A perfectly competitive
market is characterized by:
very large number of buyers and sellers
buyer and seller have no control over the
market price ... each firm is a price taker that faces a horizontal demand
curve for its product … A price taker
is a firm that faces a given market price and whose actions have no
effect on that market price.
A monopoly market is characterized by:
single seller producing a product with no close
effective barriers to entry into the market
firm is a price
maker, also called a price searcher,because it faces a downward
sloping demand curve for its product
One special type of monopoly is a
naturalmonopoly, a monopoly that arises because of the existence of economies
of scale over the entire relevant range of output. In this case, a larger
firm will always be able to produce output at a lower cost than could a
smaller firm. The pressure of competition in such an industry would result
in a long-run equilibrium in which only a single firm can survive (since
the largest firm can produce at a lower cost and can charge a price that
is less than the ATC of smaller firms).
A monopolistically competitive market is characterized
large number of firms
product is differentiated (i.e., each firm
produces a similar, but not identical, product)
entry is relatively easy
firm is a price
maker that faces a downward sloping demand curve
An oligopoly market is characterized by:
small number of firms produce most output
(a duopoly has two
major firms with several small firms)
product may be either standardized or differentiated
significant barriers to entry
recognized interdependence exists (i.e., each
firm realizes that its profitability depends on the actions and reactions
of rival firms)
Most output is produced and sold in oligopoly
and monopolistically competitive markets.
I. Characteristics of a Perfectly Competitive Market
Structure: Perfect competition is a market structure in which the decisions
of buyers and sellers as individuals have no effect on market price. Each firm is
so small that it cannot significantly affect the price of the product in question
and is a price taker.
There are a large number of buyers and sellers.
The product sold by the firms in the industry must
Buyers and sellers have equal access to information.
Any firm can enter or leave the industry without
II. Demand Curve of the Perfect Competitor:
Since the perfectly competitive firm produces a homogeneous commodity, the individual
firm will lose all of its business if it raises it price. The demand schedule for
a perfectly competitive firm is thus perfectly elastic at the market supply and
market demand determined price. The firm is a price taker, i.e. it must take price
as given because the firm cannot influence market price.
III. How Much should the Perfect Competitor Produce?
The firm has only one decision: how much should it produce?
Total Revenues: Total revenue is the price per
unit times the total quantity sold.
Comparing Total Costs with Total Revenues: The
firm will maximize profits where the total revenue curve exceeds the total cost,
the sum of total fixed and total variable costs, by the greatest amount.
IV. Using Marginal Analysis to Determine the Profit
Maximizing Rate of Production: The use of marginal analysis to determine the
profit-maximizing rate of production is preferred to comparing total cost and revenue.
The results are the same, but business decisions are really made on the margin where
marginal benefits and costs are compared.
Marginal Revenue: The change in total revenues
resulting from a change in output (and sale) of one unit of the product in question.
It is computed as the change in total revenue divided by the change in output.
When Are Profits Maximized?: Profit maximization
normally occurs at the rate of output at which marginal revenue equals marginal
V. The Meaning of Zero Economic Profits: The
average total cost curve includes the full opportunity cost of capital as well as
the opportunity cost of all other factors of production used in the production process.
Economic profits are that part of accounting profits over and above what are required
to stay in business in the long run. At the short-run break-even price, economic
profits are, by definition, zero. Accounting profits at that price are not, however,
equal to zero. They are positive.
Factors that Influence the Industry Supply Curve:
Anything that affects the marginal cost curves of the firms will influence the
industry supply curve. These are factors that cause the variable costs of production
to change, such as changes in the individual firm’s productivity, or factor
costs (wages paid to labor, price of raw material, etc.). Because these factors
affect the position of the marginal cost curve for the individual firm, they
affect the position of the industry supply curve. A change in any of these non-price
determinants of supply will shift the market supply curve.
