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McGraw-Hill/Irwin
©2009 The McGraw-Hill Companies, All Rights Reserved
Competitive MarketsCompetitive Markets
Chapter 23Chapter 23
2
The Market Supply Curve
The market supply curve determines the equilibrium price faced by an individual producer.
Equilibrium price – The price at which the quantity of a good demanded in a given time period equals the quantity supplied.
Market supply – The total quantities of a good that sellers are willing and able to sell at alternative prices in a given time period, ceteris paribus.
3
The Market Supply Curve
The market supply curve is the sum of the marginal cost curves of all the firms.
Marginal cost (MC) – The increase in total cost associated with a one-unit increase in production.
4
The Market Supply Curve
Whatever determines marginal cost also determines the competitive firm’s supply response.
5
The Market Supply Curve
The market supply of a competitive industry is determined by:
The price of factor inputs.
Technology.
Expectations.
Taxes.
The number of firms in the industry.
Competitive Market Supply
0 20 40 60
1
2
3
4
$5
Pric
e
Farmer A
Quantity
a
MCA
0 20 40 60
Farmer B
Quantity
b
MCB
0 20 40 60
Farmer C
Quantity
c
MCC
0 100 200
Market supply
Quantity
d
+ =+
7
Entry and Exit
Investment decisions shift the market supply curve to the right.
Investment decision - The decision to build, buy, or lease plant and equipment; to enter or exit an industry.
LO1
8
Entry and Exit
The profit motive drives these investment decisions.
If there are economic profits, more firms will enter the industry increasing market supply.
The typical firm will respond to the resulting lower price and profits by reducing output.
LO1
9
Quantity
Pri
ce
Quantity
Market Entry
Market demand
S2
S1
E1
E2
p1
p2
Market entry pushes price down and . . .
New firms enter
ATCMCf1
f1
p1
p2
q1 q2
Reduces profits of competitive firm
LO1
10
Tendency Toward Zero Profits
An increase in market supply causes the economic profits to disappear.
Economic profits – The difference between total revenues and total economic costs.
LO2
11
Tendency Toward Zero Profits
When economic profits disappear, entry ceases and the market price stabilizes.
A competitive market is a market in which no buyer or seller has market power.
LO2
12
Tendency Toward Zero Profits
As long as it is easy for existing producers to expand production or for new firms to enter an industry, economic profits will not last long.
LO2
13
Low Barriers to Entry
Barriers to entry are obstacles that make it difficult or impossible for would-be producers to enter a particular market.
LO2
14
Low Barriers to Entry
Barriers to entry may include:Patents.
Control of essential factors of production.
Control of distribution outlets.
Well-established brand loyalty.
Government regulation.
LO2
15
Market Characteristics of Perfect Competition
Some of the structures, behaviors and outcomes of a competitive market are:
Many firms - none of which has a significant share of total output.
Perfect information - buyers and sellers have complete information on supply, demand, and prices.
LO1
16
Market Characteristics of Perfect Competition
Some of the structures, behaviors and outcomes of a competitive market are:
Identical products - products are homogeneous; one firm’s products is the same as any other’s.
MC = p - all competitive firms seek to expand output until marginal cost equals the product’s market price.
LO1
17
Market Characteristics of Perfect Competition
Some of the structures, behaviors and outcomes of a competitive market are:
Low barriers to entry - entry barriers are low, economic profits will attract more firms.
Zero economic profit - market supply expands as long as there are economic profits, pushing prices and economic profits down.
LO1
18
Competition at Work: Microcomputers
Few, if any, product markets are perfectly competitive.
Many industries function much like a competitive market.
The microcomputer market illustrates how the process of competition works.
19
Market Evolution
As in other industries, the computer industry has evolved over time.
It was never a monopoly, nor was it ever perfect competition.
20
Initial Conditions: The Apple I
Steve Jobs and Steven Wozniak created the Apple Computer Corporation in 1977.
Other companies noted the profits and, due to the low barriers to entry, followed Apple’s lead.
21
The Production Decision
Each competitive firm seeks to make the best short-run production decision.
Production decision - The selection of the short-run rate of output (with existing plant and equipment).
22
The Production Decision
To maximize profit, each competitive firm seeks the rate of output at which marginal cost equals price.
23
Initial Equilibrium in the Computer Market
1200
1000
800
600
400
200
0 200 400 600 800 1000
Market price
Profits
mD Average
total cost
P = MR
Quantity
C
PR
ICE
OR
CO
ST
The typical firm
$1200
1000
800
600
400
200
0 20 40 60 80
Market demand
Market equilibrium
Market supply
Quantity (thousands)
Pri
ce (
per
com
pute
r)
The computer industry
LO2
24
Profit Calculations
A profit-maximizing producer seeks to maximize total profit.
Profit per unit is total profit divided by the quantity produced in a given time period; price minus average total cost.
Total profit = profit per unit X quantity sold
LO2
26
Computer Revenues, Costs and Profits
Output per
Month
Price = Marginal Revenue
Marginal Cost
Average Total Cost
Profit per Unit
0
100 $1,000 $ 300 $ 900 $ 100
200 1,000 400 650 350
300 1,000 500 600 400
400 1,000 600 600 400
500 1,000 800 640 360
600 1,000 1,00 700 300
700 1,000 1,260 780 220
800 1,000 1,740 900 100
900 1,000 1,998 1,022 –22 LO2
29
A Shift of Market Supply
The entry of new firms shifts the market supply curve to the right.
Firms will continue to enter as long as there are economic profits.
LO2
30
A Shift of Market Supply
As supply increases, price drops toward the minimum of ATC.
In long-run equilibrium, entry and exit cease, and zero economic profit (that is, normal profit) prevails.
