In this podcast we discuss the nature of perfectly competitive market structures and monopolistic market structures. We talk about how an imaginary product/industry would behave in each market structure under their different conditions and with their different attributes.
Podcast by: Kate Soanes and Gabriella Schaff
Kate: Hey everyone. Welcome to Oz-onomics, a podcast created for and by students in introductory economics classes at SUNY Oswego.
GABRIELLA: In this series, we'll have discussions about various economic principles and how they apply to our day to day lives.
KATE: Are you ready?
GABRIELLA: Let's go.
K: So Gabby, tell me about your favorite market structure! G: Well Kate, I get super excited about perfectly competitive markets. What about you? K: I’ve always been a big fan of Monopolies. G: Like the board game? K: Not quite…In today’s episode, we’re gonna talk about how products and industries behave differently within different market structures. G: Great! To help explain how perfectly competitive markets operate, let’s use an imaginary product as an example. What should we call it? K: A widget! G: Classic. So let’s say I’m a seller of widgets. In a perfect competition I’m one of many widget sellers, and there are many widget buyers. Within this market, all widgets are identical. Furthermore, in this market structure both buyers and sellers have all the info they need to make rational decisions, and firms can enter and leave the market easily. K: Wow, there’s a lot going on there. How do you decide how much to charge for your widgets? G: Well, because of all that stuff I just said. My perfectly competitive firm is considered a price taker- the pressure of competing firms forces me to accept the prevailing equilibrium price in the market. K: So you don’t get to decide what to charge? G: That’s right, the only decision I have to make is the quantity of widgets I want to produce. K: And how do you decide that? G: If you think about how it would look on a graph, the demand curve for my widgets is horizontal- I can sell any quantity I choose at that market price. So to determine how much I want to produce, I need to find the quantity that will maximize my profits. K: Let’s take a second to talk about “profits”. In any market structure, profits are what’s left after subtracting a firms costs from it’s revenues. G: I’m glad you mentioned revenue, which is the money coming in. Marginal revenue is the extra money from selling one more widget. In a perfectly competitive market situation, the marginal revenue is equal to the price. On the graph, my marginal revenue curve is the same as the demand curve- horizontal. What I really need to look at is my marginal cost, the cost of producing one more widget. Initially marginal cost decreases as I produce more widgets, but then, due to diminishing marginal returns in production, they begin to rise again after a certain point. K: How do you know where that point is? G: I follow a profit maximizing rule, which states that firms will produce the level of output where marginal revenue equals marginal cost. If I produce fewer widgets than that, I’m not earning as much profit as I could be if I made more. If I produce at a higher level than the rule indicates, then the additional costs would eat into my profits, and I’d be bringing home less money. K: So that’s it? G: Wait! We haven’t talked about my favorite part of perfectly competitive markets! Efficiency! Because I produce the exact amount of widgets that society desires, and I do it at the lowest cost, without waste, my firm, and all other firms in the widget industry, are allocatively and productively efficient. Perfect! K: That’s all very nice and neat, but I say who wants to be like everyone else? That’s why I like monopolies. G: Well there’s no accounting for taste, but I’ll hear you out… K: Thank you Gabby. A monopoly is as far as you can get from a perfectly competitive market. Let’s take that same imaginary product, the widget, and assign some different circumstances. Instead of many firms, mine is the only one selling widgets, and there are no other products on the market that are identical or even similar. G: Why isn’t anyone else selling them? K: Unlike a perfectly competitive market, where it’s easy for firms to enter and exit, a monopoly has barriers to entry. There are the legal, technological, or market forces that discourage or prevent potential competitors from entering a market. There are a couple of different types of monopoly, with different barriers. There are legal monopolies and natural monopolies. In the case of legal monopolies, it’s the government that creates the barriers by prohibiting or limiting competition. A case for this might be utilities. Necessary products that are socially beneficial to have, so the government allows for a single producer and regulates it to make sure an appropriate amount gets produced. Another reason the government might create barriers is to promote innovation. Few companies would be willing to commit the time and resources required to develop new products or technology if they know they wouldn’t be able to recoup those costs. To ensure that companies are willing to innovate, the government offers protection from competition, at least for a while, for a firm’s intellectual property. Intellectual property includes patents, trademarks, copyrights, and trade secret laws. G: So if you’re the one that devoted your resources to developing the widget, intellectual property laws would prevent anyone else from selling it? K: Exactly. A natural monopoly has different barriers. One might be economies of scale, where the long-run costs of production are lower for a large firm than for a small one. This, combined with a small market size means that competition wouldn’t be profitable. G: I see, so if your widgets are expensive to produce, and there aren’t a lot of buyers, it makes sense for you to be the only widget firm. K: That’s right. Another barrier in a natural monopoly would be sole ownership or control of a natural resource. If I own the land that the world’s only KateGabbium mine sits on, and KateGabbium is required for widget production, then I’m the only one who can make widgets. G: So if you’re the only player in the widget game, does that mean that you do get to choose your selling price? K: Yes! Sort of. Monopolies are price makers, meaning they can charge any price they want, but they can’t force anyone to buy, so they’re still constrained by consumer demand for the product. G: Let’s talk about your demand curve. K: Like in all market structures, other than perfectly competitive markets, a monopoly has a downward sloping demand curve. Also, because a monopoly is the only producer in the market, the perceived demand curve is equal to the market demand. G: So how do you decide how much to sell? K: A monopoly follows the same profit maximizing rule that your perfectly competitive firm does, which is to produce the level of output where marginal revenue equals marginal costs. This looks a bit different for a monopoly though, since that downward sloping demand curve means that price needs to be considered as well. The only way to sell more is to charge less. While costs rise at a constant rate with increased output, revenue doesn’t. Therefore, a profit maximizing firm will seek that point where marginal revenue equals marginal costs, and charge the corresponding price on the demand curve. G: It sounds like a monopoly is a pretty sweet setup… for a monopolist. Let’s hear about your efficiency. K: Well…it’s not allocatively efficient. Without competition to keep prices down, a monopolistic firm will choose whatever price and quantity offers the greatest profits. Which doesn’t necessarily produce the quantity that society desires, and this results in deadweight loss. G: We’ve been talking about widgets, but what are some real products or industries that fall into these market structures? K: You’ll have a pretty hard time naming any. These structures are really just economic models to measure real-world market situations against. G: That’s right. In reality, you won’t see a market for products that are exactly identical with zero differentiation. K: Yes, and most “monopolies” you see are actually just firms with limited competition, rather than no competition. In the U.S. there is a whole body of antitrust laws to protect society from the gouging and inefficiency created by the monopolies. G: Most real life markets fall into the categories of monopolistic competition or oligopoly… K: But, those are subjects for another episode. G: I’m Gabby Schaff! K: And I’m Kate Soanes, we’ll see you next time!
MICHAEL: There you have a folks on another edition of Oz-onomics, where economics becomes easier for Oswego students to understand where you get your money that you pay for your tuition worth. If you feel like being ahead of the curve, grab a seat, grab your phone, shift your fingers left and right. And download Oz-onomics on the podcast app. See you later.
The introduction to this podcast was provided by Kate Soanes and Gabriella Schaff. Michael Kolawale provided the outro. Music by Lobo Loco.