1. Competitive Markets
Chapter 23

2. Introduction This chapter focuses on three key questions:
How are prices determined in competitive markets?
How does competition affect the profits of a firm or industry?
What does society gain from market competition?

3. The Market Supply Curve
The market supply curve determines the equilibrium price faced by an individual producer.
Equilibrium price – The price at which the quantity of a good demanded in a given time period equals the quantity supplied.
Market supply – The total quantities of a good that sellers are willing and able to sell at alternative prices in a given time period, ceteris paribus.

4. The Market Supply Curve
The market supply curve is the sum of the marginal cost curves of all the firms.
Marginal cost (MC) – The increase in total cost associated with a one-unit increase in production.

5. The Market Supply Curve
Whatever determines marginal cost also determines the competitive firm’s supply response.

6. The Market Supply Curve
The market supply of a competitive industry is determined by:
The price of factor inputs.
Technology.
Expectations.
Taxes.
The number of firms in the industry.

7. Competitive Market Supply20 40 60 1 2 3 4 $5
Price
Farmer A
Quantity a
MCA 20 40 60
Farmer B
Quantity b
MCB 20 40 60
Farmer C
Quantity c
MCC
100
200
Market supply
Quantity d + + =

8. Entry and Exit
Investment decisions shift the market supply curve to the right.
Investment decision - The decision to build, buy, or lease plant and equipment; to enter or exit an industry.

9. Entry and Exit The profit motive drives these investment decisions.
If there are economic profits, more firms will enter the industry increasing market supply.
Each firm will respond to the resulting lower price and profits by reducing output.

10. Market Entry Market entry pushes price down and . . .
Reduces profits of competitive firm
Price
Quantity
Quantity S1 MC S2
ATC E1 f1 p1 p1 f1 p2 p2 E2
Market demand
New firms enter q1 q2

11. Tendency Toward Zero Profits
An increase in market supply causes the economic profits to disappear.
Economic profits – The difference between total revenues and total economic costs.

12. Tendency Toward Zero Profits
When economic profits disappear, entry ceases and the market price stabilizes.
As long as it is easy for existing producers to expand production or for new firms to enter an industry, economic profits will not last long.

13. Tendency Toward Zero Profits
This is how competitive markets work.
A competitive market is a market in which no buyer or seller has market power.

14. Low Barriers to Entry
Barriers to entry are obstacles that make it difficult or impossible for would-be producers to enter a particular market.

15. Low Barriers to Entry Barriers to entry may include: Patents.
Control of essential factors of production.
Control of distribution outlets.
Well-established brand loyalty.
Government regulation.

16. Market Characteristics of Perfect Competition
Some of the structures, behaviors and outcomes of a competitive market are:
Many firms - none of which has a significant share of total output.
Perfect information - buyers and sellers have complete information on supply, demand, and prices.

17. Market Characteristics of Perfect Competition
Some of the structures, behaviors and outcomes of a competitive market are:
Identical products - products are homogeneous; one firm’s products is the same as any other’s.
MC = p - all competitive firms seek to expand output until marginal cost equals the product’s market price.

18. Market Characteristics of Perfect Competition
Some of the structures, behaviors and outcomes of a competitive market are:
Low barriers to entry - entry barriers are low, economic profits will attract more firms.
Zero economic profit - market supply expands as long as there are economic profits, pushing prices and economic profits down.

19. Competition at Work: Microcomputers
Few, if any, product markets are perfectly competitive.
Many industries function much like a competitive market.

20. Competition at Work: Microcomputers
The microcomputer market illustrates how the process of competition works.

21. Initial Conditions: The Apple I
Steve Jobs and Steven Wozniak created the Apple Computer Corporation in 1977.
Other companies noted the profits and, due to the low barriers to entry, followed Apple’s lead.

22. The Production Decision
Each firm seeks to make the best short-run production decision.
Production decision - The selection of the short-run rate of output (with existing plant and equipment).

23. The Production Decision
To maximize profit, each competitive firm seeks the rate of output at which marginal cost equals price.

24. Initial Equilibrium in the Computer Market
$1200
1000
800
600
400
200 20 40 60 80
Market demand
Market equilibrium
Market supply
Quantity (thousands)
Price (per computer)
The computer industry
1200
1000
800
600
400
200
Market price
Profits m D
Average total cost
P = MR
Quantity C
PRICE OR COST
The typical firm

25. Profit Calculations
A profit-maximizing producer seeks to maximize total profit.

26. Total profit = profit per unit X quantity sold
Profit Calculations
This is not necessarily or even very frequently the same thing as maximizing profit per unit.
Profit per unit - Total profit divided by the quantity produced in a given time period.; price minus average total cost.
Total profit = profit per unit X quantity sold

27. Computer Revenues, Costs and Profits

28. Computer Revenues, Costs and Profits

29. The Lure of Profits
In competitive markets, economic profits attract new entrants.

30. Low Entry Barriers
Low entry barriers permit new firms to enter competitive markets.

31. A Shift of Market Supply
The entry of new firms shifts the market supply curve to the right.

32. A Shift of Market Supply
New entrants will continue to be attracted as long as there are economic profits in short-run competitive equilibrium.
Short-run competitive equilibrium: p = MC

33. A Shift of Market Supply
Any short-run equilibrium will not last.
As supply increases, price drops toward the minimum of ATC.
Once at minimum of ATC, there are no longer economic profits to attract firms to enter.

34. A Shift of Market Supply
In long-run equilibrium, entry and exit cease, and zero economic profit (that is, normal profit) prevails.
Long-run equilibrium: p =MC =minimum ATC

35. A Shift of Market Supply
Once established, long-run equilibrium will continue until market demand shifts or technological improvement reduces the cost of computer production.

