Competition

Market Structure

The number and relative size of firms in an industry.

Market Structures

Competitive Firm

A perfectly competitive firm is one without market power.

It is not able to alter the market price of the good it produces.

A corn farmer is an example of a perfectly competitive firm.

Competitive Market

A competitive market is one in which no buyer or seller has market power.

High tech electronics and agricultural goods are sold in competitive markets.

Monopoly

A monopoly firm is one that produces the entire market supply of a particular good or service.

Your local cable TV company is an example of a monopoly firm.

Market Power

Market power is the ability to alter the market price of a good or service.

Your campus book store has market power.

Imperfect Competition

Imperfect competition is between the extremes of monopoly and perfect competition.

In oligopoly a few large firms supply all or most of a particular product.

In monopolistic competition many firms supply essentially the same product but each has brand loyalty.

Perfect Competition

Perfectly competitive firms are pretty much faceless.

They have no brand image, no real market recognition.

A perfectly competitive firm is one . . .

Price Takers

A perfectly competitive firm is a price taker.

Individual firms output decisions do not affect the market price.

Individual firms must take the market price and do the best they can within these constraints.

Market Demand vs. Firm Demand

You must distinguish between the market demand curve and the demand curve confronting a particular firm.

The market demand curve is always downward sloping.

Market vs. Firm Demand

The Firm’s Production Decision

Choosing a rate of output is a firm’s production decision.

It is the selection of the short-term rate of output with existing plant and equipment.

Output and Revenues

The more output a competitive firm produces, the greater its revenues will be.

Total revenue is the price of a product multiplied by the quantity sold in a given time period.

Revenues vs. Profits

Profit is the difference between total revenue and total cost.

Maximizing output or revenue is not the same as maximizing profits.

Total profits depend on how costs increase as output expands

Profit Maximization

To maximize profit, the firm should produce an additional unit of output only if it brings in more revenue than it costs.

Price

Since competitive firms are price takers, they must take whatever price the market has put on their products.

Marginal Cost

Marginal cost is the increase in total costs associated with a one-unit increase in production.

Marginal cost generally increases as rate of production increases due to diminishing returns.

The Costs of Catfish Production

Profit-Maximizing Rate of Output

Never produce anything that costs more than it brings in.

Boils down to comparing price and marginal cost.

A competitive firm wants to expand the rate of production whenever price exceeds marginal cost.

Short-run profits are maximized at the rate of output where price equals marginal cost.

Short-Run Profit-Maximization Rules for Competitive Firm

Maximization of Profits for Competitive Firm

Total Profit

Total profit can be computed in one of two ways:

Total profit = total revenue – total cost

Total profit = average profit x quantity sold

Profit per unit = price minus average total cost

Total profits = profit per unit times quantity

The profit-maximizing producer never seeks to maximize per-unit profits.

The profit-maximizing producer has no particular desire to produce at that rate of output where ATC is at a minimum.

Total profits are maximized only where p = MC

Illustrating Total Profit

Supply Behavior

How firms make production decisions helps us to explain how the market establishes prices and quantities.

A Firm’s Supply

Supply is the ability and willingness to sell specific quantities of a good at alternative prices in a given time period.

Supply Behavior

To be competitive, quantity supplied is adjusted until MC = price.

The marginal cost curve is the short-run supply curve for a competitive firm.

Supply Shifts

Marginal costs determine the supply decisions of a firm.

Anything that alters marginal cost will change supply behavior.

Important influences on marginal cost and supply behavior are:

Market Supply

Market supply is the total quantities of a good that sellers are willing and able to sell at alternative prices in a given time period.

The market supply curve is the sum of marginal cost curves of all firms.

Competitive Market Supply

Determinants of Market Supply

Industry Entry and Exit

To understand how competitive markets work, we have to focus on changes in equilibrium rather than on equilibrium itself.

The number of firms in a competitive industry is not fixed.

Entry

Additional firms will enter the industry when profits are plentiful.

Economic profits attract firms.

Industry output increases.

Market supply curve shifts right as entry increases.

Price falls.

Industry output increases and price falls when firms enter an industry.

Market Entry

The Tendency Toward Zero Economic Profits

New firms continue to enter a competitive industry so long as profits exist.

Once price falls to the level of minimum average cost, all economic profits disappear.

Entry is the force driving down market prices.

The Lure of Profits

Exit

Firms exit the industry when profit opportunities look better elsewhere.

Firms leave the industry if price falls below average cost.

As firms exit the industry, the market supply curve shifts to the left.

Price rises until there are no economic losses.

At that point, average cost is at a minimum.

Equilibrium

The existence of profits in a competitive industry induces entry.

The existence of losses in a competitive industry induces exits.

Long-Run Equilibrium

In long-run competitive market equilibrium:

Price equals minimum average cost.

Economic profit is eliminated.

Economic profits will not last long as long as it is easy:

Low Barriers to Entry

There are no significant barriers to entry in competitive markets.

Barriers to entry are obstacles that make it difficult or impossible for would-be producers to enter a market.

Examples of barriers to entry include patents, brand loyalty, price controls and control of essential factors of production.

Characteristics of a Competitive Market

Many firms

Identical products

Low barriers to entry

MC = p

Zero economic profit

Perfect information

The Virtues of Competition

The market helps signal what should and should not be produced.

The market sends signals which reallocate resources to other products.

The Relentless Profit Squeeze

The unrelenting squeeze on prices and profits is a fundamental characteristic of the competitive process.

The market mechanism works best in competitive markets.

High profits in a particular industry indicate that consumers want a different mix of output.

Economic profit attracts new suppliers.

A new equilibrium is reached at which increased quantity of the desired product is produced and its price is lower.

Throughout the process producers experience great pressure to keep ahead of the profit squeeze by reducing costs.

The Social Value of Losses

Economic losses are a signal to producers that they are not using society’s scarce resources in the best way.

Unique Traits of Competitive Markets

Two unique traits of competitive markets are noteworthy:

Minimum average costs of production (HOW)

Marginal cost pricing (WHAT)

Minimum Average Costs of Production

Efficiency (technical) is the maximum output of a good from the resources used in production.

Competition drives producers to produce at the minimum average cost of production in the long run.

Marginal Cost Pricing

The amount of resources used to produce one more unit of a good is its marginal cost.

Marginal cost reflects the opportunity cost of that good.

The amount the consumer is willing to pay for the good is its price.

Marginal Cost Pricing

When the prices of goods equal their marginal costs, the mix of resources produced and consumed is efficient.

Policy Perspective

Public policy should promote competition because competitive markets do best what society wants.

This means keeping markets open and accessible to new entrants.