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“ECONOMICS for Christian Schools”
Unit III: Economics
of the Business
Firm
By Alan J. Carper
Bob Jones University Press. 1998
Chapter 9
“Market Structure and Competition”
Objectives
Students should be able to:
• List the five ways in which industries differ
• Distinguish between differentiated products and undifferentiated
products
• Define the terms barrier to entry
• Explain the conditions of imperfect competition
• Describe an oligopoly, monopoly, and a trust
• Explain how monopoly arises and distinguish between single-price
monopoly and price-discriminating monopoly.
• Explain how a single-price monopoly determines its output and price.
• Compare the performance of a single-price monopoly with that of
perfect competition.
• Explain how price discrimination increases profit.
• Explain why natural monopoly is regulated and the effects of
regulation.
Objectives
Students should be able to:
• Describe and identify monopolistic competition.
• Explain how a firm in monopolistic competition determines its
output and price in the short and the long run.
• Explain why advertising costs are high and why firms use brand
names in monopolistic competition.
• Name the five pieces of legislation intended to curb monopolies.
• Name and describe the four anticompletive activities forbidden by
the Clayton Act
Biblical Integration
• We are to be temperate in business as
well as in our personal life. Self-control
leads to victory. (1 Cor. 9:25)
Business Firms
• Every business has unique
characteristics and differing ways of
bringing products and services to
customers.
Production
• What is production?
– It is the “manufacturing and processing of
goods or merchandise, including their
design, treatment at various stages, and
financial services contributed by bankers.
Various economic laws, price data, and
available resources are among the factors in
production that must be considered by both
private and governmental producers.”
(“Production”)
PRODUCTION
• Average Product
–Average product is the total product per
worker employed.
–It is calculated as:
–Average product = Total product  Quantity of
labor
–Another name for average product is
productivity.
(Bade 304)
Productivity
• Is “the relative efficiency of economic
activity—that is, the amount of products
or services produced compared to the
amount of goods and labor used to
produce it.”
(“Productivity”)
Markets
• Arrangements that people have
developed for trading with one another
are referred to as markets.
• Business firms tend to be grouped into
specific markets. Each of these markets
is referred to as industry.
– Each industry is distinguished from every
other industry by a great many things, but
economists have indentified five key
differences.
(Carter 112)
Types of Markets
The four market types are
•
•
•
•
Perfect competition
Monopoly
Monopolistic competition
Oligopoly
(Bade 324)
Business Firms
• Why do you believe American business
firms are becoming such an endangered
species?
Competition
(Carter 111)
Perfect Competition
Perfect competition exists when
• “Many firms sell an identical product to many buyers.
• There are no restrictions on entry into (or exit from) the
market.
• Established firms have no advantage over new firms.
• Sellers and buyers are well informed about prices.”
(Bade 324)
Imperfect competition exists when there are many sellers
of slightly differentiated goods, when sellers and buyers
are reasonably aware of conditions that may affect the
market, when each seller has some control over their
good’s price, and when sellers find it relatively easy to
enter and exit the market.
(Carter 111)
Is Perfect Competition
Efficient?
– Resources are used efficiently when it is not
possible to get more of one good without
giving up something that is valued more
highly.
– To achieve this outcome, marginal benefit
must equal marginal cost. That is what
perfect competition achieves.
(Bade 342)
Monopoly
Monopoly is a market for a good or service
that has no close substitutes and in which
there is one supplier that is protected from
competition by a barrier preventing the entry
of new firms.
Did you ever set up a lemonade stand when
you were a kid?
(Bade 350)
How Monopoly Arises
Monopoly arises when there are
• No close substitutes
• Barriers to entry
– No Close Substitutes
– If a good has a close substitute, even though
only one firm produces it, that firm effectively
faces competition from the producers of
substitutes.
(Bade 350)
Barrier to Entry
Anything that protects a firm from the arrival of
new competitors is a barrier to entry.
– There are three types of barrier to entry:
• Natural
• Ownership
• Legal (or Artificial)
(Bade 350)
Natural Barrier to Entry
A natural monopoly exists when the
technology for producing a good or service
enables one firm to meet the entire market
demand at a lower price than two or more
firms could.
– One electric power distributor can meet the
market demand for electricity at a lower cost
than two or more firms could.
(Bade 350)
Ownership Barrier
A monopoly can arise in a market in which
competition and entry are restricted by the
concentration of ownership of a natural
resource.
– Debeers has created its own barrier to entry
by buying control over most of the world’s
diamonds, which prevents entry and
competition.
