CHAPTER 7 MARKET STRUCTURES

Pretending you were the owner of the company on your sheet of paper… 1) How much competition do you have (how many other companies/people sell the same or at least a similar product)? 2) Can you advertise to try to attract customers to your product? (in other words, is it possible to differentiate your product from the competition?) 3) How difficult would it be to start a business such as this? (Are there substantial start-up costs or relatively few start-up costs?) 4) Do you have the ability to charge a higher price than your competitors or do you need to charge exactly the same price as the competition? 5) Do you think you are able to make large profits or would they be modest?

Hampton Shaler Water Authority and the NFL Competition? Advertise? Difficulty to start? Price… Large profits possible?

Coca-Cola Competition? Advertise? Difficulty to start? Price… Large profits possible?

Burger King Competition? Advertise? Difficulty to start? Price… Large profits possible?

Cover Girl makeup Competition? Advertise? Difficulty to start? Price… Large profits possible?

A farmer who sells his oranges to juice companies Competition? Advertise? Difficulty to start? Price… Large profits possible?

Let’s get some things straight… Price does NOT equal cost! Price is what is charged for a good (what a producer RECEIVES by selling it). Cost is what is takes him to produce the good. Revenue = money IN Total revenue = price of product x quantity sold Cost = money OUT Total cost = cost of product x quantity sold Therefore, profit = revenue – cost (i.e., what is leftover!)

PRODUCTION COSTS Variable costs - costs that rise or fall depending on quantity produced Raw materials, wages of workers, utilities Fixed cost – cost that does not change, no matter how much of a good is produced Rent, property taxes, salaries of workers Total cost – fixed costs + variable costs Marginal cost – additional cost of producing one more unit

LABOR AND OUTPUT Basic question of any business: How many workers should we hire??? Consider: relationship between # workers and how much they produce

LABOR AND OUTPUT Marginal product of labor – change in output from hiring one more worker Increasing marginal returns – adding another worker increases total output at an increasing rate Benefits from specialization for the first few workers Ex: did adding your 2 nd worker more than double your output? Diminishing marginal returns – when adding more workers increases total output, but at a decreasing rate Workers must work with a limited amount of capital You only had one stapler, one ruler, and one pair of scissors Negative marginal returns (diminishing returns) – when adding more workers actually decreases total output

SETTING OUTPUT Always set output at marginal revenue = marginal cost !!! Marginal revenue – additional income from selling one more unit of a good (Same as PRICE) If marginal revenue (what they take IN) is still greater than marginal cost (what they pay OUT), then that additional unit sold will add more to their profit!

THE SHUTDOWN DECISION Sometimes price is so low that factory’s revenue is lower than its cost Should they continue to produce?? Firms should operate at a loss if the revenue from the goods it produces is greater than the cost of keeping it open (variable costs) They can at least cover some of their fixed costs If they shut down, they still have to pay all fixed costs!

Perfect Competition 7.1: The first type of competitor we are going to talk about! (Probably the hardest one for you to understand, so it’s all down hill from here!!!)

Four conditions for Perfect Competition Many buyers and sellers participate in the market Sellers offer identical products Buyers and sellers are well informed about products Sellers are able to enter and exit the market freely

1. Many buyers and sellers No individual buyer or seller can influence the total market quantity or the market price Supply and demand determines price without any influence from individual suppliers or consumers Sellers MUST charge this price or they will sell NONE of their product What if ONE orange farmer (out of thousands in our country) decided to charge a slightly more expensive price for his oranges?

2. Identical Products All suppliers offer the same product or service There are no differences – consumers can’t tell the difference There is no way to differentiate Commodity – a product that is considered the same regardless of who makes or sells it low-grade gasoline, notebook paper, milk a buyer will not pay extra for one particular company’s goods but will always choose the supplier with the lowest price

3. Informed buyers and sellers Buyers and sellers know enough about the market to find the best deal they can get You have full information about the product and its price

4. Free market entry and exit What are barriers to entry? How expensive or difficult it is to get into a certain business or to get out of it Start-up costs – the expenses that a new business must pay before the 1 st product reaches the customer High start-up costs or technological know-how keep many entrepreneurs from entering a market Ex: less expensive to start up a sandwich shop than a giant supermarket In perfect competition… Firms can very easily enter a market when they can make money Firms can very easily exit a market when they can’t earn enough to stay in business

Price and Output So why do we care and why are we starting with perfect competition? Because of all of the competing sellers: Perfectly competitive markets are the most efficient Competition keeps prices and production costs low Firms have no choice but to use land, labor, organizational skills, machinery, and equipment to their best advantage Prices that consumers pay are very close to what it cost to produce the good prices are the lowest possible prices just cover the most efficient sellers’ costs of doing business

To summarize, in a perfectly competitive market… How many sellers?____________________ (a lot / a few / one) Can sellers differentiate their product? Entry and exit is _________________ (easy / difficult). Therefore, barriers to entry are ___________ (low / high). Prices are kept _________________ (low / high). Therefore, they are said to be _________________ (efficient / inefficient).