Chapter 8 | Pricing Power: Monopoly to Competition and In Between Flashcards
Businesses aim for monopoly’s economic profits and price-making power. Competitors usually push businesses toward the normal profits and price taking of perfect competition.
Businesses aim for monopoly’s economic profits and price-making power. Competitors usually push businesses toward the normal profits and price taking of perfect competition.
Monopoly
— only seller of a product or service; no close substitutes are available.
– demand curve is steep and inelastic
Market power
— business’s ability to set prices.
Price maker
— monopoly with maximum power to set prices.
Businesses can set any price they choose, but cannot force consumers to buy. Even monopoly price makers must live by law of demand.
Businesses can set any price they choose, but cannot force consumers to buy. Even monopoly price makers must live by law of demand.
Perfect competition
— many sellers producing identical products or services.
– demand curve is horizontal and perfectly elastic at the market price
Price taker
— business with zero power to set prices.
How Much Competition Is Going on? Market Structure
Pricing power depends on the competitiveness of a business’s market structure — available substitutes, number of competitors, barriers to the entry of new competitors — and on elasticity of demand.
Market structure
— characteristics that affect competition and a business’s pricing power:
– available substitutes
– number of competitors
– barriers to entry of new competitors
Broader definition of market
= more substitutes and competitors = more elastic demand = less pricing power.
Narrower definition of market
= more inelastic demand = more pricing power.
Product differentiation
— attempt to distinguish product or service from those of competitors:
– allows seller to reduce competition and substitutes and increase pricing power
– can take the form of actual differences or perceived differences
Pricing power and number of competitors
– fewer competitors = more price power
– more competitors = less price power
Barriers to entry
— legal or economic barriers preventing new competitors from entering a market.
Patents and copyrights
are legal barriers — exclusive property rights to sell or license creations, protecting against competition.
– give businesses short-term monopoly power as an incentive for invention, but eventually expire to give consumers reasonably priced products and services
Economies of scale
are economic barriers — average total cost of producing decreases as quantity (scale) of production increases.
Average Total Cost
= Total cost per unit of output
Higher pricing power
= more inelastic demand
– consumers have few substitutes or strong brand loyalty
Lower pricing power
= more elastic demand
– consumers have many substitutes or no brand loyalty
Oligopoly
— few big sellers control most of the market.
Monopolistic competition
— many small businesses make similar but slightly differentiated products or services.
n moving across the continuum of market structures from monopoly to perfect competition:
– pricing power moves from price maker to price taker
– available substitutes go from none to many
– number of sellers goes from one to many, many
– entry barriers go from high to low
– elasticity of demand goes from low/inelastic to high/elastic
Competition
— active attempt to increase profits and gain the market power of monopoly.
– cutting costs
– improving quality and product innovation
– advertising and brand loyalty
– eliminating competition
– building barriers to entry
While a market economy provides extraordinary economic freedom
– to make business decisions, to invest and spend as we please, to choose our occupations — as sellers who depend on markets to earn a living we must play by the market’s competitive rules.
