Transcript market power

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Competition
•
•
Market structure in which seller cannot
influence price
Protects consumers from potentially
unreasonable prices and prohibits any supplier
market power
– Ability of individual firm to influence market price of
its product
•
Competitive market has three characteristics:
1. Many small buyers and sellers
2. Standardized product
3. No barriers to entry or exit
•
Important implication of characteristics is that competitive
firm will be a price taker
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Competition (cont.)
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Monopoly
•
Market in which only one firm (monopolist) produces
product with no close substitutes
– Historical examples:
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Long-distance phone service (AT&T)
U.S. postal service
Monopolist is not a price taker (firm unable to influence
market price of its product) but a price maker (firm able
to influence market price of its product)
– Does not mean firm will simply set highest possible price; firm
can raise price by decreasing quantity it supplies
•
Characteristics of monopolies:
1. Single firm
2. Offers for sale a unique product with no close substitutes
3. Market has strong barriers to entry
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Monopoly (cont.)
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Oligopoly
• Market in which only a few large firms dominate
(oligopolists)
– Examples:
• Automobile companies
• Ready-to-eat cereal companies
• Produce large enough share of total market
supply of product so that each of these large
firms can influence market price
• If oligopoly firms agree to get together and
cooperate on output levels, they can set price as
high as if they were a monopoly
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Concentration Ratio
•
Percentage of output produced by four largest firms in
an industry
– If four or fewer firms, concentration ratio will be 100
– If industry contains many small firms, concentration ratio will be
very low
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•
Many economists consider concentration ratio above 60
to indicate tight oligopoly in which firms have significant
market power
Although concentration ratios are useful indicators of
possible market power, they are not perfect measures
of market power
1. Concentration ratios based only on domestic (U.S.) production
and exclude foreign competition
2. Many markets are regional
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Concentration Ratios for Selected
Manufacturing Industries
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Barriers to Entry
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Market characteristic that prevents new firms from
entering market
Seven common barriers to entry:
1.
Economies of scale
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2.
Large amount of product can be produced at lower cost per unit
than small amount of product
Arise from technology used in manufacturing product, as well as
organization of labor and any discounts that producer may
receive on large purchases of inputs
Exclusive franchises
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Permission by government (often local government) for monopoly
firm to exist
Often case when there is a natural monopoly
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Market with significant economies of scale
Examples:
» Local telephone companies
» Natural gas companies
» Electric companies
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Barriers to Entry (cont.)
•
Seven common barriers to entry (cont.):
3. Control of essential raw materials
4. Patents
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Legal protections that allow inventor to be sole provider of
product for period of time
Government gives patents for new products and new
processes to encourage innovation and invention
– Although patents encourage invention, also encourage
development of market power:
1. Holder of patent will be sole producer of product for many
years
2. Patents can be misused
3. Common practice of aggressively defending patents with
patent infringement lawsuits discourages would-be
competitors from producing close substitutes
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Barriers to Entry (cont.)
•
Seven common barriers to entry (cont.):
5. Product differentiation
•
Creation of image that one firm’s product is different from
or somehow superior to other similar products
–
May be real (style, quality, or color) or artificial (created solely
by advertising)
6. Licensing
•
Government requires new entrants to obtain license
(permit) before beginning operation in many professions
and trades
7. Behavior of established firms
•
Price-cutting is example
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Competition vs. Monopoly
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Collusion
• Better known as price-fixing
• Occurs when firms cooperate to restrict
total market output and thereby obtain
higher price
• More likely in markets with relatively few
firms and substantial entry barriers
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Types of Collusion
•
Cartel agreements
–
Group of producers that has explicit agreement to limit output
and charge price higher than competitive price
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Examples:
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Organization of Petroleum Exporting Countries (OPEC)
DeBeers diamond company
Price leadership
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Charging different groups of buyers different prices
Occurs in markets in which firms never explicitly agree to
collude, but instead somehow come to realization that it is in
their best interests to charge similar prices and to restrict
output to maintain higher prices
One firm emerges as price leader and other firms adjust price
whenever leader changes its price
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Inefficiency
• Firms in concentrated markets tend to
have less incentive to be efficient than do
firms in competitive markets
– Competitive firm must minimize cost of
product in order to survive, but firm in
concentrated market protected by entry
