Chapter 14: Market Structure and Degrees of Market Power

Chapter 14: Market Structure and Degrees of Market Power

1. Overview of Market Structures

  • Beyond Perfect Competition: Discusses monopoly, oligopoly, and monopolistic competition.

  • Price Setting: When a business has market power, it can set prices strategically.

  • Problems Arising from Market Power: Addresses negative outcomes linked to the lack of competition.

  • Public Policy Solutions: Discusses government interventions to regulate market power and promote competition.

2. Evaluating Market Structures

  • Four Basic Market Structures:

    • Perfect Competition

    • Monopolistic Competition

    • Oligopoly

    • Monopoly

  • Influence of Market Structure on Business Power:

    • Shapes the market power of a business.

    • Market structure determines the strategic positioning, pricing, and output decisions of a business.

    • Key Considerations:

    • Number of competitors and potential new entrants.

    • Product differentiation versus commodification (i.e., identical products).

3. Defining Market Power

  • Market Power:

    • Definition: The extent to which a seller can charge a higher price without losing many sales to competing businesses.

    • Informative for pricing strategies.

  • Diving into the Definition:

    • Scenario 1: You are the only gas station; thus, you have substantial market power. A price increase leads to minimal loss of customers due to distance to competitors.

    • Scenario 2: As one of four gas stations, raising prices slightly will drive customers to competitors, indicating low market power.

4. Exploring Different Market Structures

  • Characteristics of Each Market Structure:

    • Perfect Competition:

    • Features:

      • Identical goods.

      • Many buyers and sellers; each small in relation to the market.

    • Implication: Zero market power; price-taker behavior is mandatory.

    • Examples:

    • Agricultural markets (corn).

    • Commodities (gold, oil).

    • Stock markets (uniform shares of companies).

    • Note: Perfect competition is rare due to product differentiation in most markets.

    • Monopoly:

    • Definition: A market with only one seller.

    • Result: High market power; NOT a price-taker — can raise prices without losing customers.

    • Example: De Beers once controlled 85% of the diamond market but faced competition from other gemstones, necessitating wise pricing despite its monopoly status.

    • Oligopoly:

    • Definition: A few large sellers dominate the market.

    • Products may vary but also can be similar.

    • Result: Substantial market power; strategic interaction amongst sellers is critical in pricing strategy.

    • Example: Major cellular service providers (AT&T, Verizon, T-Mobile) operate with large market shares, influencing pricing decisions based on competitors' actions.

    • Monopolistic Competition:

    • Definition: Many small businesses compete with differentiated products.

    • Differentiation can occur based on quality, branding, or service.

    • Result: Higher product differentiation yields more market power.

    • Examples: Varieties of apples and styles of jeans (differentiated by cut/brand).

5. Spectrum of Market Power

  • Imperfect Competition:

    • Characterized by limited competitors and/or differentiated products.

    • Firms typically operate here, presenting 'some market power.'

6. Key Insights into Imperfect Competition

  • Insights:

    1. More competitors = less market power.

    2. Market power facilitates independent pricing strategies.

    3. Effective product differentiation enhances market power.

    4. Buyers possess bargaining power in imperfect competition settings.

    5. Interdependent decisions among firms can amplify competitive dynamics.

7. Takeaways: Market Structure and Market Power

  • Perfect Competition: No market power.

  • Monopolistic Competition: Some market power.

  • Oligopoly: Some market power.

  • Monopoly: Most market power.

  • Focus on Market Power:

    • Ability to charge higher prices without significant loss of customer base.

8. Price Setting with Market Power

  • Firm Demand Curve:

    • Illustrates quantity demanded by customers based on varied pricing from the individual business.

    • Distinct from market demand curve (entire market's quantity demand) and individual's demand curve (demand from one buyer).

  • Elasticity:

    • Low market power = flat demand curve (highly elastic);

    • Some market power = steeper demand curve (less elastic).

9. Marginal Revenue Calculation

  • Marginal Revenue:

    • Definition: The additional revenue from selling one more unit.

    • Formula for Marginal Revenue:
      MR = ext{Price on extra item} - ext{Discount effect}

    • The Balancing Act: Price reductions for extra sales can simultaneously lower revenue if overall prices change.

10. Summarizing Insights about Demand

  • Insights on firm demand curve and marginal revenue placement with respect to price setting.

  • Strategic decisions on quantity produced relate to marginal revenue and average cost structures.

11. Market Power Distortion

  • Negative Implications of Market Power:

    • High prices, decreased supply, increased profits.

    • Inefficiencies result when market power supersedes competitive structures.

  • Historical Cases: Drug pricing crisis as a case for how monopolistic practices can exploit consumer needs.

12. Government Response to Market Power

  • Regulatory Framework:

    • Competition Policy: Designed to sustain market competition; encompasses rules against collusion, monitoring mergers, and encouraging trade.

    • Example: Mergers blocked for competitive thresholds – AT&T-T-Mobile, etc.

  • Policies to Minimize Market Power Abuse:

    • Implement price ceilings to curb excessive pricing from monopolies.

    • Regulations addressing natural monopolies aimed at fostering equitable market conditions.

13. Conclusion

  • Recap of the key points from the chapter focusing on market structure's direct impact on market power, pricing abilities, and necessary regulatory frameworks to balance market actions for societal benefit.