
Types of Monopoly
1) Geographic Monopoly
If there is only one store in a location, it
acts as a monopoly since it has no local
competition.
A single gas station along a lonely road in the
desert is an example of a geographic monopoly.
Types of Monopoly
1) Geographic Monopoly
If there is only one store in a location, it
acts as a monopoly since it has no local
competition.
2) Technological Monopoly
Although firms can enjoy a technological
edge in the short run, other firms will soon
copy it.
Despite Intel’s early success, it now experiences a
tremendous amount of competition.
Types of Monopoly
1) Geographic Monopoly
If there is only one store in a location, it
acts as a monopoly since it has no local
competition.
2) Technological Monopoly
Although firms can enjoy a technological
edge in the short run, other firms will soon
copy it.
3) Legal Monopoly
Sometimes the government deems it
necessary to create a monopoly.
By allowing drug companies to patent their
discoveries for 20 years, it encourages heavy
investment in research and development.
Types of Monopoly
1) Geographic Monopoly
If there is only one store in a location, it
acts as a monopoly since it has no local
competition.
2) Technological Monopoly
Although firms can enjoy a technological
edge in the short run, other firms will soon
copy it.
3) Legal Monopoly
D
Economies of
Scale
Diseconomies of
Scale
ATC
Sometimes the government deems it
necessary to create a monopoly.
4) Natural Monopoly
Exist when 1 company can produce items
cheaper than 2 competing firms.
If Average Total Cost (ATC) is still decreasing at the
output level, the firm is still in the economy of scale
portion of the graph.
Advertising
Advertising is a controversial economic subject, but it is generally considered that it
does affect the demand curve and increases revenue.
Advertising
1) Why do firms advertise?
A) It helps differentiate their products from
other firms.
B) Differentiated products give firms more
market power, allowing them to charge
higher prices.
Advertising
1) Why do firms advertise?
A) It helps differentiate their products from
other firms.
B) Differentiated products give firms more
market power, allowing them to charge
higher prices.
2) Why Can They Charge More?
A) Demand increases since consumer tastes
and brand loyalty are affected.
D1
B) Demand also increases since the
perceived utility of the item increases.
Remember, whenever demand increases, it means more
output is being sold at a higher price.
D2
Branding
Branding refers to the distinctive identity that a particular name, phrase, or symbol
bestows on a firm and its products.
Branding
1) It provides quality assurance.
A) Consumers are willing to pay for a brand
name for its quality.
Consumers are often willing to spend more on a pricey
brand name television simply because of its reputation for
quality.
Branding
1) It provides quality assurance.
A) Consumers are willing to pay for a brand
name for its quality.
B) If a brand name fails in its quality, it will
be punished by the market.
When the E. coli bacteria was found in some Jack-in-theBox hamburger meat in 1993, its sales and stock
plummeted.
Branding
1) It provides quality assurance.
A) Consumers are willing to pay for a brand
name for its quality.
B) If a brand name fails in its quality, it will
be punished by the market.
2) It provides information.
A) Especially in new situations, consumers
turn to known brands.
Imagine you are in an unfamiliar town and need a hotel
for the night. You are much more likely to stay at a brand
name hotel even if it costs more.
Branding
1) It provides quality assurance.
A) Consumers are willing to pay for a brand
name for its quality.
B) If a brand name fails in its quality, it will
be punished by the market.
2) It provides information.
A) Especially in new situations, consumers
turn to known brands.
B) Consumers are more likely to purchase
new products if it has a familiar brand
name.
Suppose you have a favorite shampoo brand. If you are in
need of face wash, hand lotion, or sunscreen, you may use
the same brand.
Market Failures
The allocation of goods and services by a free market
that is not efficient…there is a better way for
participants to be better-off and not make someone
else worse-off
Most common market failures involve:
1.inadequate competition
2. inadequate information
3. externalities
1. Inadequate Competition
A decrease in competition has several consequences:
1. inefficient resource allocations (waste of resources)—why
would a firm with few competitors have incentive to use
resources carefully?
2. higher prices
3. may enable a business to influence politics—example: big
company to demand tax breaks or move elsewhere
2. Inadequate Information
Information is needed to make economic decisions, if
not available to buyers than it is an example of a
market failure
3. Externalities
Unintended side effects
Negative externality—harm, cost, or inconvenience
suffered by a 3rd party because of actions of another
(example: pollution of steel plant, traffic congestion
due to plant)
Role of Government In the
Market
The marketplace usually keep businesses competitive with
one another
The Government has the power to regulate markets when
needed by establishing rules and laws to protect consumers
The most important laws are called antitrust legislation
which give them the power to control and break up
monopolies
The government can also keep trusts from forming and can
regulate business mergers as needed
Role of Government In the
Market
In the late 1800s, U.S. government passed laws to
restrict monopolies and trusts (to prevent market
failures due to inadequate competition)
The U.S. government has created several agencies to
monitor and restrict markets/companies
Federal Trade Commission
(FTC)1914
Administers antitrust laws forbidding unfair
competition
They monitor unfair business practices, including
deceptive advertising
Food and Drug Administration
(FDA)1906
Protects consumers from unsafe foods, drugs, or
cosmetics; requires truth in labeling of these products
Securities and Exchange
Commission (SEC) 1934
Regulates and monitors the stock market to protect
investors
Occupational Safety and Health
Administration (OSHA) 1970
Enforces regulations to protect employees at work
Investigates accidents at the workplace
Federal Communications
Commission (FCC)
Regulates the communications industry, including
radio, television, cable, and telephone services
Environmental Protection
Agency (EPA)
Protects human health by enforcing environmental
laws regarding pollution and hazardous materials
Role of Government In the
Market
The government also tries to make sure that businesses
do not engage in practices that would reduce
competition
Price fixing occurs when businesses agree to set prices
for competing products
The government can issue a cease and desist order that
requires a firm to stop an unfair business practice