Economics Chapter 7 - Market Structures PDF

CHAPTER 7 Market Structures S ECTION 1 CONCEPT REVIEW What Is Perfect Competition involves all the actions that sellers, acting Competition? independently, take to get buyers to purchase their products. S ECTION 2 CHAPTER 7 KEY CONCEPT The Impa...

CHAPTER 7 Market Structures S ECTION 1 CONCEPT REVIEW What Is Perfect Competition involves all the actions that sellers, acting Competition? independently, take to get buyers to purchase their products. S ECTION 2 CHAPTER 7 KEY CONCEPT The Impact of A market structure is an economic model that helps economists Monopoly examine the nature and degree of competition among businesses in the same industry. S ECTION 3 W H Y T H E C O N C E P T M AT T E R S Other Market Structures On trips to the mall, you’ve probably noticed something about the prices of products you’re looking to buy. If there are several different brands of the same kind of product, prices tend to be S ECTION 4 lower. If there’s just one brand, however, prices tend to be higher. Regulation and The level of competition in a market has a major impact on the Deregulation Today prices of products. The more sellers compete for your dollars, the more competitive prices will be. C ASE STUDY Competition in Gadgets and Gizmos More at ClassZone.com Go to ECONOMICS UPDATE for chapter updates and current news on competition in the cellular telephone industry. (See Case Study, pp. 220–221.) Go to SMART GRAPHER to complete graphing activities in this chapter. How do cellular phone makers Go to INTERACTIVE REVIEW for compete for your business? See the concept review and activities. Case Study on pages 220–221. Market Structures 191  SECTION What Is Perfect Competition? 1 OBJECTIVES KEY TERMS TA K I N G N O T E S In Section 1, you will market structure, p. 192 As you read Section 1, complete learn that perfect competition perfect competition, p. 192 a cluster diagram to identify the is the ideal by which major characteristics of perfect standardized product, p. 192 competition. Use the Graphic economists measure all market price taker, p. 193 Organizer at Interactive Review structures imperfect competition, p. 195 @ ClassZone.com explain the characteristics of perfect competition and why it Perfect competition is the ideal does not exist in the real world model of a market economy. analyze examples of markets Perfect Competition that come close to perfect competition The Characteristics of Perfect Competition KE Y CON CE P T S When you buy new clothes, you probably shop around for the best deal. But when you buy milk, you know that a gallon will be about the same price no matter where QUICK REFERENCE you shop. The market for clothes has a different level of competition than the market A market structure for milk. Economists classify markets based on how competitive they are. A market is an economic model structure is an economic model that allows economists to examine competition among of competition among businesses in the same industry. businesses in the same industry. Perfect competition is the ideal model of a market economy. It is useful as a model, but real markets are never perfect. Economists assess how competitive a market is by Perfect competition is the ideal model of a determining where it falls short of perfect competition. Perfect competition has five market economy. characteristics. A standardized 1. Numerous buyers and sellers. No one seller or buyer has control over price. product is one that con- 2. Standardized product. Sellers offer a standardized product—a product that sumers see as identical regardless of producer. consumers consider identical in all essential features to other products in the same market. rice, fruit, ect. 3. Freedom to enter and exit markets. Buyers and sellers are free to enter and exit the market. No government regulations or other restrictions prevent a business or customer from participating in the market. Nor is a business or customer required to participate in the market. 4. Independent buyers and sellers. Buyers cannot join other buyers and sellers cannot join other sellers to influence prices. 192 Chapter 7 5. Well-informed buyers and sellers. Both buyers and sellers are well-informed about market conditions. Buyers can do comparison shopping, and sellers can learn what their competitors are charging. QUICK REFERENCE When these five conditions are met, sellers become price takers. A price taker is A price taker is a a business that cannot set the prices for its products but, instead, accepts the market business that accepts the market price determined price set by the interaction of supply and demand. Only efficient producers make by supply and demand. enough money to serve perfectly competitive markets. C HAR ACT E RIS T IC 1 Many Buyers and Sellers A large number of buyers and sellers is necessary for perfect competition so that no one buyer or seller has the power to control the price in the market. When there are many sellers, buyers can choose to buy from a different producer if one tries to raise prices above the market level. But because there are many buyers, sellers are able to sell their products at the market price. Let’s consider the Smith family, whom you met in Chapter 5. The Smiths grow raspberries in the summer to sell at the Mont- clair Farmers’ Market. Because many farmers grow and sell rasp- berries at the same market, all of the farmers charge about the same price. If one farmer tries to charge more than the market price for raspberries, consumers will buy from the other farm- ers. Because there are many buyers—in other words, sufficient demand—the Smiths and other producers know that they can sell their product at the market price. Lack of demand will not cause them to lower their prices. C HAR ACT E RIS T IC 2 Standardized Product In perfect competition, consumers consider one producer’s product essentially the same as the product offered by another. The products are perfect substitutes. Agricultural products such as wheat, eggs, and milk, as well as other basic commodities such as notebook paper or gold generally meet this criterion. Considering the Montclair Farmers’ Market, while no two Perfect Competition pints of raspberries are exactly alike, they are similar enough that consumers will Farmers’ markets exhibit choose to buy from any producer that offers raspberries at the market price. Price many of the characteristics of becomes the only basis for a consumer to choose one producer over another. perfect competition. C HAR ACT E RIS T IC 3 Freedom to Enter and Exit Markets In a perfectly competitive market, producers are able to enter the market when it is profitable and to exit when it becomes unprofitable. They can do this because the Find an update about investment that a producer makes to enter a market is relatively low. Market forces perfect competition at ClassZone.com alone encourage producers to freely enter or leave a given market. The Smiths and other farmers consider the market price for raspberries when planning their crops. If they believe they can make a profit at that price, they grow raspberries. If not, they try some other crop. Market Structures 193  ECONOMICS ESSENTIALS F I G U R E 7.1 Characteristics of Perfect Competition Many Buyers and Standardized Products All Sellers A large products are essentially number of buyers the same. and sellers ensures that no one controls prices.  