VI. The Long-Run Industry Situation: Exit and
Exit and Entry of Firms: If firms in an industry
are making economic profits, this will signal owners of capital elsewhere in
the economy that they should enter this industry. If firms in an industry are
suffering economic losses, the losses signal resource owners within the industry
not to reinvest and if possible to leave it. Profits direct resources to their
highest-valued use. In the long run, capital and labor will flow to industries
where profitability is highest and will flow out of industries where profitability
is lowest. In a competitive long-run equilibrium situation firms will be making
zero economic profits.
Long-Run Industry Supply Curves: Market supply
curves that show the relationship between price and quantities after firms have
been allowed the time to enter into or exit from an industry, depending on whether
there have been positive or negative economic profits. Constant-Cost Industries
are those whose total output can be increased without an increase in long-run
per-unit costs. The long-run supply curve is horizontal. Increasing-Cost Industries
are those in which an increase in output is accompanied by an increase in long-run
per-unit costs, such that the long-run industry supply curve slopes upward.
Decreasing Cost Industries are those in which an increase in output leads to
a reduction in long-run per-unit costs, such that the long-run industry supply
curve slopes downward.
I. Monopolist: A single supplier that comprises
its entire industry for a good or service for which there is no close substitute
- a water company, for example.
II. Barriers to Entry: For any amount of monopoly
power to continue to exist in the long run, the market must be closed to entry in
some way. Either legal means or certain aspects of the industry’s technical or cost
structure may prevent entry.
Ownership of Resources Without Close Substitutes:
If one firm owns the entire supply of raw material input that is essential to
production of a particular commodity, then that ownership serves as a barrier
to entry until an alternative source of raw material input is found or an alternative
technology not requiring the raw material in question is developed.
Problems in Raising Adequate Capital: Certain industries
require a large initial capital investment. Firms already in the industry can,
according to some economists, obtain monopoly profits in the long run because
no competitors can raise the large amount of capital needed to enter the industry.
Economies of Scale: When economies of scale exist
firms with larger output have lower average costs that enable them to charge
a lower price and drive smaller firms out of business. A natural monopoly arises
when there are large economies of scale relative to the industry’s demand, and
one firm can produce at a lower average cost than can be achieved by multiple
Legal or Governmental Restrictions
Licenses, Franchises and Certificates of Convenience:
In many industries it is illegal to enter without a government license,
or certificate of convenience and public necessity. Because franchises or
licenses are restricted, firms already in the industry can earn long-run
Patents: A patent is issued to an inventor
to provide protection from having the invention copied or stolen for a period
of 20 years. The patent holder has a monopoly.
Tariffs: Tariffs are special taxes that are
imposed on certain imported goods. If tariffs are high enough, imports become
overpriced and domestic producers gain monopoly advantage as the only suppliers.
Regulations: Government regulation has increased
in the interest of safety and quality. Large expenditures have been necessary
by certain industries to comply. Large fixed costs spread over a larger
number of units of output by larger firms can put smaller firms at a competitive
disadvantage. This can deter entry of new firms.
Cartels: An association of producers in an industry
that agree to set common prices and output quotas to prevent competition.
III. Elasticity and Monopoly: The price elasticity
of demand for the monopolist depends on the number and similarity of imperfect substitutes.
The more numerous and more similar are these imperfect substitutes, the greater
the price elasticity of demand of the monopolist’s demand curve. The monopolist
faces a downward-sloping demand curve. This means that it cannot charge just any
price with no changes in sales because, depending on the price charged, a different
quantity will be demanded.
IV. The Social Cost of Monopolies: The monopolist
will charge a higher price and produce a lower output than will a perfectly competitive
industry, assuming the same cost structure.
I. Monopolistic Competition: A market structure
where a large number of firm’s produce similar but differentiated products which
they advertise and promote. There is relatively easy entry into the industry.
Number of Firms: In monopolistic competition, there
is a large number of firms, but not as many as in perfect competition. This
fact has several implications for a monopolistically competitive industry.
Small Share of Market: When many firms exist
in an industry each firm has a relatively small share of the total market.