barriers has no such incentive
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Price Discrimination
• Charging different groups of buyers different
prices when price differentials are not justified by
differences in costs
• Only possible when firms have significant pricemaking power
• Extremely common in United States
• Examples:
– Automobile companies charging different prices for
different models of cars
– Drug industry charging different prices for drugs
consumed by hospital patients rather than by retail
buyers
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Forces That Decrease Market Power
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Technological change
Antitrust activity
Deregulation of unwisely regulated sectors
Import competition
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Technological Change
• Economies of scale often eroded by forces
of technological changes
• Examples:
– Phone industry
– Railroads
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The U.S. Antitrust System
• Set of weapons designed to combat market power
• Consists of laws passed by Congress, agencies empowered to
administer laws, and court system to try cases under laws
• Examples of federal antitrust laws:
– Sherman Act (1890)
– Clayton Act (1914)
– Celler-Kefauver Act (1950)
• Principal agencies charged with administering law are Antitrust
Division of Justice Department and Federal Trade Commission
(FTC)
• Examples of antitrust cases:
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Ticketmaster (1993)
McDonnell Douglas and Boeing (1997)
Sprint and WorldCom (2000)
Microsoft (2000)
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Regulation and Deregulation
• Natural monopolies that exhibit substantial economies of
scale are generally regulated by state or federal
government agencies
• Regulation involves limitation of market entry by granting
exclusive franchises to firms
– Natural monopoly is regulated with respect to rates charged and
level of service offered
• Major problem with regulation occurs when public utilitytype of regulation is imposed on industries that are not
natural monopolies because they do not have substantial
economies of scale
– Regulation shelters firms from competition and actually causes
inefficiency
• Deregulation simply means lessening regulatory
restrictions
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Import Competition
• Import quotas and tariffs that limit
competition from foreign imports are often
called upon to protect American firms
– Powerful firms that lobby Congress to limit
imports are often in concentrated markets
• Restricting imports protects market power in
concentrated industries, but does not benefit
American worker or consumers
– By protecting market power in concentrated industries,
ultimately cause lower output levels, lower employment,
and higher prices to consumers
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Wal-Mart
• World’s largest privately owned company,
employing 1.7 million workers and earning
profits of $11.2 billion in 2005
• Center of controversy as critics charge that its
business practices are unethical
– Among these charges are that:
• It does not pay employees a living wage
• It does not allow workers to form unions
• It does not provide adequate health care insurance for
employees
• It discriminates by failing to promote women to management
positions
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Wal-Mart (cont.)
• Effect on local communities is controversial
– Critics argue that prices charged by Wal-Mart will
drive local establishments out of business, and that
lower prices may disappear when local businesses
fail and Wal-Mart utilizes enhanced market power
– Others argue that Wal-Mart enhances competition,
thereby bringing lower prices to consumers
– Also maintain that increased traffic resulting from
large numbers of Wal-Mart shoppers visiting local
communities will actually increase business of
downtown merchants
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International Aspects of Market Power
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The Economic Left and the Economic Right
•
THE ECONOMIC LEFT (Liberal)
– Believe competition creates
efficiency, and government
must act to reduce market
power that impedes
competition
– Support antitrust policy and
government regulatory
authority
– Feel antitrust system is
needed to control excessive
market power and that
proposed mergers should be
scrutinized closely before
allowed to take place
– Believe public utilities should
be regulated to protect
consumer from monopolistic
excesses
•
THE ECONOMIC RIGHT
(Conservative)
– Feel market power is seldom
serious problem
– Believe barriers to entry are
seldom so high as to eliminate
threat of competition from new
firms entering industry
– Believe technological change
erodes established monopoly
positions
– Seldom see need for antitrust or
economic regulation, and
believe such policies create
inefficiency
– Argue that any increased market
power created when firms
merge is controlled by potential
competition from new entrants
into industry and by
technological change
– Argue that government actually
creates monopoly power by
granting utility companies
exclusive franchises
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Appendix: Elasticity and Monopoly Profits
• Since monopolist supplies unique product,
likely that demand for product is inelastic
– When demand is inelastic, consumers do not
alter quantities they purchase very much
when price of product changes
• Monopolists take advantage of situation by
recognizing that even small reduction in quantity
supplied will be associated with much higher price
– Monopolist can increase profits by restricting output
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Appendix: Elasticity and Price Discrimination
• Two different groups of consumers of longdistance phone service:
– One group of businesspeople must phone
clients during business hours and have few
alternatives to making phone calls
• Inelastic demand
– Supplier can increase revenue by raising price
– One group of nonbusiness consumers can
use e-mail and make calls during the
evenings or weekends
• Elastic demand
– Supplier can increase revenue by reducing price
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