PERFECT COMPETITION

7.1

Objectives1. Describe the four conditions that are in

place in a perfectly competitive market.2. List two common barriers that prevent

firms from entering a market.3. Describe prices and output in a perfectly

competitive market.

Perfect Competition- a market structure in which a large number of firms all produce the same product.

I. Four Conditions for Perfect Competition

A. Many Buyers and Sellers

B. Identical Products- there are no differences between the products sold by different suppliers

i. Commodity- a product that is the same no matter who produces it, such as petroleum, notebook paper, or milk

C. Informed Buyers and Sellers- know enough about the market to find the best deal

D. Free Market Entry and Exiti. Firms must be able to enter markets

when they will make money and exit them when they will lose money

II. Barriers to EntryImperfect Competition- a market structure that does not meet

the conditions of perfect competition

A. Start-Up Costs- the expenses a firm must pay before it can begin to produce and sell goods

B. Technologyi. Some markets require a high degree of

technological know how

III. Price and OutputA. Efficiency is the primary

characteristic of perfect competitioni. Prices correctly represent the

opportunity cost of the productii. Prices are the lowest sustainable price

possible

MONOPOLY

Objectives1. Describe characteristics and give

examples of monopoly.2. Describe how monopolies are formed,

including government monopolies.3. Explain how a firm with a monopoly sets

output and price, and why companies practice price discrimination.

I. Monopoly- a market dominated by a single seller

II. Forming a MonopolyA. Economies of Scale- factors that cause a

producer’s average cost per unit to fall as output rises

i. Limited economies of scale- output will eventually rise as production rises

ii. An industry that enjoys economies of scale can easily become a natural monopoly

B. Natural Monopolies- a market that runs most efficiently when one large firm supplies all of the output

i. Utilities

C. Technology and Changei. Technology can cut fixed costs and make

small companies as efficient as one large firm

III. Government MonopoliesA. Patents- license that gives the inventor of a

new product the exclusive right to sell it for a certain period of time

B. Franchises and Licensesi. Franchise- the right to sell a good or

service within an exclusive marketii. License- a govt issued right to operate a

business

C. Industrial Organizationsi. The govt allows MLB and other sports

organizations to restrict entry of teams

IV. Output DecisionsA. The Monopoly’s Dilemma

i. Monopoly still limited by the demand curve for the product

B.Falling Marginal Revenuei. Marginal revenue is lower than the price

when the firm can control the price and cut it to sell more

V. Price DiscriminationA.Market power- the ability of a company to

change prices and output like a monopolist

C. Targeted Discounts- Companies divide consumers into large groups and design pricing policies for each group

i. Rebatesii. Senior citizen and studentsiii. Free for children

D. Limits of Price DiscriminationA. Some market powerB. Distinct customer groupsC. Difficult resale

Monopolistic Competition

Objectives1. Describe characteristics and give

examples of monopolistic competition.2. Explain how firms compete without

lowering prices.3. Understand how firms in a

monopolistically competitive market set output.

4. Describe characteristics and give examples of oligopoly.

I. Monopolistic CompetitionA. a market structure in which many companies

sell products that are similar but not identical.

i. Examples: gas station, retail store

II. Four Conditions of Monopolistic Competition

A. Many Firms- w/ a small investment, firms can begin to sell a product

B. Few artificial Barriers to entryC. Slight Control over priceD. Differentiated Products

i. differentiation

III. Nonprice Competition- A way to attract customers through style, service, or location, but not a lower price

A. Physical Characteristics

B. Location- some goods can be differentiated by where they are sold

C. Service Level- higher prices can be charged if a firm offers a high level of service

D. Advertising, image, or statusi. Advertising creates more of a perceived difference

rather than a real one

IV. Price, Output, and ProfitsA. Prices and output will be higher than in

perfectly comp. markets but lower than monopolies

B. Profit is kept down by competition w/ other firms and the ease of entry into the market

V. Oligopoly- a market structure in which a few large firms dominate the market

A. Barriers to Entry

B. Cooperation and Collusioni. Price Leadership- w/o actually ‘cooperating’ to raise

prices, firms will make it well known that they are going to raise prices and hope that others do as well

ii. Collusion- an agreement among firms to divide the market, set prices, or limit production1. Price fixing- agreement to charge one price for the same

good

C. Cartels- a formal organization of producers that agree to coordinate prices and production