Competition

Market Structure The number and relative size of firms in an industry.

Market Structures Imperfect competition Perfect competition Monopolistic competition Oligopoly Duopoly Monopoly

Competitive Firm A perfectly competitive firm is one without market power. It is not able to alter the market price of the good it produces. It is a price taker.

Competitive Market A competitive market is one in which no buyer or seller has market power. No single producer or consumer has any control over the price or quantity of the product.

Monopoly A monopoly firm is one that produces the entire market supply of a particular good or service. It is a price setter, not a price taker.

Market Power Market power is the ability to alter the market price of a good or service. Your campus book store has market power.

Imperfect Competition Imperfect competition is between the extremes of monopoly and perfect competition.

Imperfect Competition In duopoly only two firms supply a particular product. In oligopoly a few large firms supply all or most of a particular product.

Imperfect Competition In monopolistic competition many firms supply essentially the same product but each has brand loyalty.

Perfect Competition Perfectly competitive firms are pretty much faceless. They have no brand image, no real market recognition.

Perfect Competition A perfectly competitive firm is one . . . . . . whose output is so small in relation to market volume, . . . that its output decisions have no perceptible impact on price.

No Market Power The output of a lone perfect competitor is so small relative to market supply that it has no significant effect on the total market quantity or price.

Price Takers A perfectly competitive firm is a price taker. Individual firms output decisions do not effect the market price.

Price Takers Individual firms must take the market price and do the best they can within these constraints.

Market Demand vs. Firm Demand You must distinguish between the market demand curve and the demand curve confronting a particular firm.

Market Demand vs. Firm Demand The market demand curve is always downward sloping. The demand curve facing a perfectly competitive firm is horizontal.

Demand for Individual farmer's catfish Market vs. Firm Demand QUANTITY (thousand fish per day) The catfish market QUANTITY (fish per day) Demand for Individual farmer's catfish PRICE (per fish) Market supply Equilibrium price Demand facing single farmer pe pe Market demand

The Firm’s Production Decision Choosing a rate of output is a firm’s production decision. It is the selection of the short-term rate of output with existing plant and equipment.

Total revenue = price x quantity Output and Revenues Total revenue is the price of a product multiplied by the quantity sold in a given time period. Total revenue = price x quantity

Revenues vs. Profits Profit is the difference between total revenue and total cost. Maximizing output or revenue is not the same as maximizing profits.

Revenues vs. Profits Total profits depend on how costs increase as output expands.

Profit Maximization To maximize profit, the firm should produce an additional unit of output only if it brings in more revenue than it costs.

Price Since competitive firms are price takers, they must take whatever price the market has put on their products.

Marginal Cost Marginal cost is the increase in total costs associated with a one-unit increase in production.

Marginal Cost Marginal cost generally increases as rate of production increases due to diminishing returns.

The Costs of Catfish Production

The Costs of Catfish Production $18 F 16 Marginal cost 14 E 12 10 D COST (dollars per basket) 8 C 6 B 4 2 1 2 3 4 5 6 7 RATE OF OUTPUT (baskets per hour)

Profit-Maximizing Rate of Output Never produce anything that costs more than it brings in. Boils down to comparing price and marginal cost.

Profit-Maximizing Rate of Output A competitive firm wants to expand the rate of production whenever price exceeds marginal cost.

Profit-Maximizing Rate of Output Short-run profits are maximized at the rate of output where price equals marginal cost.

Short-Run Decision Rules for a Competitive Firm Price > MC increase output rate Price = MC maintain output and maximize profit Price < MC decrease output rate

Maximization of Profits for Competitive Firm

Maximization of Profits for Competitive Firm $18 Marginal cost 16 Profits decreasing 14 B p = MC 12 Price Profits increasing 10 PRICE OR COST (per basket) 8 6 Profit-maximizing rate of output 4 MCB 2 1 2 3 4 5 6 7 QUANTITY (baskets per hour)

Total Profit Total profit can be computed in one of two ways: Total profit = total revenue – total cost Total profit = average profit x quantity sold

Total Profit Profit per unit = p – ATC Profit per unit equals price minus average total cost Profit per unit = p – ATC

Total profits = (p – ATC) X q Total profits equals profit per unit times quantity Total profits = (p – ATC) X q

Total Profit The profit-maximizing producer never seeks to maximize per-unit profits.

Total Profit The profit-maximizing producer has no particular desire to produce at that rate of output where ATC is at a minimum.

Total Profit Total profits are maximized only where p = MC

Illustrating Total Profit 1 2 3 4 5 6 7 8 10 12 14 16 $18 RATE OF OUTPUT (baskets per hour) COST (per basket) Average total cost Price TOTAL PROFIT Profit per unit Cost per unit Marginal cost

Supply Behavior How firms make production decisions helps explain how the market establishes prices and quantities.

