Perfect CompetitionChapter 7 Section 1

What prevents any one firm from raising its prices?

Perfect Competition

Number of Firms: MANY

Variety of Goods: NONE

Barriers to Entry: NONE Control Over Prices: NONE

Does this picture come close to perfect competition?

P

Q

Demand

P

Q5000

D

S

Industry

(all firms)

$10 $10

The Competitive Firm is a Price Taker

Price is set by the Industry

Firm

P

Q

Demand

P

Q10,000

D

S

Industry Firm(price taker)

$7 $7

ATC

MC

Lets put costs and revenue together

to calculate profit.

Total Revenue =$63

$9

8

7

6

5

4

3

2

1

1 2 3 4 5 6 7 8 9 10

MC

ATC

•How much output should be produced?

•How much is Total Revenue? How much is Total Cost?

•Is there profit or loss? How much?

MR=D=AR=P

Total Cost=$45

Profit = $18

Q

P

Start-up Costs

• The expenses that a new business must pay before the first product reaches the customer are called start-up costs.

– Available land, labor, and capital

– Money for advestising

Technology

• Some markets require a high degree of technological know-how.

• As a result, new entrepreneurs cannot easily enter these markets.

MonopoliesChapter 7 Section 2

What Is A Monopoly?

• A monopoly is a market dominated by a single seller.

• Monopolies form when barriers prevent firms from entering a market that has a single supplier.

• Monopolies can take advantage of their monopoly power and charge high prices.

Price Discrimination

• Price discrimination is the division of customers into groups based on how much they will pay for a good.

• Although price discrimination is a feature of monopoly

– it can be practiced by any company with market power.

– Market power is the ability to control prices and total market output.

Discounts

• Targeted discounts, like student discounts and manufacturers’ rebate offers, are one form of price discrimination.

• Price discrimination requires:

– some market power

– distinct customer groups

– difficult resale

Why is public water a monopoly?

Number of Firms: ONE Variety of Goods: None

Barriers to Entry: Complete Control Over Prices: Complete

PUBLIC WATER

D

$9

8

7

6

5

4

3

2

A monopolists produces where MR=MC, buts

charges the price consumer are willing to pay

identified by the demand curve.

MCATC

1 2 3 4 5 6 7 8 9 10 Q

P

MR

Forming A Monopoly

• Market conditions can cause different monopolies to be formed

– Economies of Scale

– Natural Monopoly

– Technology and Change

Economies of Scale

• A firm will enjoy an economies of scale if

– start-up costs are high

– average costs fall for each additional unit produced

• An industry that enjoys economies of scale can easily become a natural monopoly.

– Public water

LRATC Simplified

Quantity

Costs

Long Run

Average Cost

Curve

Economies of

Scale

Constant

Returns to Scale

Diseconomies

of Scale

The law of diminishing marginal returns doesn’t apply in

the long run because there are no FIXED RESOURCES.

Natural Monopoly

• A natural monopoly is a market that runs most efficiently when one large firm provides all of the output.

– Hydroelectric plant that generates electricity from a dam on a river

Technology and Change

• Sometimes the development of a new technology can destroy a natural monopoly.

• It will cut fixed costs and make small companies as efficient as large firms

– Phone companies

Government Monopolies

• They are monopolies created by the government

– Technological Monopolies

– Franchise and Licenses

– Industrial Organizations

Technological Monopolies

• The government grants patents, licenses that give the inventor of a new product the exclusive right to sell it for a certain period of time.

– Patents on new prescription drugs

Franchise and Licenses

• A franchise is a contract that gives a single firm the right to sell its goods within an exclusive market

– National Parks asking Pepsi to sell within the park

Licenses

• A license is a government-issued right to operate a business

– Television and radio broadcasts

Industrial Organizations

• In rare cases, such as sports leagues, the government allows companies in an industry to restrict the number of firms in the market.

– NFL

– NBA

– NHL

Monopolistic Competition and Oligopoly

Chapter 7 Section 3

When do firms in monopolistic competition have some control over

prices?