(Bade 351)
Legal (Artificial) Barrier
– A legal barrier to entry creates a legal
monopoly.
– A legal monopoly is a market in which
competition and entry are restricted by
granting of a public franchise, government
license, patent, or copyright.
(Bade 350, 351)
Legal Monopoly
– A Public Franchise is an exclusive right granted to a
firm to supply a good or service. For example: The U.S.
Postal Service’s exclusive right to deliver first-class
mail.
– A government license controls entry into particular
occupations, professions, and industries.
– Patent is an exclusive right granted to the inventor of a
product or service.
• In the United States, a patent is valid for 20 years
– Copyright is an exclusive right granted to the author or
composer of a literary, musical, dramatic, or artistic
work.
(Bade 350, 351)
Is Monopoly Efficient?
– Resources are used efficiently when
marginal benefit equals marginal cost.
(Bade 360)
Is Monopoly Fair?
– Monopoly is inefficient because it creates a
deadweight loss.
– But monopoly also redistributes consumer
surplus.
– The producer gains, and the consumers lose.
(Bade 361)
Create a Monopoly by Rent
Seeking
– Rent seeking is a political activity.
– It takes the form of lobbying and trying to
influence the political process to get laws that
create legal barriers to entry.
(Bade 362)
Price Discrimination
A price-discriminating monopoly is a firm that
is able to sell different units of a good or
service for different prices.
– Airlines offer different prices for the same
trip.
(Bade 351)
Price discrimination
– Selling a good or service at a number of
different prices—is widespread.
– To be able to price discriminate, a firm must
• Identify and separate different types of buyers.
• Sell a product that cannot be resold.
(Bade 364)
Price Discrimination and
Consumer Surplus
– The key idea behind price discrimination is to
convert consumer surplus into economic
profit.
– To extract every dollar of consumer surplus
from every buyer, the monopoly would have
to offer each individual customer a separate
price schedule based on that customer’s own
willingness to pay.
(Bade 364)
Discriminating Among
Groups of Buyers
– The firm offers different prices to different
types of buyers, based on things like age,
employment status, or some other easily
distinguished characteristic.
– This type of price discrimination works when
each group has a different average
willingness to pay for the good or service.
(Bade 364)
Discriminating Among Units
of a Good
– The firm charges the same prices to all its
customers but offers a lower price per unit for
a larger number of units bought.
• Profiting by Price Discriminating
– Global Air has a monopoly on an exotic
route.
(Bade 365)
Regulation vs. Deregulation
– Regulation is the set of rules administered by
a government agency to influence prices,
quantities, entry, and other aspects of
economic activity in a firm or industry.
– Deregulation is the process of removing
regulation on prices, quantities, entry, and
other aspects of economic activity in a firm or
industry.
(Bade 424)
Efficient Regulation of
Natural Monopoly
– A natural monopoly is an industry in which
one firm can supply the entire market at a
lower price than can two or more firms.
– Regulation achieves an efficient allocation of
resources if marginal cost equals marginal
benefit (and price).
– Marginal cost pricing rule is a rule that sets
price equal to marginal cost to achieve an
efficient output.
(Bade 426)
Regulation of a Natural
Monopoly
Two possible ways of enabling a regulated
monopoly to avoid an economic loss are
Average Cost Pricing
– Average cost pricing rule is a rule that sets
price equal to average total cost.
Government Subsidy
– A payment by the government to a producer to
cover part of the costs of production.
(Bade 233, 427)
Monopolistic Competition
Monopolistic competition is a market in which
a large number of firms compete by making
similar but slightly different products.
– Monopolistic competition is a market structure
in which
• A large number of firms compete.
• Each firm produces a differentiated product.
• Firms compete on price, product quality, and
marketing.
• Firms are free to enter and exit.
(Bade 378)
Product Differentation
– Product differentiation is making a product
that is slightly different from the products of
competing firms.
– A differentiated product has close substitutes
but it does not have perfect substitutes.
– When the price of one firm’s product rises,
the quantity demanded of that firm’s product
decreases.
(Bade 378)
Competing on Quality,
Price, and Marketing
– Quality
– Design, reliability, after-sales service, and
buyer’s ease of access to the product.
– Price
– Because of product differentiation, the
demand curve for the firms’ product is
downward sloping.
– Marketing
– Advertising and packaging
(Bade 379)
Selling Costs and Demand
– Advertising and other selling efforts change
the demand for a firm’s product.
– The effects are complex:
• A firm’s own advertising increases the demand for
its product.
• Advertising by all firms might decrease the
demand for any one firm’s product.
