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CHAPTER 8 PRICING AND OUTPUT DECISIONS: PERFECT COMPETITION AND MONOPOLY QUESTIONS 1. All four of the characteristics listed in Figure 8.1A of Chapter 8 are important to ensuring that buyers and sellers are price takers. Students should recognize that the absence of any one of these factors could enable market participants to exercise a certain degree of market power. Let us consider each factor from the standpoint of sellers. a.Large number of relatively small sellers: This factor provides buyers with a considerable number of easily available alternatives. If one seller tries to raise its price, consumers can turn to the many others who would be willing to sell a product at the going market price. The relatively small size of a seller would tend to constrain any individual seller from lowering its price. After all, if its relatively small size enables it to sell all it wants to at the going market price, why sell at a lower price when you can receive the higher market price? Also, having a large number of sellers eliminates mutual interdependence in price-output decisions and makes collusion among them not possible, b.Standardized product: This ensures that the many alternative sellers mentioned above are perceived by consumers to be exactly the same as the one which tried to raise the price. If this particular firm succeeded in convincing consumers that its product was “better,” it might be able to get people to buy the product at the higher price. c.Complete information about market price: One of the many small sellers could get away with charging a higher price if consumers were ignorant about the lower priced alternatives. Complete information by all consumers prevents this from happening. d.Freedom of entry and exit: This prevents any possibility of sellers exercising some degree of market power in the long run . As illustrated in the chapter, if the price of a product rises because demand has increased, the long run entry of new sellers will tend to push the price back down. If the entry of newcomers is interfered with, those sellers already in the market would enjoy “monopolistic” profits. 2. This question is answered in 1.d. above. 3. Although there are very few “perfectly competitive” markets, the basic short run and long run behavior hypothesized by the perfectly competitive model can be found in all types of market structures in the “market economy.” Thus, managers would be well advised to learn about all types of markets, including perfect competition. The popular press is filled with stories of companies who either succeed or fail in following the behavior predicted by the perfectly competitive model. For example, looking at the personal computer market over the past decade, we can see a general pattern of change very similar to the perfectly competitive model (although the details do not quite fit).
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This note was uploaded on 04/25/2010 for the course ECON econ302 taught by Professor Rahman during the Spring '10 term at Fairmont State.

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