Lecture 6 - Competitive Firms and Markets Mercedes Miranda...

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Unformatted text preview: Competitive Firms and Markets Mercedes Miranda BE530 Mercedes Miranda BE530 1 2 1. Perfectly Competitive Markets The model of perfect competition rests on three basic assumptions: (1) price taking, (2) product homogeneity, and (3) free entry and exit. Price Taking Because each individual firm sells a sufficiently small proportion of total market output, its decisions have no impact on market price. price taker: Firm that has no influence over market price and thus takes the price as given. Product Homogeneity When the products of all of the firms in a market are perfectly substitutable with one anotherthat is, when they are homogeneous no firm can raise the price of its product above the price of other firms without losing most or all of its business. 3 1. Perfectly Competitive Markets (contd.) Free Entry and Exit free entry ( or exit): Condition under which there are no special costs that make it difficult for a firm to enter (or exit) an industry. When Is a Market Highly Competitive? Because firms can implicitly or explicitly collude in setting prices, the presence of many firms is not sufficient for an industry to approximate perfect competition. Conversely, the presence of only a few firms in a market does not rule out competitive behavior. 4 2. Profit Maximization Do Firms Maximize Profit? The assumption of profit maximization is frequently used in microeconomics because it predicts business behavior reasonably accurately and avoids unnecessary analytical complications. For smaller firms managed by their owners, profit is likely to dominate almost all decisions. In larger firms, however, managers who make day-to-day decisions usually have little contact with the owners (i.e. the stockholders). In any case, firms that do not come close to maximizing profit are not likely to survive. Firms that do survive in competitive industries make long-run profit maximization one of their highest priorities. Alternative Forms of Organization cooperative: Association of businesses or people jointly owned and operated by members for mutual benefit. 5 Example 1: Condominiums vs Cooperatives in New York Nationwide, condos are a far more common than co-ops, outnumbering them by a factor of nearly 10 to 1. In this regard, New York City is very different from the rest of the nationco-ops are more popular, and outnumber condos by a factor of about 4 to 1. What accounts for the relative popularity of housing cooperatives in New York City? Part of the answer is historical. Housing cooperatives are a much older form of organization in the U.S. The building restrictions in New York have long disappeared, and yet the conversion of apartments from co-ops to condos has been relatively slow....
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This note was uploaded on 07/15/2011 for the course ACC 360 taught by Professor Marshallhunt during the Spring '09 term at University of Michigan-Dearborn.

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Lecture 6 - Competitive Firms and Markets Mercedes Miranda...

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