Chapter 10 Identifying Markets and Market Structures 2005

Economic Principles The use of cross elasticity to define markets The relationship between firms,

Economic Principles The characteristics of monopolistic competition The characteristics of perfect competition The role

Defining the Relevant Market Relevant market • The set of goods whose cross elasticities

Defining the Relevant Market The relevant market can be defined narrowly or broadly. What

Defining the Relevant Market Example: Automobiles and transportation. • A relevant market can be

Defining the Relevant Market Example: Automobiles and transportation. • Transportation is a broader definition

Defining the Relevant Market 1. What makes up the relevant market for oil? •

Defining the Relevant Market 2. What makes up the relevant market for energy? •

Courts and Markets In many cases the courts are called upon to determine what

Courts and Markets Example: Du. Pont’s relevant market. • In 1953 the government filed

Courts and Markets Example: Du. Pont’s relevant market. • Du. Pont countered that its

Courts and Markets Example: Du. Pont’s relevant market. • By that definition, Du. Pont

Courts and Markets Example: Du. Pont’s relevant market. • The court decided in favor

Courts and Markets The decision of the courts is not revealed truth, but rather

Courts and Markets One tool the courts use to identify the relevant market is

Cross Elasticity Defines the Market The relevant market can be delineated by comparing the

Cross Elasticity Defines the Market It has been suggested that when the cross elasticity

EXHIBIT 1 © 2005 DELINEATING THE MARKET Gottheil - Principles of Economics, 4 e

Exhibit 1: Delineating the Flower Market In Exhibit 1, what is the market for

Markets and Market Structure Market structure • A set of market characteristics such as

Markets and Market Structure The most important characteristic that distinguishes one market structure from

Markets and Market Structure The number of producers within a market determines: • The

Markets and Market Structure The number of producers within a market determines: • How

EXHIBIT 2 © 2005 THE MARKET STRUCTURE SPECTRUM Gottheil - Principles of Economics, 4

Exhibit 2: The Market Structure Spectrum 1. How is the monopoly market structure characterized?

Exhibit 2: The Market Structure Spectrum 2. How is the perfectly competitive market structure

Exhibit 2: The Market Structure Spectrum 3. How is the monopolistic competition market structure

Exhibit 2: The Market Structure Spectrum 4. How is the oligopoly market structure characterized?

Markets and Market Structure Mutual interdependence • Any price change made by one firm

The World of Monopoly • A market structure consisting of one firm producing a

The World of Monopoly Complete this sentence: _____ is the most important characteristic defining

The World of Monopoly Industry • A collection of firms producing the same good.

The World of Monopoly If only one firm produces a good, then the firm

EXHIBIT 3 © 2005 A MONOPOLY’S DEMAND CURVE Gottheil - Principles of Economics, 4

Exhibit 3: A Monopoly’s Demand Curve How does the market demand curve compare to

The World of Monopoly In a monopoly market structure, it is impossible for other

The Natural Monopoly Natural monopoly • The result of a combination of market demand

EXHIBIT 4 THE NATURAL MONOPOLY 43 © 2005

Exhibit 4: The Natural Monopoly 1. What happens before the Blues enter the baseball

Exhibit 4: The Natural Monopoly 2. What happens after the Blues enter the baseball

Exhibit 4: The Natural Monopoly 3. What happens when the Blues and the Reds

Exclusive Access to Resources Some firms, by chance or by design, acquire exclusive access

Exclusive Access to Resources How might a monopoly on coal power as a source

The Patent System Patent • A monopoly right on the use of a specific

Acquisition Buying out all of the competition is another way to create a monopoly

Monopolistic Competition and Oligopoly Monopolistic competition • A market structure consisting of many firms

Monopolistic Competition and Oligopoly • A market structure consisting of only a few firms

Monopolistic Competition and Oligopoly The real extent of competition in an oligopoly market must

EXHIBIT 5 © 2005 RELATIONSHIP BETWEEN FIRMS, INDUSTRIES, AND MARKETS Gottheil - Principles of

Exhibit 5: Relationship Between Firms, Industries, and Markets 1. How many firms are depicted

Exhibit 5: Relationship Between Firms, Industries, and Markets 2. How many industries are depicted

Exhibit 5: Relationship Between Firms, Industries, and Markets 3. How many markets are depicted

Monopolistic Competition and Oligopoly Product differentiation • The physical or perceived differences among goods

Monopolistic Competition and Oligopoly As more firms enter a market, firm demand curves become

EXHIBIT 6 THE DEMAND CURVE FOR COCA-COLA: BEFORE AND AFTER SUBSTITUTES APPEAR ON THE

Monopolistic Competition and Oligopoly Firms in both the monopolistic competition and oligopoly market structures

