Stone
Chapter COREECONOMICS
Competition
8
Gerald Outline
8 chapter
Market Structure Analysis Competition: Short-Run Decisions Competition: Long-Run Adjustments Globalization, Long-Run Adjustments, and The Box
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Learning Objectives
8 chapter
At the end of this chapter, the student will be able to:
Identify the characteristics of a competitive market Explain the profit-maximizing rule Determine the best strategy for minimizing losses in the short-run Derive the short-run industry supply curve Account for the differences between constant cost industries, decreasing cost industries, and increasing cost industries.
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Market Structure Analysis
8 chapter
These factors define the intensity of competition in an industry:
Number of firms Nature of product Barriers to entry Extent of control over price
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Primary Market Structures
8 chapter
Competition Monopolistic Competition Oligopoly Monopoly
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Competitive Markets
8 chapter Characteristics of competitive markets: They have many buyers and sellers, each one so small that none can individually influence the price. Firms in the industry produce a homogeneous or standardized product. Buyers and sellers have all the information about prices and product quality they need to make informed decisions. Barriers to entry or exit are insignificant in the long run; new firms are free to enter the industry if so doing appears profitable, while firms are free to exit if they anticipate losses.
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Competitive Markets
8 chapter
In a competitive market, each individual firm is a price taker. This means that the firm can sell as much as it would like at the going market price. The firms total revenue will be equal to price x quantity sold.
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A Firm in a Competitive Market
8 chapter
Price ($) Price ($)
Panel A Industry S
Panel B Firm
200
200
d=MR=P=$200 D
Qe Industry Output
q1 Firms Output
q2
The individual firm takes the market price as given.
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The Short Run and the Long Run
8 chapter
In the short run, one factor of production is fixed, usually the plant size.
Firms cannot enter or leave the industry.
In the long run, all factors are variable.
Firms will enter the industry in response to profits. Firms will leave the industry in response to losses.
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Checkpoint
8 chapter
Market Structure Analysis
Market structure analysis allows economists to categorize industries based on a few characteristics and use this analysis to predict pricing behavior. The intensity of competition is defined by the number of firms in the industry, the nature of the industrys product, the level of barriers to entry, and how much firms can control prices.
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Checkpoint
8 chapter
Market Structure Analysis
Market structures include
competition (many buyers and sellers) monopolistic competition (differentiated product) oligopoly (only a few firms that are interdependent) monopoly (a one-firm industry)
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Checkpoint
8 chapter
Market Structure Analysis
Competition is defined by four attributes:
many buyers and sellers who are so small that none individually can influence price firms produce and sell a homogeneous (standardized) product buyers and sellers have all the information necessary to make informed decisions barriers to entry and exit are insignificant
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Checkpoint
8 chapter
Market Structure Analysis
Firms in competitive markets get the product price from national or global markets. Therefore, competitive firms are price takers. In the short run, one factor (usually plant size) is fixed. In the long run, all factors are variable, and firms can enter or leave the industry.
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Marginal Revenue
8 chapter
Marginal revenue is the change in total revenue that results from the sale of one added unit of a product. Total revenue is equal to price times quantity sold.
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The Profit-Maximizing Rule
8 chapter
A firm maximizes profit by producing at the point where marginal revenue equals marginal cost. If a firm is earning zero economic profits at this point, it means that it is earning a normal rate of accounting profit.
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Economic Profits
8 chapter
MC ATC
200
Profit
Costs ($) 180
d=MR=P=$200 AVC
Output
84
Profit = (P ATC) x Quantity
Figure 3
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Loss Minimization
8 chapter
If price falls below average total cost, the firm will incur a loss. The firm can minimize the loss by following this rule:
Continue to produce (in the short run) as long as price covers average variable cost. Shut down in the short run if price falls below average variable cost.
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Short-Run Supply Curve
8 chapter
The firms short-run supply curve is its marginal cost curve above the minimum point on the average variable cost curve. The short run supply curve for an industry is simply the horizontal summation of the supply curves of all the individual firms.
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Checkpoint
8 chapter
Competition: Short Run Decisions
Marginal revenue is the change in total revenue from selling an additional unit of a product. Competitive firms are price takers, so they can sell all they want at the going market price. As a result, their marginal revenue is equal to product price. The demand curve facing the competitive firm is a straight line demand at market price. Competitive firms will maximize profit by producing that output where marginal revenue equals cost marginal (MR = MC).
