Perfect Competition

4 Conditions that exist in a perfectly competitive market

2 common barriers that prevent firms from entering a market

Prices and output in a perfectly competitive market

CH 7.1

Perfectly competitive market

A market in which a large number of firms produce the exact same product Product is available for the same price Each firm’s contribution to the market is

small Only decision is how much to make, given

the cost and market price

4 Conditions for Perfect Competition

1. Many buyers and sellers Many participants on both sides No individual can have enough power to

influence the quantity in the market Everyone has to accept the prices as given

Market will determine price

2. Identical Products No difference between the products sold by

different suppliers Commodities - product that is the same no

matter who sells it Low grade gas, paper, milk, fruit, Buyer will always choose the cheaper supplier

3. Informed buyers and sellers Buyers know enough to look for a good

deal Sellers too – best deal for them

Full information is provided Clear incentives to gather/supply info

Trade off? Time spent researching prices?

How much is your time worth?

4. Free entry /exit Firms must be able to:

Enter the market - when they can make $ Exit the market - when they cannot

If a company has more competition, it has to sell its product for less If less competition and more control, it can

charge more

Barriers to Entry Factors that keep firms from getting

into a market and result in imperfect competition

1. Start up costs Before you can start earning money, you

have to make an investment Higher costs = less firms Impact of the Internet?

Barriers to Entry 2. Technology

Lots of technology required - higher barrier

Lots of technological know how/ skills/ training also offer higher barriers

Efficiency Perfectly competitive markets are very

efficient Competition keeps Prices and Costs low Prices reflect cost

Lowest sustainable prices Only make enough to cover your costs

and profiting enough to make it worthwhile to stay in business

Monopoly How Economists define Monopoly How do they form

Govt monopolies How do they set price and output level Price Discrimination

CH 7.2

Monopoly When barriers prevent firms from

entering the market that has a single supplier

A market dominated by a single supplier They take advantage of their power by

charging high prices

Forms of monopolies

Economies of scale Condition when a producers costs go down

as production goes up Bigger is better Hydroelectric Power

Forms of monopolies

Natural Monopolies Market that runs most efficiently

when one large firm controls the market

In exchange for being the only firm in the market, Govt will control prices

Forms of monopolies Technology can affect monopolies

Improvements in technology can break up a monopoly

Telephones/ Cell phones Cable/ Satellite Blockbuster/Streaming (Netflix)

Govt Monopolies Govt regulates natural monopolies Govt can also create monopolies

Patents Guarantees profits on research/ investment

Franchises contract to sell specific goods within an exclusive market

Licenses right to operate a business

Output decisions

Even monopolies have to choose between output and price Really cannot charge whatever they want Possibility to price yourself out of the

market Elasticity of goods

Price discrimination Targeting different consumers, allows

you to charge different amounts

Exists all over – not just in monopolies Market Power - ability of a company to

change prices and output like a monopoly without being one

Price Discrimination Targeted Discounts

Identify people who would not be willing to pay top price

Give them a discount Elderly/Students?

Identify those who need it the most Charge them the most Medical coverage/ prescriptions/treatment

Examples Airline tickets

Traveling for business may cost more Booking in advance will be cheaper

Senior/ Student discounts Kids eat/stay free

Attract families

Limits on Price Discrimination Must meet three conditions

1. Must have some market power

2. Must be able to divide customers into groups based on sensitivity to price

3. Difficult resale Cannot sell something for a price, and then have

customers sell it to others for a higher price

Monopolistic Competition

• Many companies compete selling similar goods

• Modified perfect competition• Not identical goods• Each company has a monopoly on their

version of a good

• Prices will be higher than perfectly competitive

CH 7.3

4 Conditions 1. Many sellers/firms

Start up costs are low 2. Few barriers to entry 3. Some control over the price

Goods are slightly different Substitutes

4. Differentiated products* Distinguish your goods from others

Nonprice Competition Ways to compete w/o changing price

Physical characteristics• Sizes, shapes, colors

Location Service Level Advertising, Image or status

Oligopoly Market dominated by a few large firms

3 or 4 firms that produce 70 - 80%

Some barriers to entry High start up costs Economies of scale

Cooperation and Collusion If these 3-4 companies work together

they can eliminate other competition Collusion

Agreement to set prices and production levels Price Fixing Price wars

Cartels Agreement to organize production and

prices Usually don’t last long

Incentive to produce more = $$$ Creates too much supply Excluding someone

Lower price than cartel

# of firms

Variety

Control of $

Barriers to entry

Examples

Perf. Comp.

Monop.Comp. Oligopoly Monopoly

Many Many

None

None

None

p. 170

Some Some

Some

None

ONEFew

Little

Low High

Complete

Complete

Public Water

Cars, Movie Studios

Jeans,Books

Wheat,Stock

Comparison of Market Structures

Regulation and Deregulation How do firms use market power

Practices that the Govt regulates or bans to protect competition

Deregulation and its effects

CH 7.4

Market Power Markets with a few large firms generally

have higher prices When these companies work together they

can control the prices Predatory pricing - setting your price lower

than costs to drive out competition

Govt and Competition Govt policy prevents firms from

controlling price and supply of a good in a market Federal Trade Commission Department of Justice

Anti Trust Division

Grouping/Cooperation of companies Collusion Cartels Trusts - illegal grouping of companies

that discourages competition

Anti Trust Laws Sherman Anti Trust Act - 1890

Outlawed mergers and monopolies that limited trade between states

Basis of most legislation today 1911 - US breaks up Standard Oil

They had controlled 88% of refined oil in US Clayton Anti Trust Act - 1914

Prohibits certain behaviors that can lead to monopoly

Anti Trust Robinson-Patman Act - 1936

Laws against price discrimination 1982 - Govt breaks up AT&T 1999 - Microsoft declared Monopoly by

Govt

Mergers Combination of one or more companies Govt will look to see if this will lead to

unfair advantages/ less competition If the merger will lead to lower costs,

lower prices or better products the govt will allow it

Deregulation 1970s 1980s Govt took itself out of

controlling several industries Airline, trucking, railroad, TV broadcasting,

natural gas, banking No longer controlled prices Force firms to compete and drive prices

down

Deregulation +/- +

Lowers barriers to entry Widespread growth

- Banking industry (1980s)

Banks took more risks with loans, lost $$ Govt spent billions covering losses

Airline industry After deregulation, lots of new airlines

popped up Some went out of business Some merged w/ others

Prices to big cities went down Small cities?