What Are the Characteristics of Perfect Well-informed Competition? Freedom to Enter Buyers and Sellers and Exit Markets Both buyers and Producers can enter sellers know the or exit the market market prices and with no interference. other conditions. Independent Buyers and Sellers Buyers and sellers do not band together to influence prices. ANALYZE CHARTS Imagine that you own a farm and that you have decided to sell raspberries at the Montclair Farmers’ Market. Construct your own diagram to show how the five characteristics of perfect competition will apply to your enterprise. CH A RA CT E RIS T IC 4 Independent Buyers and Sellers In a perfectly competitive market, neither buyers nor sellers join together to influ- ence price. When buyers and sellers act independently, the interaction of supply and demand sets the equilibrium price. Independent action ensures that the market will remain competitive. At the Montclair Farmers’ Market, the farmers do not band together to raise prices, nor do the consumers organize to negotiate lower prices. CH A RA CT E RIS T IC 5 Well-informed Buyers and Sellers Buyers and sellers in a perfectly competitive market have enough information to make good deals. Buyers can compare prices among different sellers, and sellers know what their competitors are charging and what price consumers are willing to pay. Buyers and sellers at the Montclair Farmers’ Market make informed choices about whether to buy or sell raspberries in that market. With all five characteristics met, the Smiths accept the market price for raspberries. All raspberry producers become price takers. A P P L ICAT ION Making Inferences A. Can you think of another market that comes close to perfect competition? Which of the characteristics does it lack? 194 Chapter 7 Competition in the Real World KE Y C ONCE P T S In the real world, there are no perfectly competitive markets because real markets QUICK REFERENCE do not have all of the characteristics of perfect competition. Market structures that Imperfect competi- lack one of the conditions needed for perfect competition are examples of imperfect tion occurs in markets competition. (You’ll learn more about imperfect competition in Sections 2 and 3.) that have few sellers or However, there are some markets—the wholesale markets for farm products such as products that are not corn and beef, for example—that come close to perfect competition. standardized. E XAM P L E 1 Corn In the United States, there are thousands of farmers who grow corn, and each one contributes only a small percentage of the total crop. Therefore, no one farmer can control the price of corn, and all farmers accept the market price. Individual farmers decide only how much corn to produce to offer for sale at that price. At the same time, there are a large number of buyers, and the price on the wholesale market is easy to determine. Corn is a fairly standardized product, and buyers usually have no reason to prefer one farmer’s corn to another’s. Buyers will not pay more than the market price. In reality, there are several reasons that imperfect competition occurs in the corn market. For one thing, the U.S. government pays subsidies to corn farmers to protect them from low corn prices. In addition, sometimes corn farmers band together to try to influence the price of corn in their favor, and corn buyers sometimes pursue the same strategy. Subsidies, group action, and other deviations from perfect competition interfere with the market forces of supply and demand. Close to Perfect E XAM P L E 2 Beef Competition Wholesale markets for The wholesale market for raw beef is another that comes close to perfect competi- agricultural products, such tion. There are many cattle producers, and there is little variation in a particular cut as corn, come close to of beef from one producer to the next. Because the beef is so similar, the wholesale perfect competition. buyer’s primary concern will be price. Both buyers and sellers can easily determine the market price, and producers sell all their beef at that price. Cattle sellers can adjust only their production to reflect the market price. As in the corn market, there are several reasons that imperfect competition occurs in the beef market. Cattle ranchers, like corn farmers, may try to join together to influ- ence the price of beef in their favor. In addition, many beef producers try to persuade buyers that there are significant differences in their products that warrant higher prices. For example, cattle that eat corn supposedly produce better tasting beef. AP P LIC AT ION Drawing Conclusions B. Why is the market for corn closer to perfect competition than the market for corn flakes? Market Structures 195  ECONOMICS For more information on creating and interpreting economic SKILLBUILDER models, see the Skillbuilder Handbook, page R16. Creating and Interpreting Economic Models Economic models help solve problems by focusing on a limited set of variables. A production costs and revenue schedule, which you learned about in Chapter 5, is a model that helps businesses decide how much to produce. Creating a graph as part of the model paints a picture of the data that makes it easier to understand. In this example, imagine you own a business that produces baseballs in a perfectly competitive market. The market price of a baseball is $1, but your costs vary depending on how many you produce. Follow the instructions to create a graph that will help you visualize the way a perfectly competitive market works. CREATING AN ECONOMIC MODEL OF BASEBALL PRODUCTION 1. Copy the graph below onto your own paper, or use @ ClassZone.com. 2. Using data from the table below, plot the curve showing the marginal costs of producing different numbers of baseballs. Label the curve “MC.” 3. Using data from the table below, plot the curve showing the marginal revenue of producing different numbers of baseballs. Label the curve “MR.” BASEBALL PRODUCTION COSTS AND REVENUES SCHEDULE Total Total Marginal Marginal Total Total Cost Revenue Profit Revenue Cost Produced (in dollars) (in dollars) (in dollars) (in dollars) (in dollars) 0 0.00 1.00 21.00 — — BA SEBALL PRODUC T I ON 1 1.00 2.00 21.00 1.00 1.00 2.25 2 2.00 2.80 20.80 1.00 0.80 Price per baseball (in dollars) 2.00 3 3.00 3.50 20.50 1.00 0.70 1.75 4 4.00 4.00 0.00 1.00 0.50 1.50 5 5.00 4.50 0.50 1.00 0.50 1.25 6 6.00 5.20 0.80 1.00 0.70 1.00 7 7.00 6.00 1.00 1.00 0.80 0.75 8 8.00 6.86 1.14 1.00 0.86 0.50 9 9.00 7.86 1.14 1.00 1.00 0.25 10 10.00 9.36 0.64 1.00 1.50 0 1 2 3 4 5 6 7 8 9 10 11 11 11.00 11.50 20.50 1.00 2.14 Quantity of baseballs T H IN K IN G E CON OMICA LLY Analyzing 1. How many baseballs should you produce each day to maximize profits? 2. Using the same graph, plot the demand curve for this perfectly competitive market. Remember that the market price will not change no matter how many baseballs are demanded. 3. How does the graph help explain the term “price takers”? 196 Chapter 7 SECTION 1 Assessment ClassZone.com REVIEWING KEY CONCEPTS E C O N O M I C S I N P R AC T I C E 1. Explain the differences between the terms in each of these pairs: a. market b. perfect competition market structure imperfect competition 2. Why are sellers in a perfectly competitive market known as price takers? 3. Why is it necessary to have standardized products in order to have perfect competition? 4. Why is independent action of buyers and sellers important to achieving perfect competition? 5. How is imperfect competition different from perfect competition? How competitive is the market for 6. Using Your Notes What are the five snowboards? characteristics of perfect competition? Perfect Refer to your completed cluster diagram. Competition Identifying Perfect Competition Perfectly competitive markets can be Use the Graphic Organizer at identified by specific characteristics. Interactive Review @ ClassZone.com The chart below lists these characteristics. CRITICAL THINKING Characteristics of Markets Perfect Competition Snowboards Hairbrushes 7. Drawing Conclusions Suppose that you went to a farmers’ Applesauce Paper clips Computer games market and found several different farmers selling cucumbers. Would you be likely to find a wide range of prices for cucumbers? Why or why not? Many buyers and sellers 8. Analyzing Effects What would happen to a wheat farmer who Standardized product tried to sell his wheat for $2.50 per bushel if the market price were $2.00 per bushel? Why? Freedom to enter and leave the market 9. Making Inferences Why are brand-name products not found Independent action in a perfectly competitive market? You will learn more about this Well-informed buyers topic in Section 3 of this chapter. and sellers Complete a Chart Five different 10. Challenge At an auction, sellers show their goods before an markets are shown in the chart. audience of buyers. The goods for sale may be similar to each other, On your own paper, complete the as in an auction of used cars, or they may be one-of-a-kind, as chart by marking which of the in an art auction. Buyers usually have an opportunity to inspect characteristics each market has. items prior to the auction. During