Chapter 8 Competition CoreEconomics 2 nd edition by Gerald W. Stone 1 © 2011 Worth Publishers ▪ CoreEconomics ▪ Stone

Chapter 8Competition

CoreEconomics 2nd edition by Gerald W. Stone

1

© 2011 Worth Publishers ▪ CoreEconomics ▪ Stone

© 2011 Worth Publishers ▪ CoreEconomics ▪ Stone 2 of 32

• Market Structure Analysis• Competition: Short-Run Decisions• Nobel Prize: Herbert Simon• Competition: Long-Run Adjustments

Chapter Outline


• At the end of this chapter, the student will be able to:– Name the primary market structures and

describe their characteristics– Define a competitive market and the

assumptions that underlie it. – Distinguish the differences between competitive

markets in the short run and the long run.

Learning Objectives


• At the end of this chapter, the student will be able to:– Analyze the conditions for profit maximization,

loss minimization, and plant shutdown.– Derive the firm’s short-run supply curve.– Use the short-run competitive model to

determine long-run equilibrium.– Describe why competition is in the public

interest.

Learning Objectives


Market Structure Analysis

• Economists use market structure analysis to categorize industries based on a few key characteristics, such as:– Number of firms– Nature of product– Barriers to entry– Extent of control over price


Primary Market Structures

• Competition• Monopolistic Competition• Oligopoly• Monopoly


Competitive Markets

• Characteristics of competitive markets:– They have many buyers and sellers, each one so

small that none can individually influence the price.

– Firms in the industry produce a homogeneous or standardized product.

– Buyers and sellers have all the information about prices and product quality they need to make informed decisions.


Competitive Markets

• In competition, each individual firm is a price taker.

• This means that the firm can sell as much as it would like at the going market price.

• The firm’s total revenue will be equal to price x quantity sold.


Competitive Markets

• Characteristics of competitive markets:– Barriers to entry or exit are

insignificant in the long run; new firms are free to enter the industry if so doing appears profitable, while firms are free to exit if they anticipate losses.


Competition

D

S

Industry Output Firm’s Output

Pric

e ($

)

Pric

e ($

)

Panel AIndustry

Panel BFirm

200 200

Qe

d=MR=P=$200

q1 q2

The individual firm takes the market price as given.


Short Run and Long Run

• In the short run, one factor of production is fixed, usually the plant size.– Firms cannot enter or leave the industry.

• In the long run, all factors are variable.– Firms will enter the industry in response to

profits.– Firms will leave the industry in response to

losses.


Market Structure Analysis

Market structures include competition (many buyers and sellers) monopolistic competition

(differentiated product) oligopoly

(only a few firms that are interdependent) monopoly (a one-firm industry)


Summary of Competition

Competition is defined by four attributes: many buyers and sellers who are so small that none

individually can influence price firms produce and sell a homogeneous

(standardized) product buyers and sellers have all the information necessary

to make informed decisions barriers to entry and exit are insignificant


Summary of Competition

• Firms in competitive markets get the product price from national or global markets. Therefore, competitive firms are price takers.

• In the short run, one factor (usually plant size) is fixed. In the long run, all factors are variable, and firms can enter or leave the industry.


Marginal Revenue

• Marginal revenue is the change in total revenue that results from the sale of one added unit of a product.

• Total revenue is pricetimes quantity sold.


The Profit-Maximizing Rule

• A firm maximizes profit by producing at the point where marginal revenue equals marginal cost.

• If a firm is earning zero economic profits at this point, it means that it is earning a normal rate of accounting profit.


Economic ProfitsMC

ATC

AVC

Figure 3

d=MR=P=$200

200

180

Cos

ts (

$)

Output of Sails 84

Profit

Profit = (P – ATC) x Quantity


Economic Profits

• In the long run, we expect that firms within a competitive industry will earn zero economic profit.

• This means that price willequal average total cost.

• Follow the example of the firm producing sailsfor windsurfing.


Economic ProfitsMC

ATC

AVC177.60

Cos

ts (

$)

Output of Sails 75

Price falls to $177.60 per sail


Short Run Decisions

• Marginal revenue is the change in total revenue from selling an additional unit of a product.

• Competitive firms are price takers, so they can sell all they want at the going market price. As a result, their marginal revenue is equal to product price.


Short Run Decisions

• The demand curve facing the competitive firm is a straight line demand at market price.

• Competitive firms will maximize profit by producing that output where marginal revenue equals marginal cost (MR = MC).

• When price is greater than the minimum point of average total cost, firms earn economic profits.


Short Run Decisions

• When price is just equal to the minimum point of average total cost, firms earn normal profits.

• When price is below the minimum point of average total cost, but above the minimum point of average variable costs, the firm continues to operate at a loss.