Thus, each has only a very small amount of control over the market clearing
Lack of Collusion: With many firms it is difficult
for them to get together to collude; that is, to agree to cooperate to set
a pure monopoly price and output. Price rigging in a monopolistically competitive
industry is virtually impossible.
Independence: Because there are so many firms,
each one acts independently of the others; no firm attempts to take into
account all of its rival firms.
Product Differentiation: Product differentiation
is the distinguishing of products by brand name, color, minor attributes and
etc. Product differentiation occurs in other than perfectly competitive markets
where products are homogeneous. Each separate, differentiated product has numerous
similar but not perfect substitutes. The greater the number of substitutes available
the greater the price elasticity of demand. The ability of a firm to raise price
is limited, and the demand curve slopes downward.
Ease of Entry: For a monopolistic competitor, potential
competition is always a threat. The easier and less costly entry is, the more
a current monopolistic competitor must worry about losing business.
Sales Promotion and Advertising: No individual
firm in a perfectly competitive market will advertise. It can sell all it wants
at the going market price. Since the monopolistic competitor has some monopoly
power, advertising may result in increased profits. Advertising should be carried
to the point where marginal revenue from advertising just equals the marginal
cost of advertising.
II. Brand Names and Advertising: Because “differentness”
has value to consumers, monopolistically competitive firms view their brand names
as valuable. Firms advertise their brand to maintain differentiation of their products
from those of other firms.
Brand Names and Trademarks: A firm’s value in the
marketplace depends largely on its current profitability and perceptions of
its future profitability.
Advertising: To help ensure that consumers differentiate
their products from those of other firms, monopolistically competitive firms
engage in advertising.
Methods of Advertising: Advertising can be
in the form of direct marketing, mass marketing, or interactive marketing.
Informational Versus Persuasive Advertising:
Informational advertising is advertising that emphasizes transmitting knowledge
about features of a product and is more likely to be used with a search
good. Persuasive advertising is advertising that is intended to alter a
consumer’s tastes and preferences and induce a consumer to purchase a particular
product. It is more likely to be used with an experience good. Both promotional
and persuasive advertising are likely to be used with credence goods which
are difficult for consumers to evaluate without help.
Advertising as Signaling Behavior: Signals
are compact gestures or actions that convey information. Heavy advertising
expenditures that establish brand names or trademarks are signals that the
company plans to stay in business.
III. Information Products and Monopolistic Competition:
A product produced using information intensive inputs at a relatively high fixed
cost but distributed for sale at a relatively low marginal cost is an information
product. Creating the first unit of an information product such as a computer program
entails a high initial up-front cost. Additional units are very inexpensive to produce.
High up-front costs of producing the first unit are fixed costs.
I. Oligopoly: An oligopoly is a market situation
in which there are very few sellers. Each seller knows the other sellers will react
to its changes in prices and quantities. An oligopoly market structure can exist
for either a homogeneous or a differentiated product.
Characteristics of Oligopolies
Small Number of Firms: An oligopoly exists
when a handful of firms dominate the industry enough to set prices.
Interdependence: This is also called strategic
dependence, which is a situation in which one firm’s actions with respect
to output, price, or product differentiation may be strategically countered
by one or more other firms in the industry. Such dependence can only exist
when there are a few major firms in an industry.
Why Oligopolies Occur
Economies of Scale: The strongest reason that
has been offered for the existence of oligopoly is economies of scale.
Economies of scale are defined as a production situation in which a doubling
of output results in less that a doubling of total costs. The firm’s average
total cost curve will slope downward as it
produces more and more output. Average total cost can be reduced by continuing
to expand the scale of operation.
Barriers to Entry: These barriers include legal
barriers, such as patents, and control and ownership over critical supplies.
Oligopoly by Merger: A merger is the
joining of two of more firms under a single ownership or control. There
are two types of mergers. A horizontal merger involves firms producing or
selling a similar product. A vertical merger occurs when one firm merges
with another from which it purchases an input or to which it sells an output.
