• Sellers set the majority of prices, buyers set most of the rest, and a few are set by negotiations.

  • Sometimes governments decree maximum or minimum prices.

• How much freedom do sellers and buyers have when they set their prices?

• Market transactions are an activity.

• Because scarcity is a logical condition, not a material one, we must choose.

  • In making our choices, we ration or prioritize. We compete.

Who qualifies as a monopolist?

• Monopoly literally means "one seller".

  • But it is a very ambiguous word.

• If we define a commodity broadly enough, not a single commodity is sold by a monopolist.

  • Ex: the telephone company never was a monopolist, but a seller in competition with the post office.

• When the commodity is defined narrowly enough, every seller is a monopolist.

  • Ex: McDonald's is the only one that sells the Big Mac.

Alternatives, Elasticity, and Market Power

• If we find a case where there really is only one seller of a good, then those with a demand for the good will have no alternatives.

  • Then we would have no negotiating power.

  • But there are always some alternatives.

• No seller is a monopolist in the strictest sense of the word because there is no such thing as a perfectly inelastic demand.

Privileges and restrictions

• In the early nineteenth century, there was often no distinction between a monopoly and a corporation.

  • Corporations had been created by special government acts.

  • They received special patents with rights and privileges that others didn't have.

• If the state allows some to engage in an activity but prosecutes others for doing so, it is creating exclusive privileges.

  • They are created in the name of commendable-sounding goals.

  • They impose restrictions on entry and exit on various industries, and they benefit only the party that can escape them.

• We can use the word monopolist to describe an organization operating with the advantage of special privileges granted by the government.

  • But most people no longer use the word this way.

Price takers and price searchers

• Who actually sets the price and how much freedom do they have?

• Price taker: a seller that cannot affect the price by his own actions.

  • The price at the local market is determined by the actions of many buyers and sellers all over the country.

  • They face perfectly elastic demand curves.

  • Ex: wheat.

• Price searcher: a seller that must choose a price.

  • They can't always sell everything they're capable of producing without lowering their prices.

Price takers' markets and optimal resource allocation

• Economists applied the disapproving term monopolist to price searchers because they wanted to emphasize the different consequences of these two types of price setting.

• Competitive markets: markets in which all buyers and sellers were price takers.

• Optimal allocation of resources: no unit of the good is being produced whose marginal opportunity cost exceeds its marginal benefit. And every unit of the good whose marginal benefit exceeds its marginal cost is being produced.

• When government place regulations, this optimal allocation can't be reached.

  • There will be waste or scarcity.

Competition as a process

• When we use the term competition we mean it to refer to an activity that individuals engage in.

• Characteristics of perfect competition:

  • There is a large number of buyers and sellers so nobody possesses market power.

  • Market participants possess full and complete information of alternatives.

  • Sellers produce a homogenous product.

  • There is costless mobility of resources.

  • Economic actors are price takers.

• But this model has made two mistakes:

  • It has overlooked the entrepreneur, which is the driving force of real-world markets.

  • It also ignores the plan-adjustment process that characterizes real-world market activity.

    • A functioning market economy provides information for the coordination of plans, but in perfect competition this task is done perfectly, so that no further gains from trade exist.

    • A profit opportunity known to all will be realized by none.

      • Ex: shopping lines at a supermarket.

• This model is only used to explain basic supply and demand.

• The model of perfect competition tends to obscure the active process by which results tend to emerge.

Summary

• The word monopoly means literally one seller. But whether any seller is the only seller depends on how narrowly or broadly we define the product. Under a sufficiently broad definition, there are innumerable sellers of every product. Under a sufficiently narrow definition, however, every seller's product differs from every other's, and all sellers are monopolists. The word monopoly is therefore inherently ambiguous and will not be used in subsequent chapters.

• The antisocial connotations of the word monopoly stem from the belief that the consumers of a sole seller have no alternatives and are therefore at the mercy of the seller. Because there are in fact alternatives to every course of action and substitutes for every good, no seller ever has unlimited power over buyers. Market power is always a matter of degree.

• The concept of price elasticity of demand provides a useful way of thinking and talking about the degree of market power. Demand elasticities, which can vary between zero and infinity, reflect the availability of substitutes. The more good alternatives buyers have, the more elastic are the demand curves sellers face and the more limited is the power of sellers to establish terms of sale strongly advantageous to themselves.

• In the early years of the USA, a monopoly usually meant an organization to which the government had granted some exclusive privilege. The monopolist was often the only legal seller. Although this meaning of the term is no longer common, it does have contemporary relevance because federal, state, and local governments are extensively involved in the granting of special privileges that restrict competition.

• A useful distinction to make in trying to understand how prices are established is the distinction between price takers and searchers. Price takers must accept the price decreed by the market. Buyers have such excellent substitutes for the product that any attempt to raise the price or otherwise shift the terms of sale will leave the seller with no customers at all. The price searchers, on the other hand, can sell different quantities at different prices and must therefore search for the most advantageous price.