the auction, buyers bid against one another to see who is willing to pay the highest price. In what Challenge Choose one market from ways is an auction similar to a perfectly competitive market? In the chart and explain what would what ways is it different? need to be done to make it perfectly competitive. Market Structures 197  SECTION The Impact of Monopoly 2 OBJECTIVES KEY TERMS TA K I N G N O T E S In Section 2, you will monopoly, p. 198 As you read Section 2, complete a describe the characteristics of cartel, p. 198 chart to show how different types a monopoly of monopolies exhibit the char- price maker, p. 198 acteristics of monopoly. Use the analyze four different types of barrier to entry, p. 198 Graphic Organizer at Interactive monopolies and discuss how natural monopoly, p. 201 Review @ ClassZone.com they come about government monopoly, p. 201 One Restricted Control explain how a monopoly sets Seller Market of Prices technological monopoly, p. 201 Natural its prices and production goals Monopoly geographic monopoly, p. 201 Government Monopoly economies of scale, p. 201 Technological Monopoly patent, p. 202 Geographic Monopoly Characteristics of a Monopoly KE Y CON CE P T S QUICK REFERENCE Perfect competition is the most competitive market structure. The least competitive is monopoly, a market structure in which only one seller sells a product for which Monopoly occurs when there are no close substitutes. The term monopoly may be used for either the market there is only one seller of a product that has no structure or the monopolistic business. Pure monopolies are as rare as perfect close substitutes. competition, but some businesses come close. For example, a cartel is a formal A cartel is a group that organization of sellers or producers that agree to act together to set prices and limit acts together to set prices output. In this way, a cartel may function as a monopoly. and limit output. Because a monopoly is the only seller of a product with no close substitutes, it A price maker is a becomes a price maker, a business that does not have to consider competitors when firm that does not have setting its prices. Consumers either accept the seller’s price or choose not to buy the to consider competitors product. Other firms may want to enter the market, but they often face a barrier when setting the prices to entry—something that hinders a business from entering a market. Large size, of its products. government regulations, or special resources or technology are all barriers to entry. A barrier to entry Let’s take a closer look at the three char- makes it hard for a new acteristics of monopoly through the De business to enter a market. Beers cartel, which held a virtual monopoly on the diamond market for most of the 20th century. At one time it controlled as much as 80 percent of the market in uncut dia- monds. De Beers used its monopoly power to control the price of diamonds and created barriers to entry that kept other firms from competing. 198 Chapter 7  ECONOMICS ESSENTIALS F I G U R E 7. 2 Characteristics of a Monopoly What Are the Characteristics of a Monopoly? ET MARK RESTRICTED Only One Seller Restricted, A single business Regulated Market controls the Government supply of a regulations or other product that Control of Prices barriers to entry has no close Monopolies act as price makers because keep other firms substitutes. they sell products that have no close out of the market. substitutes and they face no competition. ANALYZE CHARTS Imagine that you are a business person with unlimited funds. Could you gain a monopoly over the market for housing in your neighborhood? Using the chart, explain the steps you would need to take. How might your neighborhood change if one person controlled property prices? C HAR ACT E RIS T IC 1 Only One Seller In a monopoly, a single business is identified with the industry because it controls the supply of a product that has no close substitutes. For example, De Beers once produced more than half of the world’s diamond supply and bought up diamonds from smaller producers to resell. In this way, it controlled the market. C HAR ACT E RIS T IC 2 A Restricted, Regulated Market In some cases, government regulations allow a single firm to control a market, such as a local electric utility. In the case of De Beers, the company worked with the South African government to ensure that any new diamond mines were required to sell their diamonds through De Beers. The company also restricted access to the market for raw diamonds for producers outside of South Africa. By controlling the supply of diamonds, De Beers made it difficult for other producers to make a profit. C HAR ACT E RIS T IC 3 Control of Prices Monopolists can control prices because there are no close substitutes for their product and they have no competition. When economic downturns reduced demand for diamonds, De Beers created artificial shortages by withholding diamonds from the market. The reduced supply allowed the cartel to continue charging a higher price. AP P LIC AT ION Analyzing Effects A. What effect did the De Beers diamond monopoly have on the price of diamonds? Market Structures 199  A GLOBAL PERSPECTIVEPERSPECTIVE OPEC: Controlling the Oil Pipelines The Organization of the Petroleum Exporting FIGURE 7. 3 OPEC MEMBERS Countries (OPEC) does not have a monopoly on oil reserves or oil production. However, the 11 member nations of the cartel possess more than Joined Country Location two-thirds of the world’s oil reserves and produce OPEC about two-fifths of the world’s oil supply. By Algeria 1969 Africa regulating the amount of oil that flows through Indonesia 1962 Asia its pipelines, OPEC exerts control over the market Iran 1960 Middle East price for oil. Market forces often counteract OPEC’s supply Iraq 1960 Middle East adjustments. For example, in the early 1980s Kuwait 1960 Middle East demand for oil fell as consumers and businesses Libya 1962 Africa implemented strategies to reduce energy use. Despite OPEC’s efforts to reduce supply and Nigeria 1971 Africa stabilize the price, crude oil prices fell through Qatar 1961 Middle East most of the 1980s. Another factor that limits Saudi Arabia 1960 Middle East OPEC’s control over oil prices is member unity. Members sometimes choose not to follow OPEC United Arab Emirates 1967 Middle East moves to reduce oil output—because that would Venezuela 1960 South America reduce their revenues. Despite these limitations, Source: OPEC OPEC continues to play a major role in the world market for petroleum. F I G U R E 7. 4 OPEC Member Nations ARCTIC IRAQ I RAN OCEAN KUWAIT UNITED ARAB Pe Neutral ia EMIRATES rs Zone n Gu lf QATAR ATLANTIC SAUDI ARABI A IRAQ I R A N OCEAN KUWAIT ALGERIA LIBYA QATAR SAUDI ARABIA U.A.E. PA C I F I C VENEZUELA NIGERIA OCEAN PA C I F I C OCEAN INDIAN INDONESIA OCEAN ATLANTIC OCEAN OPEC nations CONNECTING ACROSS THE GLOBE 1. Applying Economic Concepts In what ways does OPEC act like a monopoly? 2. Making Inferences What will happen to OPEC’s monopolistic power as the world discovers new sources of energy? Explain your answer. 