Explorations in Economics

Explorations in Economics Alan B. Krueger & David A. Anderson

Chapter 8: Exploring Economics • Module 23: Monopoly • Module 24: Oligopoly and Monopolistic Competition • Module 25: Regulating Market Power

DO NOW Do Pizza Parlor Game Q # 1 Chapter 8 Mods 23-25

Pizza Parlor Game Chapter 8 Mods 23-25

PURE COMPETITION & MONOPOLY KEY IDEA: Market structures can be classified by the level of competition and control over price. OBJECTIVES: • To explain the concept of market structure. • To describe characteristics of pure competitiion. • To describe the characteristics of a monopoly.

MARKET STRUCTURE Market structure describes the nature of competition within a market.

Perfect Competition Perfect Competition Part 1 - YouTube Chapter 8 Mods 23-25

Perfect Competition • The economists’ ideal. • Many firms • Easy entry and exit • Standardized products • Price takers – must accept market price. • Result: lowest prices and highest quantity of any market structure. Chapter 8 Mods 23-25

MARKET STRUCTURE Imperfect competition arises when there is not enough competition among firms to prevent individual firms from raising their price above the equilibrium level determined by supply and demand.

Monopoly Monopoly Chapter 8 Mods 23-25

WHAT IS A MONOPOLY? Market power is the ability of a firm to change the market price of a good or service. Monopoly is a product market served by only one firm. The one supplier in a monopoly is called a monopolist.

WHAT IS A MONOPOLY? Barriers to entry are obstacles that prevent firms from entering particular markets. A natural monopoly is a market in which high startup costs make it prohibitively expensive for more than one firm to operate.

WHAT IS A MONOPOLY? The Four Main Sources of Market Power: • High start up costs • Exclusive Access to a Critical Input • Government Protection • Unfair Practices

Practice – Barriers to Entry • Try answering the barriers to entry worksheet. Chapter 8 Mods 23-25

MODULE 24:OLIGOPOLY KEY IDEA: When there are only a few firms in a market, they might be able to work together to reduce output below the perfectly competitive level, charge a relatively high price, and raise their profits. OBJECTIVES: • Describe what characterizes oligopolies and how they operate. • Explain why it is difficult for a small number of firms to enforce an agreement that restricts output. • Understand how monopolies and oligopolies are regulated.

Jim Cramer on Oligopoly Oligopoly: A Market That Lacks Serious Competition What is an oligopoly? Why does Cramer like them? Chapter 8 Mods 23-25

Characteristics of Oligopoly • Few companies • Standard or differentiated product • Barriers to entry – usually size • Price makers (if they agree) • If successful, oligopolies increase price and reduce quantity supplied vs. pure competition. • Very common market structure Q: What industries would you predict would be oligopolies? Chapter 8 Mods 23-25

OLIGOPOLY: A SMALLNUMBER OF FIRMS An oligopoly is a market with a small number of firms. An oligopolist is a firm in an oligopoly industry.

OLIGOPOLY: A SMALLNUMBER OF FIRMS Collusion among oligopolists exists as they work together. A cartel is a group of firms that agree to work together and act like a monopoly under a legal agreement (think OPEC).

Is Jim Cramer Right? Or the Pikeville Oligopolists Game • Two gas stations in Pikeville: Maggie’s and Pam’s. • Pikeville motorists will fill up at the cheapest station. If price is the same, they split their business 50/50. • You and your back row partner will play one of the station owners. Right side Maggie, left side Pam. • At the start of each round, note your price on an index card. • Record your profit at the end of each round. • See who can be the most successful oligopolist! Chapter 8 Mods 23-25

Controlling Market Power • How does society control the market power of monopolies or oligopolies? Chapter 8 Mods 23-25

Standard Oil and Anti-Trust Questions: • How did Rockefeller build his monopoly? What were his economic advantages? • What happened to the oil market as a result of high prices? • If Rockefeller had won in the Supreme Court, could he have kept his monopoly in the long-run? John D. Rockefeller Video — History.com Chapter 8 Mods 23-25

DIRECT REGULATION:PRICE CONTROLS Price controls are policies by which the government sets the prices in an industry. • The goal is to bring about efficient quantity of good. • Public utility rates set where MR=MC but many firms would not operate due to high start-up costs. So, regulated price is where price equals average total cost. • Difficult to set pricing policy as markets and consumer preferences change.

ANTITRUST POLICY Antitrust policy is a set of laws designed to promote competition in the marketplace. Anti-trust laws passed to: • limit non-competitive actions • limit price-fixing • prohibit predatory acts The Enforcement of Antitrust Policy The Department of Justice and the Federal Trade Commission regulate some business practices and examine proposed mergers.

Summary • Oligopoly – few firms. • If oligopolists cooperate, they can act as a monopoly. • But cooperation can break down into price wars. • Monopoly/oligopoly power is restricted two ways: • Price controls • Anti-trust laws • Cartels and other forms of collusion are banned. Chapter 8 Mods 23-25

Do Now • What is your favorite restaurant? • Why? • How much more would you pay to eat there? Chapter 8 Mods 23-25

MODULE 25:MONOPOLISTIC COMPETITION KEY IDEA: When firms can differentiate their products, they achieve some control over price – even if they are in a very competitive industry. OBJECTIVES: • Describe product differentiation. • Link differentiation to monopolistic competition. • Understand key characteristics of monopolistic competition.

Monopolistic Competition Monopolistic Competition Chapter 8 Mods 23-25

MONOPOLISTIC COMPETITION • Many firms. • Easy entry and exit. No barriers to entry. • Differentiated products • Limited ability to be a price maker. • In long run, other firms are attracted by high profits.

Brain Dump • Each team provides three examples of monopolistic competitors and how they differentiate their products. Chapter 8 Mods 23-25

MONOPOLISTIC COMPETITION Pros Cons Higher price than perfectly competitive markets Tends to produce less than pure competition. Profits are higher than the cost of capital in the short-run. • Offering a wider range of products • Competition for the service offered • Profits return to normal in the long-run

Summary • 4 types of market structures • Pure competition • Monopoly • Oligopoly • Monopolistic Competition • Characteristics: number of competitors, barriers to entry, standard vs. differentiated product, price makers/takers, impact on price, quantity and profit. • Governments control monopoly and oligopoly thru anti-trust regulations and sometimes price controls. Chapter 8 Mods 23-25

Market Structure Project Objective: Identify a product market and explain what market structure exists in this market. For example, you might investigate U.S. steel companies. • Pick a market and have Mr. G ok your choice. We want to avoid a lot of people choosing the same industry. • Open Project – Market Structures in the Teacher’s Outbox – Econ Spring 2014. Chapter 8 Mods 23-25

Market Structure Report • Number of firms, share. • Barriers to entry • Product standardized or differentiated? • Prices – how are they set • Anti-trust actions • Conclusion – supported by your facts. • References – on each page where you cite a fact. Save in Teacher’s Inbox as “Market Structure Project – Your Name” Chapter 8 Mods 23-25

Explorations in Economics