Chapter 7: Market Structure in Government and Nonprofit Industries. Soft Drinks. What is a Market? Do NFPs Compete? Some NFPs Compete Directly

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1 Chapter 7: Market Structure in Government and Nonprofit Industries Soft Drinks pers/wp/2008wp/frisvold_08_08_paper.pdf What is a Market? A market is a process in which the buyers and sellers agree on the terms of trade price, quantity, quality, etc. Lower Control Over Price Most Control Over Price Perfect Competition Imperfect Competition Monopoly We focus on the two extreme cases. Do NFPs Compete? Most NFP managers resist believing that NFP firms compete. Revenue Board members Grants Donations Volunteer time Prestige Political power and influence Do NFPs Compete? Donors exchange their money for premiums, prestige, tax breaks, and the satisfaction of doing good; nonprofits compete for those donations Volunteers trade their time for experience, training, camaraderie, knowledge about the internal workings of the firm, and the satisfaction of doing ggood. Nonprofits compete in the market for volunteers. Skilled managers, service providers, and fundraisers are scarce; nonprofits compete in the labor market for their services. Government contracts are awarded to nonprofits in a market; foundation grants are also scarce and are competed for in the marketplace. Some NFPs Compete Directly Compete head-to-head with government agencies Compete with For-Profits Compete for alliances with government and For- Profits Examples? 1

2 What Industries Are Dominated by Nonprofits? 1. The product meets the criterion for a public good Nonrivalry Nonexcludability 2. User fees do not cover all costs and donor (or tax revenue) makes up the difference 3. NFP firms enjoy a competitive advantage (either by being in the public sector or by their tax treatment) Industries Dominated by Nonprofits Dimensions on which to Analyze 1. Ease of Entry 2. Bargaining Power of Buyers 3. Availability of Substitute Products and Services 4. Rivalry Among Competitors 5. Bargaining Power of Suppliers of Inputs Effective Nonprofit Management Requires an Understanding of Markets Perfect Competition No seller can depart from the established price Monopoly A single seller with a high degree of price setting power Perfect Competition in the NFP Sector 1. Product Homogeneity 2. Free entry and exit 3. Large numbers of buyers and sellers 4. Perfect Dissemination of Information Which characteristic is the most important one? Perfect Competition in the NFP Sector Figure Product Homogeneity 2. Free entry and exit 3. Large numbers of buyers and sellers 4. Perfect Dissemination of Information Which characteristic is the most important one? 2

3 Figure 7.2 Figure 7.3 Figure 7.4 Movement Toward Equilibrium The Market The Firm Competitive Firm in the Short Run See Figure 7.5 Long-Run Equilibrium in a Competitive Market Perfectly Competitive Firms Price Takers Choose only quantity at prevailing price Contestable Markets P = MR = MC = AC 3

4 $ $ $ $ $ $ $ $ $ $

5 1972 $ $ $ $16.96 did not sell so simple a calculator Figure 7.5 Competitive Equilibrium A Different Animal Monopoly Monopoly in the Nonprofit Sector The opposite of perfect competition Monopoly Power Barriers to Entry maintain monopoly power 1. Sole ownership of a resource 2. Patent or Copyright protection 3. Large-scale production required 4. Brand name or reputation 5. Subsidies/donations are needed to provide services with public goods characteristics 6. Government may grant an exclusive franchise Is Monopoly Forever? Monopoly in the Nonprofit Sector The opposite of perfect competition Monopoly Power Barriers to Entry maintain monopoly power 1. Sole ownership of a resource 2. Patent or Copyright protection 3. Large-scale production required 4. Brand name or reputation 5. Subsidies/donations are needed to provide services with public goods characteristics 6. Government may grant an exclusive franchise Figure 7.6 Monopoly Equilibrium 5

