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Spectrum of Market Competition Perfect Competition Monopolistic Competition Oligopoly Monopoly Most competitive Least competitive Perfect Competition Conditions for Pure Competition 1.Many buyers and sellers 2. No one buyer or seller has the ability to influence price 3. Products are homogenous (very similar) Conditions for Pure Competition 4. Free exit or entry (no barriers to entry) 5. Perfect knowledge 6. Perfect mobility of resources Price Takers Both buyers and sellers are “price takers”; both must take the market price No one buyer or seller can change the price by not buying or producing. Profit Maximization The Purely Competitive firm maximizes profit where MC=MR Monopoly Single seller of a product Product has no close substitutes Single seller is only seller in market, so IS the market. Barriers to Entry Monopoly can be formed by: Natural Barriers; distance, population, economies of scale Barriers (cont’d) A monopoly can also be formed by artificial barriers Legal: patents, copyright, tariffs, licenses, franchise Illegal: predatory pricing, violence Profit Maximization A monopoly maximizes profit where MC=MR A monopoly must search for the price on the AR curve See examples on board Consumer Surplus The difference between what a consumer was willing to pay and the market clearing price they had to pay. Costs of Monopoly Price Discrimination A monopoly can charge different customers different prices, taking away Consumer Surplus Airplane example Other Costs of Monopoly Dead weight loss is the loss to consumers from the higher prices and lower production from a monopoly, in the graph Costs: Rent Seeking “Rent seeking” is the term for what the monopoly spends to become and stay a monopoly. We could also include the money spent by government, or would be competitors, to fight the monopoly X-inefficiency This is the term given to monopoly waste; since they have no competition, the monopoly has no reason to stay “lean and mean” 3 supervisors, 2 teachers Controlling a monopoly Government can require “marginal cost pricing” or “average cost pricing” See board Government could also tax or charge a licensing fee Break up a monopoly Create competing firms out of the monopoly: Standard Oil, Bell Telephone… Microsoft? Monopolistic Competition Many firms competing with products which are perceived to be different Conditions of MONOCOMP 1. Many firms 2. Differentiated product, perceived to be different 3. Easy entry to market by competitors Importance of Elasticity of Demand See the board How to get Inelastic Demand Achieve Product differentiation Price competition Non price competition Advertising Colors Any edge Oligopoly A market with only a few firms Pure Oligopoly homogenous product with a single price Differentiated Oligopoly goods are perceived to be different, so you end up with “price clusters” Price Clusters Autos: GM, Ford, Daimler/Chrysler compete at different price levels Chevy Ford Dodge $ Pontiac Mercury Chrysler $$ Cadillac Lincoln Mercedes $$$$$ Price Clusters Beer Anheiser Busch, Coors, Miller Busch, Keystone, Strohs $ Bud, Miller, Coors Michelob, MGD, Fat Tire Concentration Ratios Measure the degree of concentration in a market A four firm concentration ratio greater than 40%, is considered an oligopoly Examples From Beverages page 252 in Coca Cola text Cars 45% Pepsi 31% Tobacco Philip Morris 49% RJR 24% Schweppes 14% B&W 15% Chrysler 16% GM 29% Ford 25% Cooperation vs. Competition “People of the same trade seldom meet together… but the conversation ends in… some conspiracy to raise prices” Adam Smith Types of Cooperation Price Matching: ensures high prices, not low. Price Leadership: all firms look to one firm (biggest) to set prices matched by others Price Fixing: Collusive price setting, or cartel (illegal) Game Theory Decision Grid on board Kinked Demand Curve On board Consequences of Price Fixing 1. Consent Decree, to stop illegal activity 2. Treble Damages (3X the losses) 3. Fines and jail time Music CD agreement Music CD agreement $480 million overcharge - $67.4 million refunds - $74.7 million in free cds to schools =$338 million in profit due to price fixing