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CHAPTER 7:

DIFFERENT TYPES OF
MARKET STRUCTURES
What Are Markets?
A market is where buyers and sellers:
meet to exchange goods and services.
are affected by some level of competition.

The market may be in one specific place


or
It does not exist physically at all
(IT IS JUST A THEORY!!)

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What Are Markets?
Markets are classified by 4 structures

1. Pure (perfect) Competition

2. Monopolistic Competition

3. Oligopoly

4. Monopoly
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1. Perfect Competition
BEFORE WE BEGIN!!

This is a theoretical situation.


NO TRUE Perfectly Competitive Market
exists.

IT IS ONLY A THEORY!

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The 5 conditions of perfect competition
1) LARGE number of SMALL firms.
No single buyer or seller can influence the price.

2) Buyers and sellers deal in identical products. No product


differences. (EXAMPLES: Salt, Flour, Commodity, Corn)

3) Unlimited Competition: so many firms, that suppliers lose


the ability to set their own price.

4) No Barriers to Entry. Sellers are free to enter the market,


conduct business and free to leave the market. (Low
cost to enter)
5) Each firm is a PRICE-TAKER (more on this later)
CONSUMERS HAVE THE LARGEST SELECTION OF BUYERS TO BUY GOODS
FROM BECAUSE NO SINGLE GOOD IS2006
SWS MORE APPEALING THAN ANOTHER.
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The 5 conditions of perfect competition
4) No Barriers to entry. Sellers are free to enter the market,
conduct business and free to leave the market.

Perfect competition is the opposite of monopoly.


Here, any firm can get into the market at very little cost.

Suppose there was a market for dandelions.


Growing dandelions requires little start-up cost.
All you need are dandelion seeds, soil, water,
and some sunlight.
There is no difference between one dandelion
and another, so the market has a similar
product. The agricultural market is the best example
of a perfectly competitive market.
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Perfect Competition

Each individual firm is too small to influence


prices.
Price becomes fixed to everyone in the industry.
EXAMPLE: the price of a bushel of wheat is set
only by the interaction of supply and demand.
Generally speaking, wheat is the
same per bushel in North Georgia
as it is in Florida.

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Perfect Competition
Firms in a perfectly competitive market are
price takers. (they take the price they are given, they
cant change the price)

Since they have no control over their own


NO MARKET POWER
prices, they have _______________________.
MARKET POWER = the ability to set ones OWN prices

In other words, no one will buy an overpriced


dandelion. Why should they?
A 4-cent dandelion is the same as the 3-cent one,
so there is no reason to spend that extra penny.
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Monopolistic Competition
The 5 conditions of Monopolistic Competition
1) LARGE number of large companies (but fewer than perfect
competition).
Sellers can influence the price through creating a product identity
(more on this later)

2) Products are NOT exactly identical, BUT VERY SIMILAR,


so companies use PRODUCT DIFFERENTIATION
3) Heavy Competition: Firms must remain aware of their
competitors actions, but they each have some ability to
control their own prices.

4) Low Barriers to Entry: harder to get started because of the


amount of competition.
5) Monopolistic competition takes its name and its structure
from elements of monopoly and perfect competition. 9
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Monopolistic Competitive Market
STUDY TIP:
The key idea to understanding monopolistic competition is that
firms sell products that are similar, but not exactly alike.

EXAMPLE: Hand Soap

Essentially, all hand soaps are the same. Yet firms


can create a brand identity that separates their
hand soap from their competitors.
This brand identity can be formed through
packaging, product support, and especially
advertising.
If effective, consumers will positively identify a
certain brand and purchase it even if hand soap
costs more. SWS 2006 10
Conditions of Monopolistic Competition
The point is that firms in Monopolistic Competition must
use Product Differentiation & Non-price Competition to
sell their products.

Product Differentiation:
The real or imagined differences
between competing products in the
same industry.
Differences may be real or imagined.

Differentiation may be color, packaging, store


location, store design, store decorations,
delivery, service.. anything to make it stand
out! SWS 2006 11
Conditions of Monopolistic Competition
The point is that firms in Monopolistic Competition must
use Product Differentiation & Non-price Competition to
sell their products.

Non-Price Competition:
Non-Price Competition involves the advertising of a
product's appearance, quality, or design, rather than its
price.
Advertising to help the consumer believe that this product
is different and worth more money.

Notice these
commercials never
VS price.
mention

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Examples of Monopolistic Competition

Auto, Steel, Gas, Fast Food, Airlines.

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MERGERS OF LARGE COMPANIES
Sometimes companies fall victim to market failure. However,
not all businesses close their doors and empty their factories
and stores.
Many get swallowed up by another company. This take-
over or acquisition of a company is known as a merger.

There are THREE types of mergers: HORIZONTAL, VERTICAL, and


CONGLOMERATE.
1.) HORIZONTAL: involve firms in the SAME market, such as between two oil
companies.
Reason: Diversification

2.) VERTICAL: involve one firm buying a resource provider.


