Market Structure and Market Power Notes

Market Power

Market Power Concerns

• Are firms becoming too large?
• Are companies like Amazon, Google, and Facebook excessively dominant?
• Should large firms be regulated or broken up to foster competition?

Market Structure

Economists classify markets into four main types:

• Pure Competition
• Monopolistic Competition
• Oligopoly
• Monopoly

Market Structure Continuum

The market structures can be placed on a continuum:

Pure Competition --> Monopolistic Competition --> Oligopoly --> Monopoly

Characteristics of Market Structures

Perfect Competition

• Many buyers and sellers exist.
• No single seller can influence the market price.
• No restrictions prevent new firms from entering the industry.
• Firms and buyers are well-informed about prices and products.
• Protects consumers from unreasonable prices and prevents suppliers from having market power.
• Firms are price takers.

Stock Example demonstrating perfect competition

Scenario: You inherit 100 shares of stock in a large, well-known company.

• Determining Market Price: Market price is determined by the overall market.
• Selling Above Market Price: You would sell very little or none of your stock if you charged more than the market price.
• Impact on Stock Price: Selling 100 shares would not significantly impact the stock price.
• Selling Below Market Price: There would be no reason to sell below market price.

Monopolistic Competition

• Many firms exist, each producing slightly differentiated products.
• No restrictions on the entry of new firms.
• Most firms operate in this type of market.
• Examples: restaurants, clothing apparel, jewelry, household products, asphalt paving.

Oligopoly

• A few large firms (oligopolists) produce most of the industry's product.
• Each firm can influence the market price.
• Products may be nearly identical or differentiated (e.g., steel, cereal).
• Entry barriers limit new firms from entering.
• Firms are interdependent (e.g., Coca-Cola and Pepsi-Cola).
• Firms engage in strategic behavior, closely monitoring competitors.
• Concern: Possible cooperation on output levels to fix prices, which is illegal in the U.S.

Monopoly

• Only one firm (monopolist) produces the product, and there are no close substitutes.
• Historical examples: long-distance phone service (AT&T), U.S. Postal Service.
• The firm is a price maker, not a price taker.
• The firm can set the market price by adjusting the quantity supplied.
• Barriers to entry prevent competition.

Market Power

• Firms exercise market power by raising prices above competitive levels.
• Market power itself is not necessarily a problem; the abuse of market power is problematic.

Barriers to Entry

These are market characteristics that prevent new firms from entering the market, determined by technology, government regulations, or the firms themselves.

• Economies of scale
• Exclusive franchises
• Control of essential raw materials
• Patents
• Product differentiation
• Licensing
• Behavior of established firms

Seven common barriers to entry:

• Economies of Scale
  • Large-scale production results in lower per-unit costs.
  • Arise from technology, labor organization (e.g., assembly line), and bulk purchase discounts.
• Exclusive Franchises
  • Government-granted permission for a firm to be a monopoly.
  • Often occurs when there are significant economies of scale, creating a natural monopoly.
  • Examples: Local telephone companies, natural gas companies, electric companies.
• Control of Essential Raw Materials
  • Examples: Nickel, bauxite
• Patents
  • Legal protection granting the inventor exclusive rights to produce a product for a period.
  • Encourages innovation but can also lead to market power.
  • Patent holders can be the sole producer of a product for many years.
  • Aggressive defense of patents can discourage competitors from producing substitutes.
• Product Differentiation
  • Creating an image or brand name that distinguishes a firm's product from competitors.
  • Can be real (style, quality, color) or artificial (created by advertising, e.g., Clorox and Bayer Aspirin).
• Licensing
  • Government-required permits for new entrants in various professions and trades.
  • Debate: Does it protect consumers or firms?
• Behavior of Established Firms
  • Includes strategies like price-cutting to deter new entrants.

Collusion

• Also known as price-fixing.
• Firms cooperate to restrict market output and increase prices.
• More likely in markets with few firms and high entry barriers.

Inefficiency

• Firms in concentrated markets may have less incentive to be efficient (X-inefficiency).
• Competitive firms must minimize production costs to survive.
• Firms in concentrated markets, protected by entry barriers, may have less incentive to minimize costs.
• Considerations: Which firms conduct research and development?
• Tradeoff of economies of scale and market power.

Price discrimination

\text{Example Prices: } £3.00, £4.00, £2.00

Price Discrimination

• Charging different prices to different groups of buyers when the price differences are not justified by cost differences.
• Common in the United States.
• Function of price elasticities.
• Examples: restaurants, movies, airlines, coupons, student and senior citizen discounts.

Forces That Decrease Market Power

• Technological change
• Antitrust activity
• Deregulation of unwisely regulated sectors
• Import competition

1. Technological Change

• Economies of scale are often eroded by technological advancements.
• Examples: Phone industry, railroads.

2. The U.S. Antitrust System

• Designed to combat market power.

• Trust: A combination of corporations having a monopoly or near-monopoly.

• Examples of antitrust laws:

  • Sherman Act (1890)

  • Clayton Act (1914)

  • Celler-Kefauver Act (1950)

  • Principal agencies administering antitrust laws: Antitrust Division of the Justice Department and Federal Trade Commission (FTC).

  • Presidential administrations:

    • Reagan, Bush II: very little antitrust activity.
    • Bush I, Clinton, Obama: somewhat more active.

  • Examples of antitrust cases:

    • Ticketmaster (1993)
    • McDonnell Douglas and Boeing (1997)
    • Sprint and WorldCom (2000)
    • Microsoft (2000)

3. Regulation and Deregulation

• Natural monopolies with substantial economies of scale are generally regulated (e.g., PECO).
• Regulation covers rates charged and service levels.
• Problems arise when public utility-type regulation is applied to industries that are not natural monopolies (e.g., trucking).
• Regulation can shield firms from competition, causing inefficiency (e.g., railroads).
• Deregulation involves reducing regulatory restrictions.

4. Import Competition

• Protecting market power in concentrated industries leads to lower output, lower employment, and higher consumer prices.

Google Antitrust Lawsuit (October 2020)

• The Justice Department filed an antitrust lawsuit alleging that Google uses anticompetitive tactics to maintain a monopoly over its search engine and related advertising business.
• Google owns or controls search distribution channels accounting for about 80% of search queries in the U.S.
• The government argues that this limits competition, reduces consumer choice and innovation, and results in less competitive prices for advertisers.

Google's Search Engine Market Share (August 2020)

• Google dominates the search market across platforms, especially in mobile.
  • Desktop: Google dominates
  • Tablet: Google dominates
  • Mobile: Google dominates

Facebook Antitrust Actions (December 2020)

• The Federal Trade Commission and over 40 states accused Facebook of illegally acquiring rivals to stifle competition.
• They called for the company to break off Instagram and WhatsApp.
• Proposed new restrictions on Facebook's future deals.

Amazon Antitrust Lawsuit (May 2021)

• The attorney general for the District of Columbia sued Amazon for allegedly crushing competition.
• Independent merchants claim Amazon punishes them for listing products for less on their own websites or other sites.
• Legal experts believe these lawsuits (against Google, Facebook, and Amazon) will be lengthy and that the companies have a strong legal advantage.