200 Chapter 7 Types of Monopolies KE Y C ONCE P T S QUICK REFERENCE There are several reasons why monopolies exist, and not all monopolies are harm- ful to consumers. A natural monopoly is a market situation in which the costs of A natural monopoly occurs when the costs of production are lowest when only one firm provides output. A government monopoly production are lowest with is a monopoly that exists because the government either owns and runs the business only one producer. or authorizes only one producer. A technological monopoly is a monopoly that A government exists because the firm controls a manufacturing method, an invention, or a type of monopoly exists technology. A geographic monopoly is a monopoly that exists because there are no when the government other producers or sellers within a certain region. either owns and runs the business or authorizes only one producer. E XAM P L E 1 Natural Monopoly: A Water Company A technological In some markets, it would be inefficient to have more than one company competing monopoly occurs when for consumers’ business. Most public utilities fall into this category. Let’s look at the a firm controls a manufac- water company in your community as an example. It pumps the water from its source turing method, invention, or type of technology. through a complex network of pipes to all the homes, businesses, and public facilities in the community. It also monitors water quality for safety and removes and treats A geographic monop- oly exists when there are wastewater so that it may be recycled. no other producers within It would be a waste of community resources to have several companies developing a certain region. separate, complex systems in order to compete for business. A single supplier is most Economies of scale efficient due to economies of scale, a situation in which the average cost of produc- occur when the average tion falls as the producer grows larger. The more customers the water company serves, cost of production falls as the more efficient its operation the producer grows larger. becomes, as its high fixed costs are spread out over a large number of buyers. These economies of scale result in government support for natural monopolies. While sup- porting natural monopolies, the government also regulates them to ensure that they do not charge Natural Monopolies excessively high prices for their Most public utilities require services. complex systems, such as this water treatment facility. E XAM P L E 2 Government Monopoly: The Postal Service Government-run businesses provide goods and services that either could not be provided by private firms or that are not attractive to them because of insufficient profit opportunities. One of the oldest government monopolies in the United States is the U.S. Postal Service, which has the exclusive right to deliver first-class mail. Originally, only the government could provide this service in an efficient and cost- effective manner. However, new services and new technologies have been chipping away at this monopoly. Private delivery companies offer services that compete with the U.S. Postal Service. Many people now send information by fax, e-mail, and text messages. In addition, many pay their bills online. Market Structures 201  YO U R EC O N O M I C C H O I C E S GOVERNM ENT MONO POLY Which mail service will you choose? If you need to send thank-you notes, you could send them by regular mail, which is a government monopoly. Or you could send electronic thank-you notes by computer. ? ▲ Handwritten note ▲ E-mail message E X A MP L E 3 Technological Monopoly: Polaroid In 1947, Edwin Land, the founder of the Polaroid Corporation, invented the first instant camera. Land’s camera used a special type of film that allowed each picture to develop automatically in about a minute. Through a series of patents, Polaroid created a monopoly in the instant photography market. QUICK REFERENCE A patent is a legal registration of an invention or a process that gives the inventor the exclusive property rights to that invention or process for a certain number of A patent gives an years. The government supports technological monopolies through the issuing of inventor the exclusive property rights to that patents. Through patents, businesses are able to recover the costs that were involved invention or process for a in developing the invention or technology. certain number of years. Polaroid’s control of instant photography technology through its patents was a barrier to entry for other firms. In 1985, Polaroid won a lawsuit against Eastman Kodak Company for patent infringement. The court ruled that Kodak’s instant camera and film had violated Polaroid’s property rights, which were protected by several patents. The lawsuit effectively blocked Kodak from the instant photography market. Technological monopolies last only as long as the patent—generally 20 years—or until a new technology creates close substitutes. The rise of easier-to-use 35mm cameras, one- hour photo processing, and digital cameras all contributed to a steep decline in Polaroid’s business. While the company remains the leading seller of instant cameras and film, the technology has become a minor segment of the consumer photography market. Technological Monopoly Polaroid instant cameras use patented technology. 202 Chapter 7 E XAM P L E 4 Geographic Monopoly: Professional Sports One type of geographic monopoly in the United States is the profes- sional sports team. The major sports leagues require that teams be associated with a city or region and limit the number of teams in each league. In other words, the leagues create a restricted market for professional sports. Most cities and towns are not directly represented by a team, so many teams draw their fans from a large surrounding geographic region. Because of their geographic monopolies, the owners of these teams are able to charge higher prices for tickets to games than if they faced competition. They also have a ready market for sports apparel and other merchandise featuring the team logo and colors. Another type of geographic monopoly is created by physical Geographic Monopolies The Boston Red Sox is the only baseball team in New England, so it draws fans from isolation. For example, Joe oper- across the six-state region. ates the only gas station at an interstate exit in the middle of a desert. The next station in either direction is more than 50 miles away. Joe has a geographic monopoly because he is the only supplier of a product with no close substitutes. Drivers on the interstate in that area depend on Joe’s gas and have no other choice of supplier. They can either buy gas from Joe or Find an update on monopolies at risk running out of gas before they reach the next station. Because of his geographic ClassZone.com location as the single supplier of a product that has no close substitutes, Joe is able to control the price that he charges—and gas at Joe’s is always very expensive. Isolated locations or small communities may have other examples of geographic monopolies if the market is too small to support two similar businesses. Geographic monopolies have become less common in the United States. Cars allow people to travel greater distances to shop, and catalog marketers and Internet businesses, combined with efficient delivery companies, offer consumers more alternatives to shopping at local stores. AP P LIC AT ION Drawing Conclusions B. Which type of monopoly do you think is least harmful to consumers? Why? Market Structures 203  Profit Maximization by Monopolies KE Y CON CE P T S Although a monopoly firm is the only supplier in its market, the firm cannot charge any price it wishes. A monopolist still faces a downward-sloping demand curve. In other words, the monopoly will sell more at lower prices than at higher prices. The monopolist controls price by controlling supply. A monopoly produces less of a product than would be supplied in a competitive market, thereby artificially raising the equilibrium price. It’s difficult to study this process in the real world because most countries have laws to prevent monopolies. We have to look at small instances in which a company has a monopoly over one particular specialized product. Such a limited monopoly lasts only for the life of the patent or until a competitor develops a similar product. E X A MP L E Drug Manufacturer Pharmaceutical manufacturers offer an example of how companies with limited monopolies try to maximize their profits. On average, drug patents last for about 11 years in the United States. Drug companies try to maximize their profits during that period because when the patent expires they face competition from other manu- facturers who begin marketing generic versions of the drug. A generic drug contains the same ingredients and acts in the same way as the patented drug, but it is sold at much lower prices. As an example, consider the Schering-Plough company and its antihistamine Claritin. The drug was originally approved for use as a prescription medica- tion in the United States in 1993, although it had been patented earlier. Unlike many other such drugs, Claritin did not make users drowsy. This advantage, combined with a strong marketing campaign, led Claritin to become a top seller, making as much as $3 billion in annual worldwide sales. When the patent on Claritin expired in 2002, numerous generic equivalents entered the market. In response, Schering-Plough lowered Claritin’s price and gained approval for a nonprescription form of the drug. But sales of Claritin fell to about $1 billion as consumers switched to less costly generic equivalents. A P P L ICAT ION Applying Economic Concepts C. Using the three characteristics of monopoly, explain what happened to the market for Claritin when its patent expired. 