Monopolistic Competition and Oligopoly Market share • The percentage of total market sales produced

EXHIBIT 7 THE EFFECT OF ADVERTISING ON THE FIRM’S DEMAND CURVE 69 © 2005

Exhibit 7: The Effect of Advertising on the Firm’s Demand Curve Complete this sentence:

Perfect Competition Perfect competition • A market structure consisting of a large number of

Perfect Competition Characteristics of perfect competition: • Goods are perfect substitutes. • Firms have

EXHIBIT 8 © 2005 MARKET DEMAND CURVE AND THE DEMAND CURVE FACING A FIRM

Exhibit 8: Market Demand Curve and the Demand Curve Facing a Firm in Perfect

EXHIBIT 9 © 2005 SUMMARY SKETCH OF MARKET STRUCTURES Gottheil - Principles of Economics,

Exhibit 9: Summary Sketch of Market Structure Type of Market Perfect Competition © 2005

Exhibit 9: Summary Sketch of Market Structure Type of Market Monopolistic Competition © 2005

Exhibit 9: Summary Sketch of Market Structure Type of Number Market of Firms Oligopoly

Exhibit 9: Summary Sketch of Market Structure Type of Market Monopoly © 2005 Number

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Economic Principles The use of cross elasticity to define markets The relationship between firms, industries, and markets Market structures The characteristics of monopoly © 2005 Gottheil - Principles of Economics, 4 e 2

Defining the Relevant Market Relevant market • The set of goods whose cross elasticities with others in the set are relatively high and whose cross elasticities with goods outside the set are relatively low. © 2005 Gottheil - Principles of Economics, 4 e 4

Defining the Relevant Market The relevant market can be defined narrowly or broadly. What gets included in the relevant market will be determined by this definition. © 2005 Gottheil - Principles of Economics, 4 e 5

Defining the Relevant Market Example: Automobiles and transportation. • Transportation is a broader definition of the relevant market. It would include the automobile industry as well as all other possible forms of transportation, including taxis, buses, railways and airlines. 7 Gottheil - Principles of Economics, © 2005 4 e

Courts and Markets Example: Du. Pont’s relevant market. • In 1953 the government filed suit against Du. Pont, charging it illegally dominated the cellophane market because it produced over 80 percent of all cellophane. © 2005 Gottheil - Principles of Economics, 4 e 11

Courts and Markets Example: Du. Pont’s relevant market. • Du. Pont countered that its relevant market was not cellophane, but the broader market of flexible packaging materials. © 2005 Gottheil - Principles of Economics, 4 e 12

Courts and Markets The decision of the courts is not revealed truth, but rather an impartial judgment concerning the issue of what constitutes a relevant market. © 2005 Gottheil - Principles of Economics, 4 e 15

Cross Elasticity Defines the Market The relevant market can be delineated by comparing the cross elasticities among goods within the set and outside the set. © 2005 Gottheil - Principles of Economics, 4 e 17

Cross Elasticity Defines the Market It has been suggested that when the cross elasticity (e) between two goods is greater than or equal to three, the goods can be regarded as belonging to the same market. © 2005 Gottheil - Principles of Economics, 4 e 18

Exhibit 1: Delineating the Flower Market In Exhibit 1, what is the market for each zone? • Zone A is the Peace rose market. • The cross elasticity for goods within the set is infinite – any Peace rose will be a good substitute. • The cross elasticity for goods outside the set is zero – nothing but a Peace rose will substitute. © 2005 Gottheil - Principles of Economics, 4 e 20

Exhibit 1: Delineating the Flower Market In Exhibit 1, what is the market for each zone? • Zone A and B are the rose market. • The cross elasticity of goods within the set is relatively high (e = 25)—for most people, any rose will be a good substitute. • The cross elasticity of goods outside the set is relatively low—for most people, only a rose will make a good substitute. © 2005 21

Exhibit 1: Delineating the Flower Market In Exhibit 1, what is the market for each zone? • Zone A, B and C are the flower market. • The cross elasticity of goods within the set is still relatively high (e = 10)—for most people, any kind of flower will be a good substitute. • The cross elasticity of goods outside the set is relatively low—for most people, nothing but flowers will make a good substitute. © 2005 22

Exhibit 1: Delineating the Flower Market In Exhibit 1, what is the market for each zone? • Zone D lies outside these markets. • The cross elasticity of goods within the set is zero (e = 0)—fish do not substitute for flowers. © 2005 Gottheil - Principles of Economics, 4 e 23

