ECO105 Ch. 8: Monopoly to competition and in between: Market Structure and Pricing power

Monopoly

- Only seller of product and services
- No close substitutes available
- Demand is steep and inelastic

Market Power

Business's ability to set price

Price Maker

- Monopoly with maximum power to set price
- Business can set any price, but cannot force consumers to buy
- Even monopoly price makers must live by law of demand

Perfect Competition

- Many seller producing identical products or services
- Demand is horizontal and perfectly elastic at market price
- Only change quantity but not price

Price taker

Business with ZERO power to set price

Market Structure

Characteristics affecting competition and pricing power
1) Available substitutes
2) Number of Competitors
3) Barriers to entry of new competitors

Barriers to entry

Legal or economic barriers preventing new competitors from entering a market
1) Legal barriers: Patent and copyrights are exclusive property rights to sell or license creations
2) Economic Barriers: Economies of scale = average total cost of producing decrease as quantity (scale) of production increases
- Average total cost: total cost per unit of output
- Small = average cost higher

Broader definition of market

- More substitutes and competitors
- More elastic demand
- less pricing power

Narrower definition of market

- Fewer substitutes and competitors
- More inelastic demand
- More pricing power

Product differentiation

- Attempt to distinguish product or service from those of competitors
- Reduce competition and substitutes
- Increasing pricing power
- Can be actual differences or perceived differences (Don't need to be real)

Relationships between pricing power and number of competitors

- Fewer competitors = more price power
- More competitors = less price power

Relationships between pricing power and demand

- Higher pricing power = more inelastic demand
- consumers have few substitutes or strong brand loyalty
- Lower pricing power = more elastic demand
- consumers have many substitutes or no brand loyalty

Four main market structures

1) Monopoly
2) Oligopoly
3) Monopolistic competition
4) Perfect competition

Oligopoly

- Few big sellers control most of the market
- Eg. Coke and Pepsi

Monopolistic Competition

- Many small businesses make similar but slightly differentiated products or services
- Eg. Dry cleaning and restaurant

Competition

- Active attempt to increase profit
- Gain market power of monopoly
1) Cutting cost
2) Improving quality and product innovation
3) Advertising and brand loyalty
4) Eliminating competition
5) Building barrier to entry

Shrinkage

- Employee stealing
- happens in retail a lot

Creative destruction (Schumpeter theory )

- Competitive business innovations generate economic profits for winner, improving living standards for all
- But destroy less productive or less desirable products and production methods