Free enterprise capitalism

  • Voluntary exchange
  • Profit motive
  • Economic freedom
  • Private property rights
  • Competition – businesses attract consumers; consumers obtain the best products at lowest prices

7.1 – competition and market structures

  • Laissez-faire – philosophy that government should not interfere with business activities
  • Market structure – nature and degree of competition among firms in the same industry

Perfect competition

  • Perfect competition – a market structure characterized by a large number of well-informed independent buyers and sellers who exchange identical products
  • Necessary conditions
    • Must be a large number of buyers and sellers
    • Buyers and sellers deal in identical products
    • Each buyer and seller act independently
    • Buyers and sellers are reasonably well-informed about products and prices
    • Buyers and sellers are free to enter into, conduct, or get out of business
  • The perfect competitor is called a “price taker”
    • When everyone is dealing with identical product, no need to advertise
    • When everyone sells are identical, there is no reason for one seller to charge a price higher than anyone else
    • Large number of independent buyers and sellers, then no single buyer is big enough to push the price down and no single seller is big enough to force the price up
    • If it’s easy for sellers to enter or leave the market, then new sellers can always come in if they think they can make a profit
  • Imperfect competition – market structure that does not meet all conditions of perfect competition

Monopolistic competition

  • Monopolistic competition – market structure that meets all conditions of perfect competition except identical products
  • Product differentiation – real or imagined differences between competing products in the same industry
  • Nonprice competition – sales strategy focusing on a product’s appearance, quality, or design rather than its price
  • Firm will expand its production until its marginal cost in equal to its marginal revenue, or where marginal cost = marginal revenue
  • It’s easy for firms to enter the monopolistically competitive industry


  • Oligopoly – market structure in which a few large sellers dominate the industry, some variation of product diversity
  • Tendency of oligopolists to act together often shows up in their pricing behavior
  • Many firms prefer to compete on a nonprice basis by enhancing their products with new or different features
  • Collusion – agreement, usually, illegal, among producers to fix prices, limit output, or divide markets
  • Price fixing – agreement usually illegal, by firms to charge the same price for a product


  • Monopoly – market structure with a single seller of a particular product
  • Natural monopoly – market situation where the cost of production is minimized by having a single firm exist
  • Natural monopolies can provide services more cheaply than several competing firms
  • Economies of scale – situation in which the average cost of production falls as a firm gets larger
  • Geographic monopoly – market structure in which one firm has a monopoly in a geographic area
  • Technological monopoly – monopoly based on a firm’s ownership or control of a production method, process, or other scientific advance
  • Government monopoly – a monopoly owned and operated by the government
  • Monopolist is much larger, and they lack meaningful competition; they behave as a “price maker”; competition is “price taker”
  • No equilibrium price facing the monopolist, maximum profit is MC=MR
 Number of industryInfluence over priceProduct differentiationAdvertisingEntry into marketExamples
Perfect competitionManyNoneNoneNoneEasyPerfect: none

Near: truck farming

Monopolistic competitionManyLimitedFair amountFair amountEasyGast stations

Women’s clothing

OligopolyFewSomeFair amountSomeDifficultAutomobiles


Pure monopolyOneExtensiveNoneNoneAlmost impossiblePerfect: none

Near: water


7.2 Market failures

Types of market failures

  • Market failure – condition that causes a completive market to fail
  • The decrease in competition tends to reduce the efficient use of scarce resources – resources that could be put to other, more productive uses if they were available
  • Temptation to collude is strong
  • Public utilities are regulated by government – to make sure monopolies don’t waste or abuse resources
  • Everyone must have adequate information about market conditions
  • Immobility of resources; they don’t move to where returns are the highest, instead, they still put
  • Public goods – goods and services whose benefits are available to everyone and are paid for collectively
  • Externality – economic side effect that affects an uninvolved third party
  • Negative externality – harmful side effect that affects an uninvolved third party
  • Positive externality – beneficial side effect that affects an uninvolved third party
  • Externalities are market failures because their costs and benefits are not reflected in the market prices that buyers and sellers pay
Rival consumptionPrivate goodCommon property good
Non-rival consumptionSemi-public goodPublic good

Issues presented

Public goods – inefficiency and cost

Private goods – equity

Semi-public goods – degree of government influence; taxes

common property goods – tragedy of the commons; government

Types of market failures

Inadequate competition

Inadequate information

Resource immobility

Public goods


Dealing with externalities

  • Problem: they distort the decisions made by consumers and producers
  • Correcting negative externalities by taxation

7.3 – the role of government

Maintain competition

  • By prohibiting market structures that are not competitive; and
  • Regulating markets where full competition is not possible
  • 1800s laws were passed to restrict monopolies and trusts such as Sherman antitrust act
  • Trusts – illegal combination of corporations or companies organized to hinder competition
  • Price discrimination – practice of selling the same product at different prices to different buyers
  • Clayton antitrust act and federal trade commission act restricted unfair competition and price discrimination
  • Cease and desist order – ruling requiring a company to stop an unfair business practice that reduces or limits competition
  • Emphasis has shifted to promoting efficiency

Improve economic efficiency

  • Transparency – a term used to indicate that information and actions are not hidden and instead are easily available for review
  • Public disclosure – requirement that a business reveal information about its products or its operation to the public
  • Public goods are important because they make the economy more productive

Modified free enterprise

  • Congress passed laws to prevent evil monopolies and protect the rights of workers
  • Food and drug laws are passed to protect people from false claims and harmful products
  • Government can increase efficiency by supplying public goods and promoting transparency
  • Now the government focus on promotion of economic competition and efficiency

Antitrust legislation

  • Sherman antitrust act – protect trade from monopolies
  • Clayton antitrust act – price discrimination
  • Federal trade commission act – protect consumers and promote competition
  • Robinson-Patman act – price discrimination

Consumer protection agencies

  • Food and drug administration – purity, truthful labeling of food and drugs
  • Federal trade commission – forbidding unfair competition
  • Federal communications commission – regulates communication services
  • Securities and exchange commission – regulates and supervises sales
  • Environmental protection agency – protects environment
  • Occupational safety and health administration – investigates work accidents and protect employees
  • Consumer product safety commission – standards for consumer goods

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