EXAMPLE: steel company buys an automaker

3.) CONGLOMERATE: a company buys a business in a


UNRELATED industry.
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What is an Oligopoly?
A market in which a two-three large sellers control
most of the production of a good or service and they
work together on setting prices.
Conditions of an Oligopoly
1) Very few Sellers that control the entire market.
2) Products may be differentiated or identical (but
they are usually standardized)
3) Medium barriers to entry: Difficult to Enter the
market because the competitors work together
to control all the resources & prices.
4) The actions of one affects all the producers.
5) Collusion = an agreement to act together or
behave in a cooperative manner.
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What is an Oligopoly?
A market in which a two-three large sellers control
most of the production of a good or service and they
work together on setting prices.

Conditions of Oligopoly
5) Collusion = an agreement to act together or
behave in a cooperative manner.
Collusion Agreements: usually illegal, among
producers to fix prices, limit output, or divide markets.
(hard to prove that a group of companies is doing this)
It is also called Price Fixing: setting the same
prices across the industry.
THIS IS IN VIOLATION OF ANTI-TRUST LAWS. WHY?
Basically, the companies are acting a one large monopoly.

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Price Behavior in Oligopoly
Now, sometimes businesses do not agree with each other about the price,
and if that happens, a WAR will result.

Price Wars: Series of price cuts that competitors must


follow or lose business.
it is a fierce price competition between sellers, sometimes
the price is lower than the cost of production.
Why is that bad???

Oligopolists would like to be Independent Price setters:


a firm sets prices based on demand, cost of input
and other factors (not based on other companies prices).
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2 Types of Price Behavior in an Oligopoly

Price Leader: independent pricing decisions made by


a dominate firm on a regular basis that results in
generally uniform industry-wide prices.

ADVANTAGE: you are the company leading the price.

Independent Pricing: policy by a competitor that


ignores other producers prices.

DISADVANTAGE: other firms shut you down by


agreeing to set lower prices than yours.
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Conditions of Monopoly
Exact Opposite of Pure Competition.
A price maker. (set their own price, without regard to
supply and demand)

There is a single seller

No close substitute goods are available

High Barriers to Entry: Other sellers


cannot enter the Market.

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Types of Monopolies
4 Distinct Types of Monopolies:
1) Natural Monopoly: Where costs are minimized by
having a single producer of the product.
Gas, water, electricity: government creates Natural
Monopolies by Franchising some utilities.
Franchise - the right to produce or do business in a certain
area without competition.
Government franchises come with government regulation.
Georgia PSC (Public Service Commission)

WHY WOULD GOVERNMENT DO THIS???

Economies of Scale: As natural monopolies grow larger, this reduces its


production costs (economies of scale).
Because normally companies become more efficient as
the firm becomes larger.
Example: It is cheaper for the Tennessee Valley Authority
(TVA) to provide power in Georgia than two or three
companies.
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Types of Monopolies

2) Geographic Monopoly: The only business in


a location due to size of market.
Decreasing in the U.S. because of mobility.

EXAMPLE: Only
person selling
water in the
desert.

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Types of Monopolies

3) Technological Monopoly: Firm has


discovered a new process or product.
Constitution gave government the right to grant
technological monopolies.
Patent: 17 years exclusive rights to a developed
technology.
Copyright: (Artists and writers) Life plus 50 years.

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Types of Monopolies

4) Government Monopoly: Retained by the


government.
Liquor sales in some counties, uranium
production, water, etc.

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3 Conditions of Efficient & Successful
Markets
Markets work best when four conditions are met:
1) Adequate competition must exist in all
markets.
2) Buyers and sellers are reasonably well-
informed about conditions and
opportunities.
3) Resources must be free to move from one
industry to another.

Market Failure occurs when any of the 3


conditions alter significantly.
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Types & Causes for Market Failure
1) Inadequate Competition: Dangers to monopolies
Monopolies may waste and misallocate scarce
resources because there is no competition.
2) Inadequate Information: A free enterprise economy
requires information.
It is difficult to employ resources for the fullest benefit of
society without adequate information.
3) Resource Immobility: The efficient allocation or resources
require that land, labor, capital and entrepreneurs be free to move
to markets where returns are the highest
4) Externalities / Side Effects: A side effect that benefits or harms
a third party that was not directly involved in the activity.
Negative Externality: People are harmed or inconvenienced
by an economic decision.
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The Role of Government

Government has the power to maintain competition,


regulate monopolies, or to run government-owned
monopolies.
Since the late 1800s the US have passed laws to
restrict and regulate monopolies and trusts.

Trust: a legally formed combination of


companies.

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The Role of Government

Antitrust Legislation
Interstate Commerce Act: Passed by Congress
in 1887. It was aimed at the railroads.
Charges of unfair pricing prompted Congress
to act.

1887 PRESENT

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The Role of Government

1890 - Sherman Antitrust Act - law against


monopolies that hindered competition or made
competition impossible because of the restraint
of trade that is created by a monopoly.

1887 PRESENT

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The Role of Government

1914 - Clayton Antitrust Act - outlawed price


discrimination - charging different customers different
prices for the same product. Further defined Sherman.
(preferred pricing)

1887 PRESENT

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The Role of Government

1914 - Federal Trade Commission Act - passed


to enforce the Clayton Antitrust Act. It gave the
authority to issue Cease and Desist order.
Cease and Desist Order: FTC ruling requiring a company to stop an
unfair business practice that reduces or limits competition.

1887 PRESENT

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STUDY FOR YOUR TEST!!

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