6 Monopoly Figure 7.7 The Firm and Market Demand Curve with Equilibrium Do monopolists always make a profit? Do monopolists always charge as high a price as possible? Natural Monopoly Exclusive government franchises are often granted to natural monopolies Natural monopolies are not always and forever Natural monopolies are usually price regulated Natural monopolies have LRAC monotonially falling (i.e., one firm is cheaper than two, three, or more firms) Figure 7.8 Long-Run Equilibrium in a Competitive Market We mimic this with Average Cost Pricing (see P A in previous slide) Average Cost Pricing Operate where AC = D P = MR = MC = AC Figure 7.8 Long-Run Equilibrium in a Competitive Market We mimic this with Marginal Cost Pricing (see P M in the previous slide) Marginal Cost Pricing Operate where MC = D P = MR = MC = AC 6

7 Monopoly Deadweight Loss Three Basic Strategies Monopoly Overcharge P M Monopoly Profit Deadweight Loss (welfare-loss triangle) 1. Cost Reduction; 2. Product Differentiation; 3. Reduction in Competitive Intensity P C 1. Cost Reduction Is sustainable only if it is difficult to reproduce 2. Product Differentiation Equivalent to a reduction in the elasticity of demand for the product The more unique your product relative to other market offerings, the less elastic your product will be. Example: Perdue Chicken (Successful) Prelude Lobster (Unsuccessful) 3. Reduction in Competitive Intensity Rent Seeking Rent Seeking An economic rent is the portion of earnings in excess of the minimum amount needed to attract the worker to accept a particular job or a firm to enter a particular industry. Governmental decisions to grant monopolies, determine rates for utilities, or establish tariffs or other trade barriers can create rents for firms. Experiment 7

8 Source of Most Rents Governmental decisions to grant monopolies, determine rates for utilities, or establish tariffs or other trade barriers can create rents for firms. Capturing Rents Firms attempt to capture rents for themselves rather than having to go elsewhere. They do so both by participating legitimately and legally in the political and regulatory processes and, sometimes, by paying bib bribes. The result is a costly public policy problem because rent seeking activities serve no social function other than to transfer rents; they are a social cost of immense proportions. Price Discrimination (or Monopoly Price Discrimination) The practice of charging different prices to various customers for a given product. 1) Third-Degree or Market Segmentation 2) Second-Degree or Multipart Pricing 3) First-Degree or Perfect Price Discrimination Wildwood, New Jersey 8

9 Table 7.1 continued Table 7.1 Conditions Required For Third-Degree Price Discrimination There must be some degree of monopoly power in the market. Price Discrimination at Notre Dame Third Degree You must be able to identify separate market segments. You must be able to preclude buyers from reselling in another segment. Third-Degree Price Discrimination at Notre Dame Price Discrimination Third Degree Third Degree Example You are employed by a hospital that has succeeded through some innovative contracts in dividing its market into three distinct segments; each segment is completely sealed off from the other. The demand curves for the hospital s output are Customer group 1: P 1 = 63-4Q 1 MR 1 = 63-8Q 1, Customer group 2: P 2 = 105-5Q 2 MR 2 = Q 2 Customer group 3: P 3 = 75-6Q 3 MR 3 = 75 12Q 3 Note that MR = MC determines the price/quantity combination in each market -- even with price discrimination where P 1, P 2, and P 3 are the prices charged in each market, Q 1, Q 2, and Q 3 are the amounts sold in each market. The hospital s total cost function is: TC = Q MC= 16 Exercise 7.9, page 262 9

10 Third Degree Example Profits are maximized where MC = MR First-Degree and Second Degree Price Discrimination (Perfect Price Discrimination) MC = 16 MC = 16 = MR 1 = 63-8Q 1 8Q 1 = Q 1 = 47/8 = P 1 = 63-4 (5.875) = 39.5 MC = 16 = MR 2 = Q 2 10Q 2 = Q 2 = 89/10 = 8.9 P 2 =105 5 (8.9) = 60.5 MC = 16 = MR 3 = 75-12Q 3 12Q 3 = Q 3 = 59/12 = 4.92 P 3 = 75-6 (4.92) = Exercise 7.9, page 262 Peak-Load Demand (Electricity Usage by Time of Day) End of Chapter 7 Chapter 8 10

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