ECON 14

Market Structure and Degrees of Market Power

• Chapter Objective: Learn how to set prices when you have market power.

  • 14.1 Beyond Perfect Competition: Monopoly, Oligopoly, and Monopolistic Competition

    • Evaluate how market structure shapes market power.

  • 14.2 Setting Prices with Market Power

    • Calculate optimal pricing with market power.

  • 14.3 The Problem with Market Power

    • Analyze how market power distorts market forces.

  • 14.4 Public Policy to Restrain Market Power

    • Assess policies to mitigate market power issues.

The Story of Apple

• Founded by Steve Wozniak and Steve Jobs in a garage, Apple became the first company to exceed $1 trillion in valuation.

• Key Factors of Apple's Success:

  • Obsessive Perfectionism of Steve Jobs.

  • Understanding of Economics: Strategic focus on dominating markets rather than competing directly.

  • Example: The iPhone launched the smartphone market, leading to reduced competition and higher profit margins.

• Conclusion: Much of Apple's success derived from its market power in specific product categories.

Understanding Market Structure

• The chapter focuses on how market structure influences pricing strategies.

• Key Questions for Business Strategy:

  • Number of competitors: many vs few.

  • Anticipating new entrants into the industry.

  • Degree of product differentiation.

• Market Structure Importance:

  • Determines market power: Ability to raise prices without losing many sales.

  • Example: A lone gas station in a town has higher market power versus one of four at an intersection.

Perfect Competition

• Definition: Many competitors selling identical goods.

• Characteristics:

  • Price takers: Sellers cannot influence the market price; raising prices means losing all customers.

  • Examples include agricultural markets, commodities markets, and stock markets.

• Outcome: Businesses in perfect competition have zero market power and must follow market prices.

Monopoly vs. Oligopoly vs. Monopolistic Competition

• Monopoly:

  • A single seller dominates the market (e.g., YKK zippers);

    • Market Power: Significant, as no direct competition exists.

• Oligopoly:

  • Few large firms dominate (e.g., Verizon, AT&T, T-Mobile);

    • Strategic Interdependence: Firms must consider rivals' actions in their decision-making.

• Monopolistic Competition:

  • Many firms sell similar but differentiated products (e.g., jeans);

    • Product Differentiation: Allows businesses to gain market power and increase prices.

Market Structure Implications

• Spectrum of Market Power: From perfect competition to monopoly, illustrating varying degrees of market power.

• Imperfect Competition: Most markets lie in between perfect competition and monopoly; businesses face some competition but have market power.

Strategies in Imperfectly Competitive Markets

• Insight 1: More competitors reduce market power;

• Insight 2: Market power enables independent pricing strategies;

• Insight 3: Successful product differentiation increases market power;

• Insight 4: Buyer negotiations can give them pricing leverage;

• Insight 5: Business decisions are interdependent in strategic contexts.

Setting Prices with Market Power

• Learning Objective: Calculate the best price in relation to market power.

• Price-Setting Decisions:

  • Balancing volume versus profit margin is crucial.

• Firm Demand Curve: Shows how quantity demanded changes with price.

• Marginal Revenue Curve: Measures additional revenue from selling one more unit, highlighting the trade-off between quantity sold and price.

Calculating Marginal Revenue

• Marginal Revenue Formula: Difference between output effect and discount effect.

• Example of Sofia’s Car Sales: Selling price changes and their effect on quantity sold.

The Rational Rule for Sellers

• Key Principle: Sell an additional unit if marginal revenue equals marginal cost.

• Use the demand curve to find optimal pricing based on quantity produced.

Problems with Market Power

• Economic Crisis Example: High AIDS drug pricing highlights market power issues; solutions involve improving affordability through reduced pricing powers.

  • Market Outcomes Examination: Market power leads to high prices and inefficiently low quantities produced.

Public Policy to Restrain Market Power

• Government Interventions Include:

  • Anti-collusion laws.

  • Merger regulations.

  • Encouraging international trade to increase competition.

  • Price ceilings to protect consumers from monopolist pricing.

Conclusion on Market Power

• Market power leads to inefficiencies and pricing issues; understanding market structure is vital for effective business strategy.

• Realizing the complexity of market mechanisms guides strategies for market stability and consumer benefit.