(Bade 392)
OLIGOPOLY
– Another market type that stands between
perfect competition and monopoly.
– Oligopoly is a market type in which:
• A small number of firms compete.
• Natural or legal barriers prevent the entry of new
firms.
Oligopoly is a market with a small number of firms,
and each firm is large and can influence the market
price.
(Bade 402)
OLIGOPOLY
– In monopoly, one firm controls the total
quantity supplied and so it also controls the
price.
– In perfect competition, no firm is big enough
to influence the total quantity supplied, so no
firm can influence the price.
– Oligopoly is unlike both of these cases.
– More than one firm controls the quantity
supplied, so no one firm controls the price.
But each firm is large, and the quantity
produced by each firm influences the price.
(Bade 402)
OLIGOPOLY
• Collusion
– When a small number of firms share a
market, they can increase their profit by
forming a cartel and acting like a monopoly.
– A cartel is a group of firms acting together to
limit output, raise price, and increase
economic profit.
– Cartels are illegal but they do operate in some
markets.
– But cartels usually breaks down—as we will
explain.
(Bade 402, 408)
OLIGOPOLY
• A duopoly is a market in which there are only
two producers.
• Duopoly in Airplanes
– Identifying oligopoly is the flip side of
identifying monopolistic competition.
– The borderline between oligopoly and
monopolistic competition is hard to pin down.
– As a practical matter, we try to identify
oligopoly by looking at concentration
measures.
(Bade 402, 403
Is Oligopoly Efficient?
– In an oligopoly, price usually exceeds
marginal cost.
– So the quantity produced is less than the
efficient quantity.
– Oligopoly suffers from the same source and
type of inefficiency as monopoly.
– Because oligopoly is inefficient, antitrust laws
and regulations are used to try to reduce
market power and move the outcome closer
to that of competition and efficiency.
(Bade 416)
Entry and Exit
In the long run, firms respond to economic
profit and economic loss by either entering or
exiting a market.
New firms enter a market in which the
existing firms are making positive economic
profits.
Existing firms exit the market in which firms
are incurring economic losses.
Entry and exit influence price, the quantity
produced, and economic profit.
(Bade 337)
The Effects of Entry
Economic profit is an incentive for new firms to
enter a market, but as they do so, the price
falls and the economic profit of each existing
firm decreases.
(Bade 337)
The Effects of Exit
Economic loss is an incentive for firms to exit a
market, but as they do so, the price rises and
the economic loss of each remaining firm
decreases.
(Bade 338)
Technology
Two forces are at work in a market undergoing
technological change.
1. Firms that adopt the new technology make
an economic profit.
– So new-technology firms have an incentive
to enter.
2. Firms that stick with the old technology
incur economic losses.
– These firms either exit the market or switch
to the new technology.
(Bade 340)
Legislation
• The Sherman Antitrust Act
– This act was passed to institute proceedings against
trusts in order to dissolve them, but the Supreme
Court did not allow the Act to be enforced until 1904,
breaking up the Northern Securities Company and
then in 1911, against the Standard Oil Trust and the
American Tobacco Company.
• The Clayton Act of 1914
– Enumerated and clarified certain anticompetitive
practices, thereby prohibiting: Interlocking
directorates, Tying contracts, Anticompetitive
takeovers, and Price discrimination.
• The Federal Trade Commission Act of 1914
– Provided for the establishment of the FTC, which
investigates alleged violations, hold hearings, and issues
“cease and desist” orders if the suspected firm is found
guilty of “unfair methods of competition or “unfair acts or
practices.”
• The Robinson-Patman Act of 1936
– Made it illegal for suppliers to hinder competition by
selling “at unreasonably low prices.”
• The Celler-Kefauver Antimerger Act of 1950
– Designed to expand and enhance the Clayton Anti-Trust
Act. The Act restricted corporations that threaten
competition especially monopolistic mergers and
acquisitions. It also barred corporations from
monopolizing other company's land, equipment and/or
property.
Works Cited
Bade, Robin and Michael Parkin. Foundations of Economics. Boston:
Pearson Education, Inc. 2007.
Carper, Alan. Economics for Christian Schools. Greenville: Bob Jones
University Press, 1998.
"New King James Version, The." Logos Bible Software. CD_ROM.
ed. 2004.
"Production," Microsoft® Encarta® Online Encyclopedia 2009
http://encarta.msn.com © 1997-2009 Microsoft Corporation. All
Rights Reserved.
"Productivity," Microsoft® Encarta® Online Encyclopedia 2009
http://encarta.msn.com © 1997-2009 Microsoft Corporation. All
Rights Reserved.