204 Chapter 7 SECTION 2 Assessment ClassZone.com REVIEWING KEY CONCEPTS E C O N O M I C S I N P R AC T I C E 1. Explain the differences between the terms in each of these pairs: a. monopoly b. natural monopoly c. technological monopoly cartel geographic monopoly government monopoly 2. What is the relationship between economies of scale and a natural monopoly? 3. How does a patent awarded to one company act as a barrier to entry to another company wishing to enter the same market? 4. Why is a monopolist a price maker rather than a price taker? 5. Why do technological monopolies exist only for a limited time? 6. Using Your Notes Why One Restricted Control Seller Market of Prices Identifying Types of Monopolies is a geographic monopoly Natural able to control the price of Monopoly You learned in this section that there its product? Refer to your Government are four types of monopolies: natural, Monopoly government, technological, and completed chart. Technological geographical. Use the Graphic Organizer Monopoly at Interactive Review @ Geographic Monopoly What Type? The table below lists ClassZone.com examples of several monopolies. For each example, identify the type of CRITICAL THINKING monopoly. Some types have more than one example. 7. Analyzing Causes and Effects Companies that produce Example of Type of generic drugs are not required to repeat the clinical tests that the Monopoly Monopoly original manufacturer of the drug is required to run before the U.S. interstate drug receives its patent. How does this fact affect the prices of highway system generic drugs and why? Electric utility company 8. Analyzing Effects A powerful monopoly is broken up into The only bank in a several smaller, competing companies. What are the costs and small town benefits for the general public? The company that received a patent 9. Drawing Conclusions In 2003, 95 percent of the households in for the Frisbee America had access to only one cable TV company in their area. A city’s public What kind of monopoly did cable TV companies have? Explain transportation your answer. system Natural gas 10. Challenge Among the drugs to fight high cholesterol, the most company effective are known as statins. The drugs are similar, but each Challenge In which type of is different enough to have its own patent. In 2005, there were monopoly is the government least seven such drugs on the market. In 2006, the patents ended likely to be involved? Give reasons for for two of the drugs. What effect did this have on the entire your answer. category of statin drugs, including those whose patents were still in effect through 2006? Explain why this might be the case. Market Structures 205  SECTION Other Market Structures 3 OBJECTIVES KEY TERMS TA K I N G N O T E S In Section 3, you will monopolistic competition, p. 206 As you read Section 3, complete learn that monopolistic product differentiation, p. 206 a chart to compare and contrast competition and oligopoly monopolistic competition and nonprice competition, p. 207 oligopoly. Use the Graphic are market structures that fall focus group, p. 208 Organizer at Interactive Review between perfect competition oligopoly, p. 209 @ ClassZone.com and monopoly market share, p. 209 Monopolistic Oligopoly identify the characteristics of Competition monopolistic competition start-up costs, p. 209 describe the characteristics of oligopoly Characteristics of Monopolistic Competition KE Y CON CE P T S QUICK REFERENCE Most markets in the real world fall somewhere between the models of perfect competition and monopoly. One of the most common market structures is monopolistic Monopolistic competition, in which many sellers offer similar, but not standardized, products. The competition occurs when many sellers offer market for T-shirts printed with images or slogans is one example. The market is similar, but not standard- competitive because there are many buyers (you, your friends, and many other buyers) ized, products. and many sellers (stores at the mall, online merchants, sports teams, and many other Product differen- sellers). The market is monopolistic because each seller has influence over a small tiation is the effort to segment of the market with products distinguish a product that are not exactly like those of their from similar products. competitors. Someone looking for a pink T-shirt with fuzzy kittens would not accept a black monster-truck rally T- shirt as a close substitute. Product differentiation and non- price competition are the distinguishing features of monopolistic competition. Product differentiation is the attempt to distinguish a product from similar prod- ucts. Sometimes, the effort focuses on substantial differences between prod- ucts, such as vehicle gas mileage ratings. 206 Chapter 7 But companies also try to differentiate their products when there are few real differ- ences between products. For example, a battery company might spend millions of dollars on advertising to convince consumers that their batteries last longer than other batteries—even though the real difference in longevity may be minimal. QUICK REFERENCE Another way companies in monopolistic competitive markets try to gain busi- ness is through nonprice competition. Nonprice competition means using factors other Nonprice competition than low price—such as style, service, advertising, or giveaways—to try to convince occurs when producers use factors other than low price customers to buy one product rather than another. If you’ve ever decided to eat at a to try to convince customers particular fast food restaurant just to get the cool gizmo it’s giving away, you have to buy their products. participated in nonprice competition. Monopolistic competition has four major characteristics: many buyers for many sellers, similar but differentiated products, limited lasting control over prices, and freedom to enter or exit the market. Let’s take a closer look at each of these charac- teristics by focusing on the market for hamburgers. C HAR ACT E RIS T IC 1 Many Sellers and Many Buyers In monopolistic competition there are many sellers and many buyers. The number of sellers is usually smaller than in a perfectly competitive market but sufficient to allow meaningful competition. Sellers act independently in choosing what kind of product to produce, how much to produce, and what price to charge. When you want a hamburger, you have many different restaurants from which to choose. The number of restaurants assures that you have a variety of kinds of hamburgers to choose from and that prices will be competitive. No single seller has Find an update about a large enough share of the market to significantly control supply or price. monopolistic competition However, there are probably a few restaurants that make burgers you really like at ClassZone.com and others with burgers you really don’t like. The restaurants that make your favorite burgers have a sort of monopoly on your business. C HAR ACT E RIS T IC 2 Similar but Differentiated Products Sellers in monopolistic competition gain their limited monopoly-like power by making a distinctive product or by convincing consumers that their product is different from the competition. Hamburger restaurants might advertise the quality of their ingredients or the way they cook the burger. They might also use distinctive packaging or some special service—a money-back guarantee if the customer is not satisfied with the meal, for example. One key method of product differentiation is the use of brand names, which Hamburger Valhalla Healthy Eats Chili-Cheese Burger Veggie Burger White bread bun Whole wheat bun Cheese and chili Organic pickles, onions, tomatoes All-beef patty Veggie patty Standard pickles, onions, tomatoes, lettuce Organic lettuce Market Structures 207  encourage consumer loyalty by associating certain desirable qualities with a particular brand of hamburger. Producers use advertising to inform consumers about product