GED Social Studies Practice Test: Competition (or Lack of It)

You probably grumble about your cable TV bill. You think it’s too high (though the company doesn’t think so). So what can you do? Build your own cable network? Not very likely. Switch cable companies? No such luck. There’s only one company servicing your area.

You’re so upset you decide to go shopping. At the mall you find a dizzying array of clothing. Don’t like one style? Move on to another section of the store or, even better, another store. Find something you like? See if you can get it (or something like it) for less in a different store.

In the first example, we see lack of competition. In the second, we see the benefits of competition. As a general rule, highly competitive markets offer a greater selection of goods and services and a wider variety of prices (remember, different consumers have different amounts of money to spend).

Let’s look at four models of competition. Remember, these are models — not exact descriptions of how things actually work, but how things would work, given a set of assumptions.

Perfect Competition. In the ideal market structure, known as perfect competition, buyers and sellers would be able to act in precise conformance with the laws of supply and demand. No one agent controls demand, supply, or prices. It also assumes that there are identical products (or nearly identical) products offered, that buyers are completely rational (which they often are not — and economics is pretty bad at explaining human economic behavior), and sellers can enter, or exit, a market easily.

When there are identical products, buyers will shop around for the best price, and sellers will have to compete to offer the product at the lowest possible price (and still make a profit). In this enviable situation, the buyer is comparing not apples and oranges, but apples and apples. Let’s say all clothing stores offer the same brand of jeans. All you have to do is go from store to store to find the best price.

One thing that’s assumed in perfect competition is that buyers are well-informed and know what they want. Another assumption is that it’s easy for a supplier to set up a business and enter the market (assuming there’s profit to be made) and can also fold up and exit the market if the business isn’t profitable or the good(s) it offers aren’t selling. Today, we hear a lot about “pop-up” stores. That means someone can easily rent a space, buy stock, and open up for business in a matter of days or months. When the stock is sold out, the store often closes. That’s easy entry and exit. Compare that with a department store, which has to buy or lease space (or   build a store), hire lots of employees, carry a wide variety of goods, and advertise.

Monopolistic Competition.  In this model, sellers offer different products, and each seller wants to “corner the market” in its particular niche. Store X wants to sell all of the pink jean, while Store Y offers jeans in different fabrics and textures. We Americans like variety; we call it product differentiation. There may also be non-price competition (unlike perfect competition, in which the sole criterion for differentiation is price). Designer clothes will keep you as warm and dry as non-label clothes, but people will often pay more for a “name.” There’s a market for both kinds of products.

And this is where advertising comes in. A seller may spend millions of dollars trying to convince you that its product or service is better than others. Advertising may be pretty, clever, or persuasive (or all three), but it has one central purpose: to increase demand.

Oligopoly. Drive around and look at how many brands of gasoline you can buy. Chances are, you’ll see the same brands over and over. There are only a handful of international oil companies that refine and provide gasoline in the United States and elsewhere. Oligopoly is a market structure in which there are just a handful of large sellers that control all (or most) of the market for a particular good or service. Decades back, there were seven international oil companies (known as the “Seven Sisters”). That was it. If you wanted oil, you had to buy from one of the seven.

In an oligopoly, there are identical or nearly identical products. Gasoline is gasoline. Cable TV is cable TV. There’s just not much difference between the product from Company A and that from Company B.

An oligopoly tends to be a closed system. It’s a difficult market to enter. Jane Entrepreneur might want to open an oil company, but it’s going to be an almost impossible task; she’d have to buy or lease oil properties, build refineries, hire oil tankers, and establish a network of distributors. The bar to entry is almost impossible to overcome. If you’re in, you’re in. But newcomers are (a) not welcome; and (b) few and far between.

The prices for goods in oligopolies tend to be similar from seller to seller, and each seller watches its competitors closely. Even though the product is more or less identical, producers try to differentiate (usually through advertising) by stressing a particular trait (“cleans your engine”; “reduces friction”) in order to build brand loyalty.

Usually, one firm will make a change (increase or decrease in price), and the other firms of the oligopoly will follow suit. Just look at price wars among airlines or oil companies.

You might ask, “Why don’t the sellers in an oligopoly get together and agree on prices and agree to split up the market?” Well, you may recall reading about monopolistic practices of railroads and steel companies in the 19th century, and how such collusion (working together in secret) hurt consumers. Collusion and price-fixing are illegal under antitrust laws and state governments and the federal government tend to enforce antitrust laws vigorously.

Monopoly. Think about the board game you played as a kid. If you own one of the properties and have hotels on it, you have to pay the rent (or go to jail). Three conditions are required for a monopoly to exist: (1) there is only ONE seller; (2) no substitute or similar good or service is available; and (3) other sellers cannot enter the market.

Before 1984, there was the phone company: American Telephone and Telegraph. If you wanted to call someone, your money went to AT&T. The company owned the telephones in your home, the wires over which the signals were sent; the switching centers; and the billing centers. If you didn’t want to use AT&T, you had to use two soup cans and some string. In 1984, the federal government used its antitrust laws to break up the company.

In many areas, there’s one cable or satellite TV provider. Don’t like the service you get? Tough noogies.

It is true that a monopoly is efficient. AT&T provided high quality (just think about the quality of your phone calls today) — but at a high price. It was able to deliver its services efficiently because of economy of scale — it was able to use its human, natural, and capital resources efficiently and didn’t have to worry about splitting them up and dealing with competition.

Today, you’ll often find monopolies in cable and television service, as well as electric service. In the New York area, for example, you get your electricity from the Consolidated Edison Company. That’s it. The truth is, having a dozen companies with duplicative generating stations, substations, power lines, and the like would be inefficient.

However, in many instances, state governments and the federal government will regulate a monopoly — usually by imposing caps on what it may charge — to prevent the abuse of consumers.

 

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