Unit 4, Lesson 10 Competition AOF Business Economics Copyright © 2008–2011 National Academy Foundation. All rights reserved.

Economics looks at characteristics and outcomes when considering competitive markets Characteristics Large number of buyers and sellers Products are alike Low or no barriers to entry Outcomes Firms and consumers are “price takers” (the market sets prices) Zero profits, after allowing for the opportunity cost of capital Consumers get low prices Economically efficient (low price, better suppliers gain market share) What economic forces are at work here? Similar products and lots of choices Many firms competing

There’s no economic profit in a perfectly competitive market If a firm begins to make profit (total revenue > total cost) providing a product or service, competitors soon enter to take a piece of the pie Competition lowers the price until it just covers the costs (opportunity cost of capital included) With “no profit,” how can firms continue to exist? More competitors means lower profits for each firm

There are advantages to a highly competitive market It’s efficient: Society’s resources are used well to produce the products customers want Firms have to operate at the lowest possible per-unit cost Consumers get the lowest possible price Who benefits more from a competitive market: consumers or producers?

There are disadvantages to a highly competitive market No profit means no money for research and development Doesn’t consider social costs and benefits (only “private” costs are considered) Smoke from packing facility pollutes the air Pretty avocado trees benefit neighbors Research goes down while pollution goes up Is this a good tradeoff for lower prices?

Monopolies share certain attributes Characteristics Single seller (high barriers to entry) A unique product with no close substitutes Price maker Outcomes Monopoly maximizes profits by limiting production and setting prices well above the cost of production New firms cannot enter to increase supply and decrease costs Inefficient use of resources What are possible barriers to entry?

Monopolies have some advantages to the consumer Monopoly profits provide discretionary funds, above the cost of production and the opportunity cost of capital. These can be used to pay for research and development Under some circumstances, monopolies are more economically efficient than alternatives: High fixed costs + low marginal costs = Extreme economies of scale Who benefits more from a monopoly: producers or consumers?

Price generally higher, and quantity lower, than with competition: Less produced than in a competitive market Price can be substantially higher than the per-unit cost of production Often economically inefficient: Consumers willing and able to pay more than the full cost of production can’t do so Firms willing to produce at a lower price can’t do so Monopolies also have disadvantages Why does a monopoly have limited incentives to produce more? Prices are often higher in a monopolistic market than they would be in a competitive market

Patents grant firms an exclusive right to a new product, technology or process, for a period of time Monopoly profits provide an incentive to invest in research and development (R&D) Patents create monopolies How is illegal downloading of songs like a patent infringement? The longer the patent right, the greater the incentive for research and development

Are monopolies good or bad? Good Incentivizes companies to engage in R&D and helps them pay for it Patents reward the entrepreneurial innovation in new products and technology Are the economic costs of creating a monopoly worth the benefits of R&D? Bad Monopolies often mean higher prices, and fewer goods produced, than with competition The supplier gains, but consumers pay high prices Barriers to entry lead to inefficiencies

Markets are constantly shifting New products are invented, which make old ones obsolete Government regulations change the playing field Consumer needs and tastes change The cost of resources rises or falls The business economist must understand local and global economic shifts Markets change for many reasons, including: