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Econ 6.2

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Sharna Johnson

on 11 March 2013

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Transcript of Econ 6.2

Oligopolies The most common noncompetitive market in the U.S. is the Oligopoly – a market structure in which a few large sellers control most of the production of a good or service. In general, an oligopoly exists when three conditions are present:

1. There are only a few large sellers
2. Sellers offer identical or similar products
3. Other sellers cannot enter the market easily. Oligopolies at Work Imperfectly Competitive Markets The few sellers in an oligopolistic market have more control over prices than do the many sellers in a monopolistically competitive one. This control stems mainly from legal methods of determining prices. Sometimes, however, oligopolies try to control prices through illegal means. Monopolies Because a monopoly’s market structures dictate that a single seller controls all production of a good or service, the conditions found in a monopoly are the opposite of those found in perfect competition. In general, a monopoly exists when three conditions are present:
1. There is a single seller.
2. No close substitute goods are available.
3. Other sellers cannot enter the market easily. Some monopolies develop when a producer develops new technology that enables the creation of a new product or that changes the way an existing product is made. Sellers may protect their inventions or technology they develop by applying to the U.S. government for patents. Patents grant a company or an individual the exclusive right to produce, use, rent, and sell an invention or discovery for a limited time—20 years in the United States.

Written works and works or art are protected in much the same way. By granting copyrights, the U.S. government gives authors, musicians, and artist’s exclusive rights to publish, duplicate, perform, display, and sell their creative works. Natural Monopolies Government Monopolies Governments often run monopolies, usually of basic necessities like public utilities. Any market in which a government is the sole seller of a product is a government monopoly. They provide public goods that cannot always be supplied through the normal workings of the price system. Types of Monopolies Certain conditions make it likely and sometime even advantageous for consumers that a monopoly will form in a particular market. There are four main types of monopolies: natural, geographic, technological, and government. Each of these forms under different conditions. Geographic Monopolies Sometime a monopoly forms because a market’s potential profit is so limited by its geographic location that only a single seller decides to enter the market. The number of these monopolies has decreased in recent years, one reason is that people have become increasingly mobile, they can travel longer distances to shop. This means that even in rural areas more sellers can reach more buyers than ever before. Monopolies at Work The single seller in a monopolistic market has a great deal of control over prices. But sellers in a monopoly cannot just charge any price it wants. Three forces limit the seller’s control over prices: consumer demand, potential competition, and government regulation.

1. Consumer Demand – At some point, the price of a product can become so high that the quantity demanded falls to zero.

2. Potential Competition - High profits may attract other provider to a market, whereas high entry costs had kept competitors out at lower levels.

3. Government Regulation – To protect consumers from paying unnecessarily high prices, governments monitor and regulate monopolies. This regulation watches over quantity, quality, and price of products. Identical or Similar Products Few Large Sellers Difficult Market Entry The existence of a few large sellers is the defining characteristic of an oligopoly. No other market structure has this feature. A market is considered a oligopoly when the largest three or four sellers produce most (70% or more) of the market’s total output. When there are a few large sellers, each one has a large share of the overall sales in the market. Because the sellers have so much at stake, they are less likely to take risks, such as offering new products. If a seller introduced a new product that failed, for example, that seller's share of the market – and its profits – likely would drop significantly. Thus, sellers in an oligopoly tend to offer identical or similar products. A few sellers can maintain their control only if the other sellers cannot easily enter the market. The relative difficulty of entering an oligopolistic market depends on start up costs, government regulation about entering the market and consumer loyalty to the established sellers’ products. If any of these factors is insignificant enough, other sellers can enter the market, compete with the original few sellers, and end those sellers oligopoly. Nonprice Competition Interdependent Pricing Price Leadership Price War Price War Collusion Cartels Like sellers in monopolistic competition, sellers in an oligopoly control prices somewhat through nonprice competition. That is, oligopolistic sellers attempt to differentiate their products through advertising and by encouraging consumers to develop loyalty and by encouraging consumers to develop loyalty to particular brand names. Nonprice competition can become fierce among sellers in an oligopoly. The market is actually an oligopoly in which a few companies differentiate their products by creating numerous brand names. Sellers in an oligopoly also maintain a degree of control over price through interdependent pricing, or by being very responsive to – or dependent on – the pricing the actions of their competitors. Interdependent pricing is particularly common in oligopolies because sellers are reluctant to risk their markets share – causing them to not only offer similar products but also offer them at similar prices. The most common form of interdependent pricing is price leadership, in which one of the largest sellers in the market takes the lead by setting a price for its product. If competitors also institute that price, the market leader has in effect controlled the price of all products. If the competing companies do not follow the leader, the price leader then has not affected the price of its product. In fact, it may be forced to change its price again to be competitive with the other sellers’ prices. A failed pricing policy may spark a price war, in which sellers aggressively undercut each other’s prices in an attempt to gain market share. Price wars can initially benefit consumers by lowering prices. If this level of competition lasts a long time, a seller may lose so much money that it is forced out of business. When a price war ends, prices tend to rise again as oligopolistic sellers return to price leadership and nonprice competition. If one or more sellers have gone out of business, prices may rise even higher than before the price war because of reduced competition. Nonprice competition and price leadership are legal methods of determining prices. On the other hand, collusion – when sellers secretly agree to set production levels or prices for their products – is legal and carries heavy penalties. Collusion tends to raise prices higher than they would be under the competitive forces of supply and demand. In other cases, sellers form a cartel, in which companies openly organize a system of prices setting and market sharing. Cartels are illegal in the U.S. because they fix prices. Many other countries allow the formation of cartels. Cartels are often short-lived and unstable. Members may be tempted to produce more than they’re agreed upon market share in order to earn more profits. Some cartels have maintained power over their markets for generations. Single Seller No Close Substitutes Difficult Market Entry A monopoly is identifiable by the presence of only one seller. No other market structure has this feature. By establishing total control of the production of a good or service, the single seller can monopolize the market. A lack of close substitute goods reinforces a single seller’s monopoly over the market. A substitute good is one that consumers will use to replace the purchase of a similar but higher-priced good. For a single seller to maintain a monopoly, other sellers must not be able to easily enter the market. The difficulty of entering a monopolistic market depends on start-up costs and the level of technical knowledge needed. If either of these factors is low enough, other sellers can enter the market, compete with the original seller, and end that seller’s monopoly. The development of monopolies is made more difficult by government regulation. In some markets, competition is inconvenient and impractical. These natural monopolies feature a single large seller that produces a good or service most efficiently. Usually this seller can do so because of its economies of scale. That is, the seller’s large scale, or size, allows it to use its human, capital, and other resources more efficiently and economically than if those resources were divided among several smaller producers. Public and private utilities, like electric companies and cable television services, are natural monopolies.

As a result, governments give utilities and other natural monopolies the exclusive right to provide certain goods or services in a specific area. The government closely regulates these monopolies to ensure that they provide quality service at reasonable prices. Technological Monopolies
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