No Free Lunch: Economics for a Fallen World: Third Edition, Revised

Chapter Eight: Market Structure: From competition to monopoly 185 MONOPOLY Most products that we buy and sell are not in perfectively competitive markets; most goods and services are at least a little different from one another. A Burger King Whopper is not the same burger as a McDonald’s Big Mac or a Wendy’s Double Cheese (and certainly not the same as my favorite In-N-Out burger, a Double-Double! See Figure 8.4 ) ; nor is an iMac exactly the same product as a Dell computer. Chevrolet tries to convince us that its cars are higher quality than other cars, and Walmart tries to convince us they are always cheaper than Target. SUBWAY sandwiches are healthier than other fast food fare, and Levi’s Dockers are the best business casual pant. On and on, entrepreneurs try to convince us of the superiority and distinction of their product from a competitor. And I buy their argument! How about you? For example, I refuse to buy most potato chips other than the Lay’s brand, and all my favorite tools are USA-made Sears Craftsman—despite the fact that they cost at least double what similar tools would cost at Harbor Freight or Walmart. Maybe you prefer Pepsi to Coke (or the other way around), or KFC to Taco Bell. All of these individual preferences and product distinctions lead to a very different result from the perfectly competitive model. Instead of firms being price takers, they are price searchers . Under a price taker model with perfect competition, if Farmer Joe raised his price even a penny above the market price, his sales would go to zero, since there were identical products available (in all respects). In a price searcher model, however, the firm can raise their product’s price without losing all of their sales. How many sales they would lose depends on the elasticity of demand for their product (which, as we discussed earlier, depends in large part on the availability of substitutes). In this model, the entrepreneur must decide on the optimal price to charge to maximize her profits. Clearly, a higher price will result in higher revenue for each sale, but higher prices will also result in lower total sales as the quantity demanded falls. So firms have to search for the optimum price to charge. Consider Figure 8.5 . Take some time to read the corresponding caption and see if you can understand each shape and why each line (D, S, MR) has the position it does. In a price taker market, the market equilibrium would occur at P* and Q*. In a price searcher market, however, the price is not a given, and the searcher will use market research and a subsequent trial and error process to determine the actual demand curve for the firm’s product. Because the firm faces a downward-sloping demand curve, to gain an additional sale, the firm will have to lower the price. But when they lower the price for the next sale, they have to lower the price for all their products. Since each Price searchers: These firms are either a monopoly or, through product differentiation, have the ability to set the price of their products. These firms are called price searchers as they must search to find the consumer demand for their product. Figure 8.4, In-N-Out Double Cheese Vs Wendy’s Double Cheese. Both burgers have two beef patties and cheese, but are they the same thing? I certainly don’t think so, and neither does In-N-Out nor Wendy’s want you to think so. If this is true, the highly competitive fast food industry is filled with monopolists. So which appeals to you more: made fresh for you or “do what taste’s right”? Photograph of Wendy’s Double 1 Photograph of In-N-Out’s Cheeseburger 2