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Checkpoint
8 chapter
Competition: Short Run Decisions
When price is greater than the minimum point of average total cost, firms earn economic profits. When price is just equal to the minimum point of average total cost, firms earn normal profits. When price is below the minimum point of average total cost, but above the minimum point of average variable costs, the firm continues to operate at a loss.
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Checkpoint
8 chapter
Competition: Short Run Decisions
When price falls below the minimum point on the average variable cost curve, the firm will shut down and incur a loss equal to the amount of total fixed costs. The short run supply curve of the firm is the marginal cost curve above the minimum point on the average variable cost curve.
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Long Run Adjustments
8 chapter
If firms in the industry are earning short run economic profits, new firms can be expected to enter the industry in the long run, or existing firms may increase the scale of their operations. Losses will lead to the exit of some firms. Final equilibrium in the long run is the point at which industry price is just tangent to the minimum point on the ATC curve.
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Competition and the Public Interest
8 chapter
The long-run outcome in competitive markets will be:
Productively Efficient
Goods are supplied at the lowest possible opportunity cost.
Allocatively Efficient
The market is directing scarce resources to the goods where they are most highly valued.
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Long Run Industry Supply
8 chapter
Long run industry supply is related to the degree to which increases and decreases in industry output influence the prices firms must pay for resources. For example, when all firms in an industry expand, this new demand for raw materials and labor may push up the price of some inputs. When this happens, it gives rise to an increasing cost industry in the long run.
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Decreasing Cost Industries
8 chapter
An industry that experiences economies as it expands is known as a decreasing cost industry.
Perhaps raw materials suppliers enjoy economies of scale as this industrys demand for their product increases. The semiconductor industry seems to fit this profile: As the demand for semiconductors has risen over the past few decades, their price has fallen dramatically.
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Constant Cost Industries
8 chapter
Some industries expand in the long run without significant changes in average cost. These are known as constant cost industries.
Some fast food restaurants and retail stores re-create their operations from market to market without a noticeable rise in costs.
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CheckpointLong-Run Adjustments
8 chapter
When competitive firms are earning short run economic profits, these profits attract firms into the industry. Supply increases and market price falls until firms are earning zero economic profits. Losses mean that some firms will leave the industry. This reduces supply, increasing prices until profits return to normal. Competitive markets are efficient because: P = MR = MC = SRATCmin = LRATCmin.
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CheckpointLong-Run Adjustments
8 chapter Competitive markets are productively efficient because products are produced at their lowest possible opportunity cost. Competitive markets are allocatively efficient because P = MC and consumer and producer surplus is at a maximum. An industry where prices rise as the industry grows is an increasing cost industry. Decreasing cost industries see their prices fall as the industry expands, possibly due to huge economies of scale or rapidly improving technology. Constant cost industries seem to be able to expand without facing higher or lower operating costs.
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Globalization and The Box
8 chapter
The development of shipping containers has facilitated the expansion of trade. Firms producing products in foreign countries can fill a container and send it directly to the customer or wholesaler in the United States. A 40-foot container with 32 tons of cargo shipped from China to the United States costs roughly $2,000, or 3 cents a pound. This efficiency has facilitated the expansion of trade worldwide and increased the competitiveness of many industries.
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Chapter Summary
8 chapter
Competition is a market structure in which industries contain many sellers and buyers, each so small that they ignore the others behavior and sell a homogeneous product.
Sellers are assumed to maximize the profits they earn through sale of their products. Further, we assume that buyers and sellers have all the information necessary for efficient transactions, and that sellers can sell as much of their products as they want at market equilibrium prices.
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Chapter Summary
8 chapter
In the long run, firms will produce output where P = MR = MC = LRATCmin and profits are enough to keep capital in the industry. This output level is efficient because it gives consumers just the goods they want and provides these goods at the lowest possible opportunity costs. Competitive market efficiency represents the benchmark for comparing other market structures.
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Chapter Summary
8 chapter
Most business you encounter such as barber shops, salons, bars, restaurants, coffee houses, gas stations, fast food, cleaners, grocery stores, shoe and clothing stores all operate like competitive firms. While their products (and locations) are slightly different, they basically take their prices from the market and earn normal profits over the long term.
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