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Unformatted text preview: Chapter Introduction Firms in Competitive Markets If your local gas station raised its price for gasoline by 20 percent, it would see a large drop in the amount of gasoline it sold. Its customers would quickly switch to buying their gasoline at other gas stations. By contrast, if your local water company raised the price of water by 20 percent, it would see only a small decrease in the amount of water it sold. People might water their lawns less often and buy more water- efficient showerheads, but they would be hard-pressed to reduce water consumption greatly and would be unlikely to find another supplier. The difference between the gasoline market and the water market is obvious: Many firms supply gasoline to the local market, but only one firm supplies water. As you might expect, this difference in market structure shapes the pricing and production decisions of the firms that operate in these markets. In this chapter, we examine the behavior of competitive firms, such as your local gas station. You may recall that a market is competitive if each buyer and seller is small compared to the size of the market and, therefore, has little ability to influence market prices. By contrast, if a firm can influence the market price of the good it sells, it is said to have market power. Later in the book, we examine the behavior of firms with market power, such as your local water company. Our analysis of competitive firms in this chapter sheds light on the decisions that lie behind the supply curve in a competitive market. Not surprisingly, we will find that a market supply curve is tightly linked to firms' costs of production. Less obvious, however, is the question of which among a firm's many types of costfixed, variable, average, and marginalare most relevant for its supply decisions. We will see that all these measures of cost play important and interrelated roles. 14-1 What Is a Competitive Market? Our goal in this chapter is to examine how firms make production decisions in competitive markets. As a background for this analysis, we begin by reviewing what a competitive market is. 14-1a The Meaning of Competition A competitive market, sometimes called a perfectly competitive market, has two characteristics: There are many buyers and many sellers in the market. The goods offered by the various sellers are largely the same. As a result of these conditions, the actions of any single buyer or seller in the market have a negligible impact on the market price. Each buyer and seller takes the market price as given. As an example, consider the market for milk. No single consumer of milk can influence the price of milk because each buyer purchases a small amount relative to the size of the market. Similarly, each dairy farmer has limited control over the price because many other sellers are offering milk that is essentially identical....
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- Spring '08