differences and to persuade them to choose their offering. How do hamburger restaurants decide how to differentiate their products? They conduct market research, the gathering and evaluation of information about consumer preferences for goods and services. For local restaurants, market research may be limited to listening to their customers’ praise or complaints and paying attention to what competing restaurants offer. QUICK REFERENCE The large chain restaurants can afford to use more sophisticated research techniques to gain information about consumers’ lifestyles and product preferences. One technique A focus group is a is the focus group—a moderated discussion with small groups of consumers. Another moderated discussion with market research technique is the survey, in which a large number of consumers small groups of consumers. are polled, one by one, on their opinions. The results of market research help the restaurants differentiate their hamburgers and attract more customers. CH A RA CT E RIS T IC 3 Limited Control of Prices Product differentiation gives producers limited control of price. Hamburger restaurants charge different prices for their product depending on how they want to appeal to customers. The price of some hamburgers is set as low as possible to appeal to parents of younger eaters or to those on tight budgets. Prices for name-brand hamburgers or burgers with better quality ingredients may be set slightly higher. If consumers perceive that the differences are important enough, they will pay the extra price to get the hamburger they want. Yet producers in monopolistic competition also know that there are many close substitutes for their product. They understand the factors that affect demand and recognize that consumers will switch to a substitute if the price goes too high. CH A RA CT E RIS T IC 4 Freedom to Enter or Exit Market There are generally no huge barriers to entry in monopolistically competitive markets. It does not require a large amount of capital for someone to open a hamburger stand, for example. When firms earn a profit in the hamburger market, other firms will enter and increase competition. Increased competition forces firms to continue to find ways to differentiate their products. The competition can be especially intense for small businesses facing much larger competitors. Some firms will not be able to compete and will start to take losses. This is the signal that it is time for those firms to exit the market. Leaving the restaurant market is relatively easy. The owners sell off the cooking equipment, tables, and other supplies at a discount. If their finances are solid, they may then look for another market where profits might be made. Ease of Entry and Exit A P P L ICAT ION Applying Economic Concepts In monopolistic competition, sellers may enter and exit A. Think about an item of clothing that you purchased recently. How did the seller the market freely. differentiate the product? List several ways, then compare lists with a classmate. 208 Chapter 7 Characteristics of an Oligopoly KE Y C ONCE P T S QUICK REFERENCE Oligopoly (OL-ih-GOP-ah-lee), a market structure in which only a few sellers offer a similar product, is less competitive than monopolistic competition. In an oligopoly, Oligopoly is a market a few large firms have a large market share —percent of total sales in a market—and structure in which only a dominate the market. For example, if you want to see a movie in a theater, chances few sellers offer a similar are the movie will have been made by one of just a few major studios. What’s more, product. the theater you go to is probably part of one of just a few major theater chains. Both Market share is a the market for film production and the market for movie theaters are oligopolies. company’s percent of total sales in a market. There are few firms in an oligopoly because of high start-up costs—the expenses that a new business must pay to enter a market and begin selling to consumers. Making Start-up costs are the expenses that a new busi- a movie can be expensive, especially if you want to make one that can compete with what ness faces when it enters the major studios produce. And getting it into theaters across the country requires a huge a market. network of promoters and distributors—and even more money. An oligopoly has four major characteristics. There are few sellers but many buyers. In industrial markets, sellers offer standardized products, but in consumer markets, they offer differentiated products. The few sellers have more power to control prices than in monopolistic competition, but to enter or exit the market is difficult. The Breakfast Cereal C HAR ACT E RIS T IC 1 Few Sellers and Many Buyers Industry In an oligopoly, a few firms dominate an entire market. There is not a single Just a few large companies produce the majority of supplier as in a monopoly, but there are fewer firms than in monopolistic competi- breakfast cereals available. tion. These few firms produce a large part of the total product in the market. Economists consider an industry to be an oligopoly if the four largest firms control at least 40 percent of the market. About half of the manufacturing industries in the United States are oligopolistic. The breakfast cereal industry in the United States is dominated by four large firms that control about 80 percent of the market. Your favorite cereal is probably made by one of the big four manufacturers. Although they offer many varieties of cereals, there is less compe- tition than there would be if each variety were produced by a different, smaller manufacturer. C HAR ACT E RIS T IC 2 Standardized or Differentiated Products Depending on the market, an oligopolist may sell either standardized or differenti- ated products. Many industrial products are standardized, and a few large firms control these markets. Examples include the markets for steel, aluminum, and flat glass. When products are standardized, firms may try to differentiate themselves based on brand name, service, or location. Breakfast cereals, soft drinks, and many other consumer goods are examples of differentiated products sold by oligopolies. Oligopolists market differentiated prod- Market Structures 209  ucts using marketing strategies similar to those used in monopolistic competition. They use surveys, focus groups, and other market research techniques to find out what you like. The companies then create brand-name products that can be marketed across the country or around the world. CH A RA CT E RIS T IC 3 More Control of Prices Because there are few sellers in an oligopoly, each one has more control over product price than in a monopolistically competitive market. For example, each breakfast cereal manufacturer has a large enough share of the market that decisions it makes about supply and price affect the market as a whole. Because of this, a seller in an Find an update oligopoly is not as independent as a seller in monopolistic competition. A decision about oligopolies at ClassZone.com made by one seller may cause the other sellers to respond in some way. For example, if one of the leading breakfast cereal manufacturers lowers its prices, the other manufacturers will probably also lower prices rather than lose customers to the competition. Therefore, no firm is likely to gain market share based on price, and all risk losing profits. But if one manufacturer decides to raise prices, the others may not follow suit, in order to take customers and gain market share. Consequently, firms in an oligopoly try to anticipate how their competitors will respond to their actions before they make decisions on price, output, or marketing. CH A RA CT E RIS T IC 4 Little Freedom to Enter or Exit Market Start-up costs for a new company in an oligopolistic market can be extremely high. Entering the breakfast cereal industry on a small scale is not very expensive—but the profits are low too. The factories, warehouses, and other infrastructure needed to compete against the major manufacturers require large amounts of funds. In addition, High Start-up Costs existing manufacturers may hold patents that act as further barriers to entry. New firms may not have the funds to construct large Firms in an oligopoly have established brands and plentiful resources that make it factories. difficult for new firms to enter the market successfully. For example, breakfast cereal manufacturers have agreements with grocery stores that guarantee them the best shelf space. Existing manu- facturers also have economies of scale that help them to keep their expenses low. Smaller firms, with smaller operations, lack the economies of scale. However, all of the investments by firms in an oligopoly make it difficult for them to exit the market. When a major breakfast cereal manufacturer begins losing money, its operations are too vast and complex to sell and reinvest easily, as a small business might. It must trim its operations and work to stimulate demand for its product. A P P L ICAT ION Categorizing Information B. Which of these products produced by oligopolies are standardized and which are differentiated: automobiles, cement, copper, sporting goods, tires? 