36. The Competitive Price and Profit Squeeze
An expanded market supply . . .
Lowers price and profits for the typical firm
20,000
$1000
800
Quantity (computers per month)
Price (per computer)
500
600
800
$1000
Price or Cost (per computer)
Quantity (computers per month) MC S1
ATC S2
Old price
Profits G
New
price H m
Market demand

37. The Competitive Squeeze Approaching Its Limit
The computer industry
The typical firm
20,000
$1000
800
Quantity (computers per month)
Price (per computer)
500
600
800
$1000
Price or Cost (per computer)
Quantity (computers per month) MC
ATC S2 S3
Old price
700 J
620
New
price
Profits m K
Market demand

38. Short- vs. Long-Run EquilibriumMC
ATC pS qS
Price or Cost
Quantity
Short-run equilibrium (p = MC) pS
Price or Cost pL qL
Quantity MC
ATC
Long-run equilibrium (p = MC = ATC)

39. Long-Run Rules for Entry and Exit

40. Home Computers vs. Personal Computers
Once long-run equilibrium was reached in the microcomputer market, producers were forced either:
To develop a better product (to increase demand), or
To reduce costs of production.

41. Home Computers vs. Personal Computers
Manufactures of computers did both —separating the market into home computers and personal computers

42. Price Competition in Home Computers
The home computer market confronted the fiercest form of price competition leaving the only option to make an extra buck to push the cost curve down.

43. Price Competition in Home Computers
Costs were pushed down by reducing the number of components and using more powerful computer chips.

44. Further Supply Shifts
With strong competition, often the only way for a firm to improve profitability is to reduce costs.
Cost reductions were accomplished through technological improvements.

45. Further Supply Shifts
Technological improvements are illustrated by a downward shift of the ATC and MC curves.

46. Lower Costs Shifts the Supply Curve Downward
Price (per computer)
Quantity (computers per month)
Old MC
New MC
Old
ATC
New
ATC J N
$700 R
430
600

47. Shutdowns
Once a firm is no longer able to cover variable costs, it should shut down production.
The shutdown point is the rate of output at which price equals minimum AVC.

48. Exits
Most firms withdrew from the home computer market due to low profits.
The exit rate in matched the entry rate of

49. The Personal Computer Market
Firms initially competed on the basis of product improvements.
Eventually, firms could not sell all the PCs they produced at prevailing prices.
They were forced to cut their prices.
Many shut down.

50. Competitive Process
Competitive market pressures were a driving force in the spectacular growth of the computer industry.
Consumers reaped substantial benefit from competition in computer markets.

51. Allocative Efficiency: The Right Output Mix
The market mechanism works best in competitive markets.
Market mechanism – the use of market prices and sales to signal desired output (or resource allocations).

52. Allocative Efficiency: The Right Output Mix
High profits in a particular industry indicate consumers want a different mix of output.
A competitive market determines the opportunity cost of producing different goods.

53. Allocative Efficiency: The Right Output Mix
The price signal the consumer gets in a competitive market is an accurate reflection of opportunity cost.
Opportunity cost – The most desired goods or services that are forgone in order to obtain something else.

54. Allocative Efficiency: The Right Output Mix
The marginal cost pricing characteristic of competitive markets answers the WHAT-to-produce question efficiently.
Marginal cost pricing – The offer (supply) of goods at prices equal to their marginal cost.

55. Allocative Efficiency: The Right Output Mix
The amount consumers are willing to pay for a good (its price) equals its opportunity cost (marginal cost).

56. Production Efficiency
Production efficiency means that we are producing at minimum average total cost.
Efficiency – Maximum output of a good from the resources used to produce it.

57. Production Efficiency
When competitive pressure on prices is carried to the limit, the products in questions are produced at the least possible cost.

58. Production Efficiency
Society is getting the most it can from its available (scarce) resources.

59. Zero Economic Profit
In the long-run, all economic profit is eliminated.

60. Summary of Competitive Process
Quantity (units per time period)
Price (dollars per unit)
Market demand
Industry ATC
Industry MC
Short-run
equilibrium a c b
Long-run equilibrium

61. Relentless Profit Squeeze
The sequence of events common to a competitive market situation includes the following.

62. Relentless Profit Squeeze
High prices and profits signal consumers’ demand for more output.

63. Relentless Profit Squeeze
Economic profit attracts new suppliers.

64. Relentless Profit Squeeze
The market supply shifts to the right.

65. Relentless Profit Squeeze
Prices slide down the market demand curve.

66. Relentless Profit Squeeze
A new equilibrium is reached with increased quantities being produced and sold and the economic profit approaching zero.

67. Relentless Profit Squeeze
Throughout the process, producers experience great pressure to keep ahead of the profit squeeze by reducing costs.

68. Relentless Profit Squeeze
The potential threat of other firms expanding production or of new firms entering the industry keeps existing firms on their toes.

69. The Economy Tomorrow: HDTV for $500?
The first HDTV sets appeared on the American market in 1993.
They were not supplied in commercial quantities until 1998.
The 56-inch Panasonic HDTV went on sale for a base price of $5,500 in August 1998.

70. Price and Competition
In the first year of availability, consumers purchased only 10,000 HDTVs at the price of $5,500.
They purchased 23 million analog TVs at a price closer to $300.

71. Price and Competition
New entrants to the HDTV market are expected to dramatically lower prices and increase unit sales.

72. Price and Competition
Sony, Sharp, Hitachi, Zenith, RCA, Samsung, Sanyo and others promised better and cheaper HDTVs.

73. Competitive Markets
End of Chapter 23