Markets and Market Structure Market structure • A set of market characteristics such as number of firms, ease of firm entry, and substitutability of goods. © 2005 Gottheil - Principles of Economics, 4 e 24

Markets and Market Structure The most important characteristic that distinguishes one market structure from another is the number of producers selling in the market. © 2005 Gottheil - Principles of Economics, 4 e 25

Markets and Market Structure The number of producers within a market determines: • The control an individual producer has in the market. • How producers respond to decisions consumers make. © 2005 Gottheil - Principles of Economics, 4 e 26

Markets and Market Structure The number of producers within a market determines: • How producers respond to decisions other producers in their market make. • How producers respond to the market prices they face. © 2005 Gottheil - Principles of Economics, 4 e 27

Exhibit 2: The Market Structure Spectrum 1. How is the monopoly market structure characterized? • Only one firm is producing goods. • The goods have no substitutes. • No other firm can enter the market. © 2005 Gottheil - Principles of Economics, 4 e 29

Exhibit 2: The Market Structure Spectrum 2. How is the perfectly competitive market structure characterized? • A considerable number of firms are producing goods. • The goods are perfect substitutes. • Firms can easily enter the market. © 2005 Gottheil - Principles of Economics, 4 e 30

Exhibit 2: The Market Structure Spectrum 3. How is the monopolistic competition market structure characterized? • Greater than a few, but fewer than a considerable number of firms are producing goods. • Firms can enter the market, but without the ease allowed in perfectly competitive markets. © 2005 Gottheil - Principles of Economics, 4 e 31

Exhibit 2: The Market Structure Spectrum 4. How is the oligopoly market structure characterized? • Only a few firms are producing goods. • Entry into the market is relatively difficult. © 2005 Gottheil - Principles of Economics, 4 e 32

Markets and Market Structure Mutual interdependence • Any price change made by one firm in the oligopoly affects the pricing behavior of all other firms in the oligopoly. © 2005 Gottheil - Principles of Economics, 4 e 33

The World of Monopoly Complete this sentence: _____ is the most important characteristic defining a monopoly. i. The size of the firm. ii. Being the only firm. © 2005 Gottheil - Principles of Economics, 4 e 35

The World of Monopoly In a monopoly market structure, it is impossible for other firms to enter the market. Factors that contribute to impossible entry include the nature of the market, exclusive access to resources, the patent system, and acquisition. © 2005 Gottheil - Principles of Economics, 4 e 41

The Natural Monopoly Natural monopoly • The result of a combination of market demand firm’s costs such that only one firm is able to produce profitably in a market. © 2005 Gottheil - Principles of Economics, 4 e 42

Exhibit 4: The Natural Monopoly 1. What happens before the Blues enter the baseball market in Exhibit 4? • The Reds charge $7 person and draw a crowd of 40, 000. The ATC is $5. The Reds’ profit = $(7 - 5) × 40, 000 = $80, 000. © 2005 Gottheil - Principles of Economics, 4 e 44

Exhibit 4: The Natural Monopoly 2. What happens after the Blues enter the baseball market and each team charges $7 person? • Attendance is split between the Blues and Reds. With an attendance of only 20, 000, the ATC climbs to $11. Losses for each team = $(7 -11) × 20, 000 = -$80, 000. © 2005 Gottheil - Principles of Economics, 4 e 45

Exhibit 4: The Natural Monopoly 3. What happens when the Blues and the Reds lower the price person to $4? • At $4 person, attendance climbs to 35, 000 per team. The ATC is $5. 50. Losses for each team = $(4 - 5. 50) × 35, 000 = -$52, 500. © 2005 Gottheil - Principles of Economics, 4 e 46

Exclusive Access to Resources Some firms, by chance or by design, acquire exclusive access to a nonreproducible good. New discoveries of the resource or the creation of alternatives to the resource destroy the monopoly. © 2005 Gottheil - Principles of Economics, 4 e 47

Exclusive Access to Resources How might a monopoly on coal power as a source of energy be destroyed? • A new producer finds a new source of coal and is able to enter the market. • Alternatives to coal, such as solar and wind power, are developed. © 2005 Gottheil - Principles of Economics, 4 e 48

The Patent System Patent • A monopoly right on the use of a specific new technology or on the production of a new good. The monopoly right is awarded to and safeguarded by the government to the firm who introduces the new technology or good. © 2005 Gottheil - Principles of Economics, 4 e 49

Acquisition Buying out all of the competition is another way to create a monopoly market structure. Andrew Carnegie, the first U. S. steel mogul, built his empire by consuming the competition. © 2005 Gottheil - Principles of Economics, 4 e 50