A Firm’s Supply Supply is the ability and willingness to sell specific quantities of a good at alternative prices in a given time period.

Supply Behavior To be competitive, quantity supplied is adjusted until MC = price. The marginal cost curve is the short-run supply curve for a competitive firm.

Supply Shifts Marginal costs determine the supply decisions of a firm. Anything that alters marginal cost will change supply behavior.

Supply Shifts Important influences on marginal cost and supply behavior are: Price of factor inputs Technology Expectations

Market Supply Market supply is the total quantities of a good that sellers are willing and able to sell at alternative prices in a given time period.

Market Supply The market supply curve is the sum of marginal cost curves of all firms.

Competitive Market Supply 1 2 3 4 $5 20 40 60 (a) Farmer A MCA a PRICE (per pound) 20 40 60 (b) Farmer B MCB b 1 2 3 4 $5 20 40 60 (c) Farmer C MCC c 1 2 3 4 $5 + + QUANTITY (pounds per day)

Competitive Market Supply 1 2 3 4 $5 (d) Market supply QUANTITY (pounds per day) 50 100 150 200 250 300 d PRICE (per pound) =

Competitive Market Supply Determinants of Market Supply Price of factor inputs Technology Expectations Number of firms in the industry

Industry Entry and Exit To understand how competitive markets work, we focus on changes in equilibrium rather than on equilibrium itself.

Industry Entry and Exit The number of firms in a competitive industry is not fixed. Industry entry and exit is a driving force effecting market equilibrium.

Entry Additional firms will enter the industry when profits are plentiful.

Entry Economic profits attract firms. Industry output increases. Market supply curve shifts right as entry increases. Price falls.

Entry Industry output increases and price falls when firms enter an industry.

Market Entry QUANTITY (thousands of pounds per day) PRICE (per pound) Entry of new firms E1 p1 p2 E2 Market Demand q1 q2

The Tendency Toward Zero Economic Profits New firms continue to enter a competitive industry so long as profits exist.

The Tendency Toward Zero Economic Profits Once price falls to the level of minimum average cost, all economic profits disappear.

The Tendency Toward Zero Economic Profits Entry is the force driving down market prices. Price falls until there are no economic profits. At that point, average cost is at a minimum.

Reduces profits of competitive firm The Lure of Profits Market entry pushes price down and . . . Reduces profits of competitive firm QUANTITY (thousands of pounds per day) QUANTITY (pounds per day) S1 S2 MC ATC S3 E1 p1 p1 p2 p2 p3 p3 Market demand

Exit Firms exit the industry when profit opportunities look better elsewhere. Firms leave the industry if price falls below average cost. As firms exit the industry, the market supply curve shifts to the left.

Exit Price rises until there are no economic losses. At that point, average cost is at a minimum.

Equilibrium The existence of profits in a competitive industry induces entry. The existence of losses in a competitive industry induces exits.

Long-Run Equilibrium In long-run competitive market equilibrium: Price equals minimum average cost. Economic profit is eliminated.

Long-Run Equilibrium Economic profits will not last long as long as it is easy: For existing producers to expand production, or For new firms to enter an industry.

Low Barriers to Entry There are no significant barriers to entry in competitive markets. Barriers to entry are obstacles that make it difficult or impossible for would-be producers to enter a market.

Characteristics of a Competitive Market Many firms Identical products Low barriers to entry MC = p Zero economic profit Perfect information

The Virtues of Competition The market helps signal what should and should not be produced. The market sends signals which reallocate resources to other products.

The Relentless Profit Squeeze The unrelenting squeeze on prices and profits is a fundamental characteristic of the competitive process.

The Relentless Profit Squeeze The market mechanism works best in competitive markets. Market mechanism – the use of market prices and sales to signal desired outputs.

The Relentless Profit Squeeze High profits in a particular industry indicate that consumers want a different mix of output.

The Relentless Profit Squeeze As more firms enter the industry, consumers get their desired mix of output. They get more of the goods they desire at a lower price.

Maximum Efficiency Competitive pressure on prices forces suppliers to produce at the least possible cost. Society gets the most it can from its available (scarce) resources.

Zero Economic Profits All economic profits are eliminated at the limit of the competitive process.

The Social Value of Losses Economic losses are a signal to producers that they are not using society’s scarce resources in the best way.

Policy Perspective Government should promote competition because competitive markets do best what society wants. This means keeping markets open and accessible to new entrants.

Competition End of Chapter 6