210 Chapter 7 Comparing Market Structures KE Y C ONCE P T S Each of the four market structures has different benefits and problems. And each type creates a different balance of power—namely, the power to influence prices— between producers and consumers. Consumers get the most value in markets that approach perfect competition. No actual markets are perfectly competitive, but in those that come close, prices are set primarily by supply and demand. However, such markets usually deal in a standard- ized product, so consumers have little choice other than the best price. In monopolistic competition, consumers continue to benefit from companies competing for their business. But businesses gain some control over prices, so they are more likely to earn a profit. Opening a business in such a market is usually rela- tively affordable, which is another benefit for businesses. In markets dominated by oligopolies, consumer choices may be more limited than in more competitive markets. Businesses in such markets gain more control of price, making it easier for them to make a profit. However, the cost of doing business in such a market is high. A market ruled by a monopoly is very favorable for the business that holds the monopoly. It faces little or no competition from other companies. And monopoly gives consumers the least influence over prices. They decide only whether they are willing to buy the product at the price set by the monopolist. F I G U R E 7. 5 Comparing Market Structures Number Sellers’ Control Barriers to Enter Type of Product of Sellers over Prices or Exit Market Perfect Competition Many Standardized None Few Monopolistic Many Similar but Limited Few Competition differentiated Oligopoly Few Standardized for industry; Some Many differentiated for consumers Monopoly One Standardized, but no Significant Very many—market close substitutes restricted or regulated ANALYZE CHARTS 1. If you were starting a business, which market structures would make it easiest for you to enter the market? 2. Which market structures offer the highest potential profits? Why? AP P LIC AT ION Drawing Conclusions C. What difference does it make to consumers whether a market is ruled by monopolistic competition or by an oligopoly? Market Structures 211  ECO N O M I C S PAC ES E T T E R Joan Robinson: Challenging Established Ideas In this section, you learned about monopolistic competition and oligopoly. British economist Joan Robinson was one of the first to write about these market structures. FAST FACTS As strange as it may seem to us now, most economists before 1930 described market Joan Robinson competition only in terms of the extremes of perfect competition and monopoly. Career: Economics professor, Cambridge University Explaining Real-World Competition Born: October 31, 1903 In 1933, Joan Robinson challenged the prevailing ideas about competition. Her first major book, The Economics of Imperfect Competition, described market structures that Died: August 5, 1983 existed between monopoly and perfect competition. Robinson’s work appeared shortly Major Accomplish- after Harvard economist Edward Chamberlin published his book Theory of Monopo- ment: Developed theory of imperfect competition listic Competition. The two economists had developed their ideas independently. Robinson and Chamberlin described the type of Books: The Economics competition that exists among firms with differentiated of Imperfect Competition (1933), The Accumulation products. Such firms gain more control over the price of Capital (1956), Eco- of their product, but their control is limited by nomic Philosophy (1963), the amount of competition. They also described Introduction to Modern the nature of oligopoly and of monopsony, a Economics (1973) market structure in which there are many sellers Famous Quotation: but only one large buyer. “It is the business of Robinson continued to contribute important economists, not to tell us what to do, but show ideas throughout her long career in economics. why what we are doing Her theory of imperfect competition remains a anyway is in accord with key element of the field of microeconomics today. proper principles.” Economists recognized that Robinson’s theory more accurately reflected modern market economies in which firms compete through product differ- Joan Robinson entiation and advertis- developed the theory of imperfect ing and in which many competition. industries are controlled Learn more about by oligopolies. Joan Robinson at ClassZone.com APPLICATION Making Inferences D. Why do you think Joan Robinson chose the term imperfect competition to describe the nature of most real-world markets? 212 Chapter 7 SECTION 3 Assessment ClassZone.com REVIEWING KEY CONCEPTS E C O N O M I C S I N P R AC T I C E 1. Explain the relationship between the terms in each of these pairs: a. product differentiation b. focus group c. oligopoly nonprice competition market share start-up costs 2. How is monopolistic competition similar to perfect competition and how is it similar to monopoly? 3. Describe some of the techniques sellers use to differentiate their products. 4. Why are standardized products sometimes found in oligopoly but not in monopolistic competition? 5. Is it easier for a new firm to enter the market under monopolistic competition or oligopoly? Why? Perfect competition or monopoly? 6. Using Your Notes How does The Impact of Market Structure Monopolistic Oligopoly the number of sellers compare in Competition Each of the four market structures monopolistic competition and oligopoly? carries different consequences for Refer to your completed chart. businesses and consumers. Imagine what would happen if there were Use the Graphic Organizer at only one type of market structure. Interactive Review @ ClassZone.com Use Figure 7.5 on page 211 as a guide as you do this exercise. CRITICAL THINKING a. What would your town look like if every market was perfectly 7. Contrasting Economic Information What makes the market competitive? What would happen for wheat different from the markets for products made from to your consumer choices? wheat, such as bread, cereal, and pasta? b. What would happen if every market was ruled by monopolistic 8. Applying Economic Concepts In 2005, a major U.S. automaker competition? announced a new discount plan for its cars for the month of c. What would the town look like June. It offered consumers the same price that its employees paid if oligopolies controlled every for new cars. When the automaker announced in early July that it market? was extending the plan for another month, the other two major U.S. automakers announced similar plans. What market structure d. What if every market in your is exhibited in this story and what specific characteristics of that town was ruled by a monopoly? market structure does it demonstrate? How could you tell the difference between situation A and D? 9. Analyzing Effects Blue jeans are produced under monopolistic competition, so their prices are higher than if they were produced Challenge Now think about what under perfect competition. Do the positive effects for consumers your town actually looks like. What of blue jeans justify the higher prices? Why or why not? types of market structures are most prevalent? Are you satisfied with the 10. Challenge Why do manufacturers of athletic shoes spend mix of market structures, or do you