Measuring Industry Concentration: The percentage
of all sales contributed by the leading four or leading eight firms in an industry
is sometimes called the industryconcentrationratio.
II. Deterring Entry into an Industry: Existing
firms in an industry devise strategies to deter entrance into that industry. By
getting a local, state or federal government to restrict entry or by adopting certain
pricing and investment strategies they may deter the entrance of new firms.
Increasing Entry Costs: Any strategy undertaken
by firms in an industry with the intent or effect of raising the cost of entry
into the industry by a new firm. To sustain a long price war, existing firms
might invest in excess capacity so that they may expand output during the price
war, thus signaling potential competitors that they will engage in a price war.
Existing domestic firms can also raise the cost of entry by foreign firms by
getting the U.S. government to pass stringent environmental or health and safety
Limit-Pricing Strategies: The existing firms may
lower their market price until they sell the same quantity as before a new firm
entered the industry. Existing firms limit their price to be above competitive
prices, but if there is a new entrant, the new limit price will be below the
one at which a new firm can make a profit. The limit-pricing model is a model
that hypothesizes a group of colluding sellers who together set the highest
common price they believe they can charge without new firms seeking to enter
Raising Customers’ Switching Costs: If an existing
firm can make it more costly for customers to switch from its product or service
to a competitor’s, the existing firm can deter entry. In the computer industry
switching costs were high because computer operating systems have not
been compatible across company lines.
Some Examples of Oligopolies in the Modern Economy
Examples of oligopolies in the United States include the major media outlets, film
industries and beer industries. These markets are controlled by only a few sellers.
Media conglomerates Include NBC/Comcast, News-Corp, Disney, Viacomm, CBS and Time
Warner, which control almost all viewed televised media. In the beer industry, Coors
and Anheuser Busch control approximately 80% of all beer sales in the United States.
Although these oligopolies have some limited competition in terms of public broadcasting
networks or microbreweries, the fact is that all other market entries are a fraction
of a percent of market share in comparison to major corporate businesses.
Take a closer look at some of the oligopoly markets here at home.
The US Media Industry
(click on the thumbnail
to the left)
When the info graph to the left was created, six media giants controlled almost
90% of what we read, watched or heard -- Disney, GE, News-Corp, Viacomm, CBS and
Time Warner. By 2014, that figure rose to 98%. If you visit the
Journalism Review website you can search through an index that will show you
what each company currently owns.
To give you an idea of their power, in 2003, Mattel had a dispute with CBS because
CBS did not broadcast Barbie in the Nutcracker during prime time. Mattel
threatened to pull millions of dollars of advertisements from Nickelodeon. Viacomm
responded by telling Mattel if they did Viacomm would blacklist Mattel from advertising
on any Viacomm property. Mattel of course backed down.
The four banks shown to the left are the four largest in the US. Together they dominate
the financial industry. If you add Goldman Sachs and Morgan Stanley, the domination
is almost complete. Use the link above to view an excellent graphic and a
short write-up on how things got this way.
The Cell Phone Industry
In what would be one of the biggest deals since the financial crisis broke, the
US telecom giant AT&T has agreed to buy
T-Mobile USA from Deutsche Telekom for $39 billion, creating the biggest mobile
operator in the US. The deal would bring together the second and third largest mobile
groups in the US and will thus face intense regulatory scrutiny. If approved, the
merger would shrink the number of major national wireless operators in the US from
four to three.
This merger will create a new monster-sized cell-phone network (ATT-Mobile?).
The new combine will be ⅓ larger than the current
king-of-the-hill, Verizon Wireless. Indeed, there will be only really three networks
left, the new ATT-Mobile, Verizon Wireless, and Sprint-Nextel. Consumer choices
and options will narrow further. Competition, already weak, will diminish further.
It’s also an example of how globalization, which is about increasing world competition,
can lower competition worldwide.
here's one more graphic just to rub salt in the wound.