Spectrum of Market Competition

Perfect Competition

Monopolistic Competition

OligopolyMonopoly

Most competitive

Least competitive

Perfect Competition

Conditions for Pure Competition

1.Many buyers and sellers2. No one buyer or seller has

the ability to influence price3. Products are homogenous

(very similar)

Conditions for Pure Competition

4. Free exit or entry (no barriers to entry)

5. Perfect knowledge6. 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 productProduct has no close

substitutesSingle 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 barriersLegal: 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 firms2. Differentiated product,

perceived to be different3. Easy entry to market by

competitors

Importance of Elasticity of Demand

See the board

How to get Inelastic Demand

Achieve Product differentiationPrice competitionNon price competition

AdvertisingColorsAny edge

Oligopoly

A market with only a few firmsPure Oligopoly homogenous

product with a single priceDifferentiated 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 levelsChevy Ford Dodge $Pontiac Mercury Chrysler $$Cadillac Lincoln Mercedes $$$$$

Price Clusters

BeerAnheiser Busch, Coors, Miller

Busch, Keystone, Strohs $Bud, Miller, CoorsMichelob, 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 page 252 in text

Beverages Tobacco Cars

Coca ColaPhilip Morris GM

45% 49% 29%

Pepsi RJR Ford

31% 24% 25%

Schweppes B&W Chrysler

14% 15% 16%

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