ajaz_eco204_2009_chapter_5.1

ajaz_eco204_2009_chapter_5.1 - University of Toronto,...

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University of Toronto, Department of Economics, ECO 204 2009 2010 S. Ajaz Hussain ECO 204 2009 2010 S. Ajaz Hussain (Draft) Chapter 5.1: Competition 1 Please help improve the course by sending me an e mail about typos or suggestions for improvements The remaining chapters, for the most part, model a variety of business problems ranging from pricing, output, and market segmentation to decision making under uncertainty, competitive strategy, decisions with opportunity costs, and market analysis (issues related to the “selling” side of a business). In this chapter, we examine these issues for “competitive” firms and markets. But just what do we mean by competitive firms and markets? 1. “Competition” A competitive firm sells output as a price taker : it believes that its output does not impact the market price of the product (this is a behavioral assumption). Observe no assumptions have been made on whether the firm hires inputs as a price taker: a competitive firm may or may not hire inputs as a price taker but always sells output as a price taker. An example of input and output price taking competitive firms are coffee farmers who (arguably) procure inputs (fertilizer, labor, etc) from (locally) competitive markets and sell coffee in a (globally) competitive market (coffee is traded on the ICE ; see Coffee C benchmark contract for Arabica coffee). An example of inputs price making but output price taking competitive firms are primary aluminum smelters (see HBS case Aluminum Industry in 1994 ). Aluminum production requires massive amounts of electricity and many smelters strike deals with local electric utilities to purchase power at reduced rates. However, aluminum – like many commodities including metals – is traded in a competitive market (aluminum is traded on the London Metal Exchange ). To reiterate: a competitive firm sells output as a price taker, which raises an interesting question: how and why do firms become price takers? This is an important question for business strategy, one that has been ignored by many companies much to their detriment. History is replete with firms that took their market power for granted only to wake up one day and find their product to have become “commoditized”. As such, it is critical to monitor, and if possible deter, conditions likely to foster Note to self: for summer 2010 version put section of measures of market structure (using the concentration metric). 1 ECO 204 (Draft) Chapter 5.1
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University of Toronto, Department of Economics, ECO 204 2009 2010 S. Ajaz Hussain competitive behavior: inability to differentiate the product 2 , lower barriers to entry and exit, greater flow of information, and greater number of sellers. It is important to stress that none of these conditions defines competitive behavior; rather, if these conditions exist, competitive behavior is likely to ensue.
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This note was uploaded on 05/02/2011 for the course ECO 204 taught by Professor Hussein during the Fall '08 term at University of Toronto- Toronto.

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ajaz_eco204_2009_chapter_5.1 - University of Toronto,...

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