money to sign up professional athletes to wear and promote their think some markets would be better shoes rather than differentiating their products strictly on the served by different structures? basis of physical characteristics such as design and comfort? Market Structures 213  SECTION Regulation and 4 Deregulation Today OBJECTIVES KEY TERMS TA K I N G N O T E S In Section 4, you will regulation, p. 214 As you read Section 4, complete explain how government acts antitrust legislation, p. 214 a hierarchy diagram to track main to prevent monopolies ideas and supporting details. trust, p. 214 Use the Graphic Organizer at analyze the effects of anti- merger, p. 214 Interactive Review @ competitive business practices price fixing, p. 216 ClassZone.com describe how government acts market allocation, p. 216 to protect consumers Regulation and Deregulation predatory pricing, p. 216 discuss why some industries cease and desist order, p. 217 Promoting have been deregulated and Competition the results of that deregulation public disclosure, p. 217 details deregulation, p. 218 Promoting Competition KE Y CON CE P T S QUICK REFERENCE The forces of the marketplace generally keep businesses competitive with one another and attentive to consumer welfare. But sometimes the government uses regulation — Regulation is a set of controlling business behavior through a set of rules or laws—to promote compe- rules or laws designed to control business behavior. tition and protect consumers. The most important laws that promote competition are collectively called Antitrust legislation defines monopolies and antitrust legislation, laws that define monopolies and gives government the give government the power to control them and break power to control them. them up. A trust is a group of firms combined for the A trust is a group of purpose of reducing competition in an industry. (A firms combined in order trust is similar to a cartel, which you learned about in to reduce competition in Section 2.) To keep trusts from forming, the govern- an industry. ment regulates business mergers. A merger is when A merger is the joining one company combines with or purchases another to of two firms to form a form a single firm. single firm. Origins of Antitrust Legislation During the late 1800s, a few large trusts, such as Standard Oil, dominated the oil, steel, and railroad industries in the United States. The U.S. government became concerned that these combinations would Standard Oil Company This use their power to control prices and output. As a cartoon dramatizes how Standard result, in 1890, the government passed the Sherman Oil controlled the oil industry. 214 Chapter 7 Antitrust Act. This gave government the power to control monopolies and to regulate business practices that might reduce competition. Over time, other laws strength- ened the government’s ability to regulate business and to encourage competition. To understand why government officials pushed for antitrust laws, consider one of the trusts that developed in the late 1800s—the Standard Oil Company. By merg- ing with other companies and eliminating competitors, Standard Oil gained control of about 90 percent of the U.S. oil industry. Such a huge holding, government offi- cials contended, gave Standard Oil the ability to set production levels and prices. In 1911, the U.S. government won a court case under the Sherman Antitrust Act that required the breakup of the trust. In order to increase competition, Standard Oil was forced to relinquish control of 33 companies that had once been part of the trust. Antitrust Legislation Today At various times, the U.S. government has used antitrust legislation to break up large companies that attempt to maintain their market power through restraint of competition. The government might allow a large dominant firm to remain intact because it is the most efficient producer. Or it might order that the company change its business practices to allow other firms to compete more easily. The responsibility for enforcing antitrust legislation is shared by the Federal Trade Commission (FTC) and the Department of Justice. A major focus of their work is the assessment of mergers. The government tends to support mergers that might benefit consumers. For example, larger firms are often able to operate more efficiently, and lower operating costs may lead to lower prices for consumers. On the other hand, the government tends to block mergers that lead to greater market concentration in the hands of a few firms. A merger that makes it more difficult for new firms to enter a market will also be looked upon with concern. To evaluate a potential merger, the government looks at how a particular market is defined. A company that is proposing a merger would try to define its market as broadly as possible, in order to make its control of the market seem smaller. For example, a soft drink producer might claim that its market competition includes all bever- ages, such as water, tea, coffee, and juice. To determine whether the merger will increase the concentration in the market and decrease competition, the government considers the market share of the firms before and after the proposed merger. Government regulators also look at whether the merger allows a firm The Federal Trade Commission (FTC) In 2004, Deborah Platt Majoras became head of to eliminate possible competitors. If this analysis shows that a merger the FTC, an agency that enforces antitrust laws. will reduce competition and more than likely lead to higher prices for consumers, the regulators will deny the companies’ effort to merge. AP P LIC AT ION Drawing Conclusions A. Which of these mergers would the government be more likely to approve and why: two airlines that serve different cities or two banks in a small town? Market Structures 215  Ensuring a Level Playing Field KE Y CON CE P T S In addition to evaluating mergers, the government also tries to make sure that businesses do not engage in practices that would reduce competition. As you have learned, competition enables the market economy to work effectively. When busi- nesses take steps that counteract the effects of competition, prices go up and supplies go down. In the United States, laws prohibit most of these practices. The FTC and the Department of Justice enforce these laws. Prohibiting Unfair Business Practices Businesses that seek to counteract market forces can use a variety of methods. One is QUICK REFERENCE price fixing, which occurs when businesses work together to set the prices of comp- Price fixing occurs eting products. A related technique is when competing businesses agree to restrict their when businesses agree to output, thereby driving up prices. set prices for competing For example, in the mid-1990s the five major recorded music distributors began products. enforcing a “minimum advertised price” for compact discs sold in the United States. Market allocation As a result, CD prices remained artificially high. The FTC estimated that consum- occurs when competing ers paid about $480 million more for CDs than they would have if prices had been businesses divide a market established by market forces. In 2000 the FTC reached an agreement with the dis- amongst themselves. tributors to end this anticompetitive practice. Predatory pricing Another way businesses seek to avoid competition is by market allocation, which occurs when businesses set prices below cost for a time occurs when competing businesses negotiate to divide up a market. By staying out of to drive competitors out of each other’s territory, the businesses develop limited monopoly power in their own a market. territory, allowing them to charge higher prices. For example, in the early 1990s agribusiness conglomerate Archer Daniels Midland (ADM) conspired with companies in Japan and Korea to divide the worldwide market for lysine, an additive used in livestock feeds. Around the same time, ADM also conspired with European companies to divide the worldwide market for citric acid, an additive used in soft drinks, canned foods, and other consumer products. Both of these illicit agreements also included price fixing. In 1996, the Department of Justice charged ADM with antitrust violations in both the lysine and citric acid markets. ADM pleaded g