Monopolistic Competition and Oligopoly Monopolistic competition • A market structure consisting of many firms producing goods that are close substitutes. Firm entry is possible but less open and easy than in perfect competition. © 2005 Gottheil - Principles of Economics, 4 e 51

Monopolistic Competition and Oligopoly The real extent of competition in an oligopoly market must be measured by the number of firms in all the industries producing close substitutes. © 2005 Gottheil - Principles of Economics, 4 e 53

Exhibit 5: Relationship Between Firms, Industries, and Markets 1. How many firms are depicted in Exhibit 5? i. 1 ii. 3 iii. 15—Each box represents one firm. © 2005 Gottheil - Principles of Economics, 4 e 56

Exhibit 5: Relationship Between Firms, Industries, and Markets 2. How many industries are depicted in Exhibit 5? i. 1 ii. 3—The steel industry, the concrete industry and the aluminum industry. iii. 15 © 2005 Gottheil - Principles of Economics, 4 e 58

Exhibit 5: Relationship Between Firms, Industries, and Markets 3. How many markets are depicted in Exhibit 5? i. 1—All of the firms and all of the industries are part of the construction market. ii. 3 iii. 15 © 2005 Gottheil - Principles of Economics, 4 e 60

Monopolistic Competition and Oligopoly Product differentiation • The physical or perceived differences among goods in a market that make them close, but not perfect, substitutes for each other. © 2005 Gottheil - Principles of Economics, 4 e 61

Exhibit 6: The Demand Curve for Coca-Cola: Before and After Substitutes Appear on the Market 1. How can Coke’s demand curve be described before substitute goods appear on the market? • Coke’s demand curve equals the market demand curve. © 2005 Gottheil - Principles of Economics, 4 e 64

Exhibit 6: The Demand Curve for Coca-Cola: Before and After Substitutes Appear on the Market 2. How does Coke’s demand curve change after substitute goods appear on the market? • Coke’s demand curve shifts to the left, while the market demand curve remains at D 1. © 2005 Gottheil - Principles of Economics, 4 e 65

Monopolistic Competition and Oligopoly Brand loyalty • The willingness of consumers to continue buying a good at a price higher than the price of its close substitutes. © 2005 Gottheil - Principles of Economics, 4 e 66

Monopolistic Competition and Oligopoly Firms in both the monopolistic competition and oligopoly market structures have strong incentives to advertise. Advertising is a way to increase market share and make demand more inelastic. © 2005 Gottheil - Principles of Economics, 4 e 67

Exhibit 7: The Effect of Advertising on the Firm’s Demand Curve Complete this sentence: After advertising, Coke’s demand curve shifts to the _____. i. Right ii. Left © 2005 Gottheil - Principles of Economics, 4 e 70

Perfect Competition Perfect competition • A market structure consisting of a large number of firms producing goods that are perfect substitutes. Firm entry is open and easy. © 2005 Gottheil - Principles of Economics, 4 e 72

Perfect Competition Characteristics of perfect competition: • Goods are perfect substitutes. • Firms have insignificant market share. • Firms have free entry. • Firms cannot influence price. © 2005 Gottheil - Principles of Economics, 4 e 73

Exhibit 8: Market Demand Curve and the Demand Curve Facing a Firm in Perfect Competition 1. Why is the demand curve for a perfectly competitive firm horizontal? • The perfectly competitive firm cannot influence price. Therefore, it can produce any quantity it desires and price will always remain the same. © 2005 Gottheil - Principles of Economics, 4 e 75

Exhibit 8: Market Demand Curve and the Demand Curve Facing a Firm in Perfect Competition 2. What would happen if a firm decided to charge $0. 66 for potatoes in Exhibit 8? • The quantity demanded would fall to zero. © 2005 Gottheil - Principles of Economics, 4 e 76

Exhibit 9: Summary Sketch of Market Structure Type of Market Perfect Competition © 2005 Influence Number Type of Entry over of Firms Products Price? Many Identical Gottheil - Principles of Economics, 4 e Full No 78

Exhibit 9: Summary Sketch of Market Structure Type of Market Monopolistic Competition © 2005 Number of Firms Many Type of Products Influence Entry over Price? Difficult Differentiated /Easy Gottheil - Principles of Economics, 4 e Yes 79

Exhibit 9: Summary Sketch of Market Structure Type of Number Market of Firms Oligopoly © 2005 Few Type of Products Entry Usually Difficult Differentiated Gottheil - Principles of Economics, 4 e Influence over Price? Yes 80

Exhibit 9: Summary Sketch of Market Structure Type of Market Monopoly © 2005 Number Type of of Firms Products One -- Entry Influence over Price? Impossible Yes Gottheil - Principles of Economics, 4 e 81