Long-run equilibrium: p = MC = minimum ATC
LO2
31
A Shift of Market Supply
Once reached, long-run market equilibrium will continue until something changes.
Long-run equilibrium will change if market demand shifts or if technological improvements reduce production costs.
LO2
32
500 6000
800
$1000
Price
or C
ost (
per c
ompu
ter)
Quantity (computers per month)
0 20,000
$1000
800
Quantity (computers per month)
Price
(per
com
pute
r)The Competitive Price and Profit
Squeeze
Profits
S1S2
Market demand
An expanded market supply . . .
MCOld price
G
Hm
ATC
Lowers price and profits for the typical firm
Newprice
LO2
33
500 6000
800
$1000
Price
or C
ost (
per c
ompu
ter)
Quantity (computers per month)
0 20,000
$1000
800
Quantity (computers per month)
Price
(per
com
pute
r)The Competitive Squeeze
Approaching Its Limit
Profits
S2
Market demand
The computer industry
MC
Old priceJ
Km
ATC
The typical firm
Newprice
S3
700620
LO2
34
Short- vs. Long-Run Equilibrium
MCATC
pS
qS
Pric
e or
Cos
t
Quantity
Short-run equilibrium (p = MC)
pS
Pric
e or
Cos
t pL
qL
Quantity
MCATC
Long-run equilibrium (p = MC = ATC)
LO2
35
Long-Run Rules for Entry and Exit
Price Level Result for typical firm Market Response
P > ATC Profits New firms enterindustry, Existing firmsexpand
P < ATC Loss Firms exit industry,Existing firms contract
P = ATC Break even No exit or entry,Existing firms maintaincurrent capacity
LO2
36
Home Computers vs. Personal Computers
Once long-run equilibrium was reached in the microcomputer market, producers were forced either:
To develop a better product (to increase demand), or
To reduce costs of production.
37
Home Computers vs. Personal Computers
Manufacturers of computers did both -separating the market into home computers and personal computers.
38
Price Competition in Home Computers
The home computer market confronted the fiercest form of price competition.
For most firms, the only option to make an extra buck was to push the cost curve down.
39
Price Competition in Home Computers
Costs were pushed down by reducing the number of components and using more powerful computer chips.
LO3
40
Further Supply Shifts
With strong competition, often the only way for a firm to improve profitability is to reduce costs.
Cost reductions were accomplished through technological improvements.
LO3
41
Further Supply Shifts
Technological improvements are illustrated by a downward shift of the ATC and MC curves.
LO3
42
Pric
e (p
er c
ompu
ter)
Quantity (computers per month)
Lower Costs Shifts the Supply Curve Downward
OldMC
NewMC
OldATC
NewATC
J N
R
430 600
$700
LO3
43
Shutdowns
Once a firm is no longer able to cover variable costs, it should shut down production.
The shutdown point is the rate of output at which price equals minimum AVC.
44
Exits
Most firms withdrew from the home computer market due to low profits.
The exit rate in 1983-85 matched the entry rate of 1979-82.
45
The Personal Computer Market
Firms initially competed on the basis of product improvements.
Eventually, firms could not sell all the PCs they produced at prevailing prices.
They were forced to cut their prices.
Many shut down.
46
The Competitive Process
Competitive market pressures were a driving force in the spectacular growth of the computer industry.
Consumers reaped substantial benefit from competition in computer markets.
LO3
47
Allocative Efficiency: The Right Output Mix
The market mechanism works best in competitive markets.
Market mechanism – the use of market prices and sales to signal desired output (or resource allocations).
LO3
48
Allocative Efficiency: The Right Output Mix
High profits in a particular industry indicate consumers want a different mix of output.
A competitive market determines the opportunity cost of producing different goods.
LO3
49
Allocative Efficiency: The Right Output Mix
The price signal the consumer gets in a competitive market is an accurate reflection of opportunity cost.
Opportunity cost – The most desired goods or services that are forgone in order to obtain something else.
LO3
50
Allocative Efficiency: The Right Output Mix
Marginal cost pricing efficiently answers the WHAT-to-produce question.
Marginal cost pricing – The offer (supply) of goods at prices equal to their marginal cost.
LO3
51
Allocative Efficiency: The Right Output Mix
The amount consumers are willing to pay for a good (its price) equals its opportunity cost (marginal cost).
LO3
52
Production Efficiency
Production efficiency means that we are producing at minimum average total cost.
Efficiency – Maximum output of a good from the resources used to produce it.
LO3
53
Production Efficiency
Competitive pressure on prices force producers to produce at the lowest possible cost.
Society is getting the most it can from its available (scarce) resources.
LO3
55
Quantity (units per time period)
Pric
e (d
olla
rs p
er u
nit)
Summary of Competitive Process
Industry ATCIndustry MC
Market demand
Short-runequilibrium
Long-run equilibrium
a
bc
LO3
56
Relentless Profit Squeeze
The sequence of events common to a competitive market situation includes the following:
High prices and profits signal consumers’ demand for more output.
Economic profit attracts new suppliers.
The market supply shifts to the right.
LO3
57
Relentless Profit Squeeze
The sequence of events common to a competitive market situation includes the following:
Prices slide down the market demand curve.
A new equilibrium is reached with increased quantities being produced and sold and economic profit approaching zero.
LO3
58
Relentless Profit Squeeze
The sequence of events common to a competitive market situation includes the following:
Throughout the process, producers experienced great pressure to keep ahead of the profit squeeze by reducing costs.
LO3
59
Relentless Profit Squeeze
The potential threat of other firms expanding production or of new firms entering the industry keeps existing firms on their toes.
LO3