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SOLUTIONChapter 10 - Competitive Markets 1 Chapter 10...

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Competitive Markets 1 Chapter 10 COMPETITIVE MARKETS QUESTIONS AND ANSWERS Q10.2 One way of inferring competitive conditions in a market is to consider the lifestyle enjoyed by employees and owners. In vigorously competitive markets, employee compensation tends to be meager and profits are apt to be slim. Describe the perfectly competitive market structure and provide some examples. Q10.2 ANSWER Perfect competition is a market structure characterized by a large number of buyers and sellers of an essentially identical product, where each market participant's transactions are so small that they have no influence on the market price of the product. Individual buyers and sellers are price takers. This means that they take market prices as given, and devise their production strategy accordingly. Free and complete demand and supply information is available in a perfectly competitive market, and no meaningful barriers to entry and exit are present. As a result, vigorous price competition is prevalent, and only a normal rate of return on investment is possible in the long-run. Excess profits are possible only in periods of short-run disequilibrium before rivals are able to mount an effective competitive response. Examples of perfectly competitive markets include: agricultural markets for corn, wheat, soybeans and other grains; commodity, stock and bond markets; and unspecialized input markets (e.g., unskilled labor), among others. Many retail markets, like gas stations, are also vigorously competitive. Q10.5 “A higher minimum wage means some low wage workers will get fired because there will be less money available for labor costs. An international minimum wage, scaled according to the working conditions and cost of living in a particular country, would allow local workers to benefit without significant trade disruption.” Discuss this statement and explain why the demand curve is apt to be horizontal in the unskilled labor market. Q10.5 ANSWER In competitive markets, the demand curve tends to be horizontal because homogeneous products are offered by several competitors. In product markets, firms are price takers in perfectly competitive markets. This means that the activity level of each firm is so small relative to that of the overall industry total that no influence on industry prices is noted following a change in the firm's production decisions. All of the firm's output can be sold at the industry's prevailing price. Price discounts are unnecessary to sell even dramatically higher firm output. Moreover, the presence of perfect substitutes means that buyers would immediately switch to alternate suppliers following a price increase.
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2 Chapter 10 Thus, prices above the industry norm are not feasible. This gives rise to a horizontal firm demand curve.
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