Number of Firms: MANY Variety of Goods: SOME

Barriers to entry: LOW Control over Prices: LITTLE

Monopolistic Competition

Monopolistic Prices

• Prices will be higher than they would be in perfect competition

– firms have a small amount of power to raise prices.

– Too much competition stops most price changes

Monopolistic Profits• While monopolistically competitive firms can earn

profits in the short run

– they have to work hard to keep their product distinct enough to stay ahead of their rivals.

Monopolistic Competition Profit (Short-Run)

• In the short-run, it behaves like a monopoly

– Downward sloping demand curve and downward sloping marginal revenue

• To maximize profits, its sets marginal revenue to marginal cost

– It sets prices and output just like a monopoly

Differentiated Product

• Firms have some control over their selling price because they can differentiate

– Distinguish their goods from other products in the market

– Firms profit by selling their differences

Nonprice Competition• It is a way to attract

customers through:

– Style

– Service

– Location

– but not a lower price

• 1. Characteristics of Goods

• 2. Location of Sale

• 3. Service Level

• 4. Advertising Image

Why are high barriers to entry an important part of oligopoly?

Number of Firms: FEW Variety of Goods: SOME

Barriers to entry: HIGH Control over Prices: SOME

Oligopoly

Oligopolydescribes a market dominated by a few

large, profitable firms.

Collusion

• Collusion is an agreement among members of an oligopoly to set prices and production levels.

– The outcome is called price fixing

– This is illegal in the U.S.

Cartels• A cartel is an association by

producers established to coordinate prices and production.

– Every member has to agree to the output levels

– Each member has a strong incentive to break the agreement

• Profit motive

– This is illegal in the U.S.

Payoff Matrix

• When there are only two players, their interaction is displayed in a payoff matrix

– Each row corresponds to an action of each player

– Each column represents an action by the other party

Prisoner’s Dilemma

• Each player has the ability to choose themselves over the other party

• When both act this way, neither party benefits

Dominant Strategy

• An action that is the dominate strategy regardless of the other player– Works if you do not have

the ability to communicate with the other party

– It exists as the best alternative strategy

• Not all games have a dominant strategy– Depends of the payoffs in

the game

How does a monopolistic competition differ from monopoly?COMPARISON OF MARKET STRUCTURES

PERFECTECONOMY

MONOPOLISTIC COMPETITION

OLIGOPOLY MONOPOLY

Number of Firms

Many Many A FewDominate

One

Variety of Goods

None Some Some None

Control over Prices

None Little Some Complete

Barriers to Entry

None Low High Complete

Examples Wheat, Shares of Stock

Jeans, Books Cars, Movie Studios

Public Water

Regulation and DeregulationChapter 7 Section 4

Market Power

• Markets dominated by a few large firms:

– tend to have higher prices

– lower output than markets with many sellers

• Controlling prices and output is known as market power

Predatory Pricing

• To control prices and output like a monopoly, firms sometimes use predatory pricing

– Sets the market price below cost levels for the short term

– Drives out competitors

Government and Competition

• Government policies keep firms from controlling the prices and supply of important goods.

• Antitrust (Anti-monopoly) Laws

– Laws that encourage competition in the marketplace.

– Sherman Anti-Trust Act

Regulating Business Practices

• The government has the power to regulate business practices

• If these practices in question give too much power to a company that already has few competitors.

Breaking Up Monopolies

• The government has used anti-trust legislation to break up existing monopolies

– The Standard Oil Trust• John D. Rockefeller

– AT&T• Became the “Bell System”

• Broke AT&T into several different companies

Blocking Mergers

• A merger is a combination of two or more companies into a single firm.

• The government can block mergers that would decrease competition.

Preserving Incentives

• In 1997, new guidelines were introduced for proposed mergers

• Gave companies an opportunity to show that their merging benefits consumers.

Deregulation

• Deregulation is the removal of some government controls over a market. – is used to promote

competition

• Many new competitors enter a market that has been deregulated. – This is followed by an

economically healthy weeding out of some firms from that market

– Which can be hard on workers in the short term.