Short Run Decisions

• When price falls below the minimum point on the average variable cost curve, the firm will shut down and incur a loss equal to the amount of total fixed costs.

• The short run supply curve of the firm is the marginal cost curve above the minimum point on the average variable cost curve.


Economic Profits

MC

ATC

AVC

162.50

Cos

ts (

$)

Output of Sails65

Price falls to $162.50 per sail

Shutdown point


Short-Run Supply Curve

• The firm’s short-run supply curve is its marginal cost curve above the minimum point on the average variable cost curve.

• The short run supply curve for an industry is simply the horizontal summation of the supply curves of all the individual firms.


Long Run Adjustments

• If firms in the industry are earning short run economic profits, new firms can be expected to enter the industry in the long run, or existing firms may increase the scale of their operations.

• Losses will lead to the exit of some firms.• Final equilibrium in the long run is the point

at which industry price is just tangent to the minimum point on the ATC curve.


Long Run Adjustments

MC

ATC

In long run equilibrium, the firm will earn zeroeconomic profit, and the market will produce the maximum possible consumer and producersurplus.

Consumer Surplus

ProducerSurplus

P=ATC

Industry Firm

PP


The Public Interest

• The long-run outcome in competitive markets will be:– Productively Efficient

• Goods are supplied at the lowest possible opportunity cost.

– Allocatively Efficient• The market is directing scarce resources to the goods

where they are most highly valued.


Increasing Cost Industry

• Economies or diseconomies of scale determine the shape of the long-run average total cost curve for individual firms.

• When all firms in an industry expand, this new demand for raw materials and labor may push up the price of some inputs. When this happens, it gives rise to an increasing cost industry.


Decreasing Cost Industries

• A decreasing cost industry arises when economies of scale present themselves with the entry of more firms:– Perhaps raw materials suppliers enjoy economies

of scale as this industry’s demand for their product increases.

– The semiconductor industry seems to fit this profile: As the demand for semiconductors has risen over the past few decades, their price has fallen dramatically.


Constant Cost Industries

• Constant cost industries expand in the long run with no significant rise in average cost. – Some fast food franchises

and retail stores re-create their operations from market to market withoutany upward gravitation ofthe average cost curve.


Long-Run Adjustments

• When competitive firms are earning short run economic profits, these profits attract firms into the industry. – Supply increases and market price falls until

firms are earning zero economic profits.

• Losses mean that some firms will leave the industry. This reduces supply, increasing prices until profits return to normal.



• Competitive markets are efficient becauseP = MR = MC = SRATCmin = LRATCmin.

• Competitive markets are productively efficient because products are produced at their lowest possible opportunity cost.

• Competitive markets are allocatively efficient because P = MC and consumer and producer surplus is at a maximum.



• An industry where prices rise as the industry grows is an increasing cost industry.

• Decreasing cost industries see their prices fall as the industry expands.

• Constant cost industries seem to be able to expand without facing higher or lower operating costs.


Globalization and “The Box”

• The development of shipping containers has facilitated the expansion of trade.– Firms producing products in

foreign countries can fill a container and send it directly to the customer or wholesaler in the United States.


Globalization and “The Box”

• A 40-foot container with 32 tons of cargo shipped from China to the United States costs roughly $5,000, or 7 cents a pound.– This efficiency has facilitated the expansion of

trade worldwide and increased the competitiveness of many industries.


Try It!

• In the long run, a firm in a competitive industry will produce at the point where– A) price equals average total cost.– B) price equals average variable cost.– C) average variable cost is minimized.– D) marginal cost is minimized.


Try It!

• In the long run, a firm in a competitive industry will produce at the point where– A) price equals average total cost.

Correct!– B) price equals average variable cost– C) average variable cost is minimized– D) marginal cost is minimized


Chapter Summary

• Competition is a market structure in which industries contain many sellers and buyers, each so small that they ignore the others’ behavior and sell a homogeneous product.

• Sellers maximize profits by producing at the point where price equals marginal cost.


Chapter Summary

• In the long run, firms will produce output where P = MR = MC = LRATCmin and profits are enough to keep capital in the industry.

• This output level is efficient because it gives consumers just the goods they want and provides these goods at the lowest possible opportunity costs.

• Competitive market efficiency represents the benchmark for comparing other market structures.


Chapter Summary

• Most business you encounter such as barber shops, salons, bars, restaurants, coffee houses, gas stations, fast food, cleaners, grocery stores, shoe and clothing stores all operate like competitive firms.

• While their products (and locations) are slightly different, they basically take their prices from the market and earn normal profits over the long term.

Documents

Chapter 8 Competition CoreEconomics 2 nd edition by Gerald W. Stone 1 © 2011 Worth Publishers ▪ CoreEconomics ▪ Stone