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Competition
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Market Structure
• The number and relative size of firms in
an industry.
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Market Structures
Imperfect competition
Perfect
Monopolistic Oligopoly Duopoly Monopoly
competition competition
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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.
– It is a price taker.
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Competitive Market
• A competitive market is one in which no
buyer or seller has market power.
• No single producer or consumer has
any control over the price or quantity of
the product.
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Monopoly
• A monopoly firm is one that produces
the entire market supply of a particular
good or service.
– It is a price setter, not a price taker.
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Market Power
• Market power is the ability to alter the
market price of a good or service.
– Your campus book store has market power.
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Imperfect Competition
• Imperfect competition is between the
extremes of monopoly and perfect
competition.
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Imperfect Competition
• In duopoly only two firms supply a
particular product.
– In oligopoly a few large firms supply all
or most of a particular product.
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Imperfect Competition
• In monopolistic competition many
firms supply essentially the same
product but each has brand loyalty.
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Perfect Competition
• Perfectly competitive firms are pretty
much faceless.
• They have no brand image, no real
market recognition.
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Perfect Competition
• A perfectly competitive firm is one . . .
. . . whose output is so small in relation
to market volume,
. . . that its output decisions have no
perceptible impact on price.
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No Market Power
• The output of a lone perfect competitor
is so small relative to market supply that
it has no significant effect on the total
market quantity or price.
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Price Takers
• A perfectly competitive firm is a price
taker.
• Individual firms output decisions do not
effect the market price.
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Price Takers
• Individual firms must take the market
price and do the best they can within
these constraints.
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Market Demand vs. Firm
Demand
• You must distinguish between the
market demand curve and the demand
curve confronting a particular firm.
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Market Demand vs. Firm
Demand
• The market demand curve is always
downward sloping.
• The demand curve facing a perfectly
competitive firm is horizontal.
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Market vs. Firm Demand
PRICE
(per fish)
Demand for Individual
farmer's catfish
The catfish market
pe
Market
supply
Equilibrium price
pe
Demand facing
single farmer
Market
demand
QUANTITY (thousand fish per day)
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QUANTITY (fish per day)
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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.
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Output and Revenues
• Total revenue is the price of a product
multiplied by the quantity sold in a given
time period.
Total revenue = price x quantity
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Revenues vs. Profits
• Profit is the difference between total
revenue and total cost.
• Maximizing output or revenue is not the
same as maximizing profits.
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Revenues vs. Profits
• Total profits depend on how costs
increase as output expands.
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Profit Maximization
• To maximize profit, the firm should
produce an additional unit of output only
if it brings in more revenue than it costs.
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Price
• Since competitive firms are price takers,
they must take whatever price the
market has put on their products.
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Marginal Cost
• Marginal cost is the increase in total
costs associated with a one-unit
increase in production.
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Marginal Cost
• Marginal cost generally increases as
rate of production increases due to
diminishing returns.
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The Costs of Catfish Production
Rate of
Output
0
1
2
3
4
5
McGraw-Hill/Irwin
Total Cost
$10
15
22
31
44
61
Marginal
Cost
$ 5
7
9
13
17
Average
Cost
$15.00
11.00
10.33
11.00
12.20
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The Costs of Catfish Production
COST (dollars per basket)
$18
F
Marginal cost
16
14
E
12
10
D
8
6
C
B
4
2
0
McGraw-Hill/Irwin
1
2
3
4
5
RATE OF OUTPUT (baskets per hour)
6
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7
Profit-Maximizing Rate of
Output
• Never produce anything that costs more
than it brings in.
• Boils down to comparing price and
marginal cost.
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Profit-Maximizing Rate of
Output
• A competitive firm wants to expand the
rate of production whenever price
exceeds marginal cost.
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Profit-Maximizing Rate of
Output
• Short-run profits are maximized at the
rate of output where price equals
marginal cost.
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Short-Run Decision Rules for a
Competitive Firm
• Price > MC
increase output rate
• Price = MC
maintain output and
maximize profit
• Price < MC
decrease output rate
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Maximization of Profits for
Competitive Firm
Quantity Price
0
1
2
3
4
5
—
$13.00
13.00
13.00
13.00
13.00
McGraw-Hill/Irwin
Total
Total
Revenue Cost
0 $10.00
$13.00
15.00
26.00
22.00
39.00
31.00
52.00
44.00
65.00
61.00
Total
Marginal
Profit Price
Cost
-$10.00
—
—
– 2.00 $13.00 $5.00
+ 4.00 13.00
7.00
+ 8.00 13.00
9.00
+ 8.00 13.00 13.00
+ 4.00 13.00 17.00
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Maximization of Profits for
Competitive Firm
PRICE OR COST (per basket)
$18
Marginal cost
16
14
12
10
B
p = MC
Profits decreasing
Profits increasing
Price
8
6
4
MCB
Profit-maximizing
rate of output
2
0
McGraw-Hill/Irwin
1
2
3
4
5
QUANTITY (baskets per hour)
6
7
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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
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Total Profit
• Profit per unit equals price minus
average total cost
Profit per unit = p – ATC
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Total Profit
• Total profits equals profit per unit times
quantity
Total profits = (p – ATC) X q
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Total Profit
• The profit-maximizing producer never
seeks to maximize per-unit profits.
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Total Profit
• The profit-maximizing producer has no
particular desire to produce at that rate
of output where ATC is at a minimum.
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Total Profit
• Total profits are maximized only where p
= MC
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Illustrating Total Profit
$18
COST (per basket)
16
14
12
Average
total cost
TOTAL
PROFIT
10
Price
Profit per unit
8
6
Cost per unit
Marginal cost
4
2
0
McGraw-Hill/Irwin
1
2
3
4
5
RATE OF OUTPUT (baskets per hour)
6
7
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Supply Behavior
• How firms make production decisions
helps explain how the market
establishes prices and quantities.
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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.
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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.
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Supply Shifts
• Marginal costs determine the supply
decisions of a firm.
• Anything that alters marginal cost will
change supply behavior.
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Supply Shifts
• Important influences on marginal cost
and supply behavior are:
– Price of factor inputs
– Technology
– Expectations
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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.
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Market Supply
• The market supply curve is the sum of
marginal cost curves of all firms.
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Competitive Market Supply
PRICE (per pound)
$5
(a) Farmer A
$5
MCA
4
a
3
+
2
1
0
(b) Farmer B
$5
40
60
b
3
c
3
+
2
0
MCC
MCB 4
4
2
1
20
(c) Farmer C
1
20
40
60
0
20
40
60
QUANTITY (pounds per day)
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Competitive Market Supply
(d) Market supply
=
PRICE (per pound)
$5
4
d
3
2
1
0
50
100
150
200
250
300
QUANTITY (pounds per day)
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Competitive Market Supply
• Determinants of Market Supply
– Price of factor inputs
– Technology
– Expectations
– Number of firms in the industry
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Industry Entry and Exit
• To understand how competitive markets
work, we focus on changes in
equilibrium rather than on equilibrium
itself.
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Industry Entry and Exit
• The number of firms in a competitive
industry is not fixed.
• Industry entry and exit is a driving force
effecting market equilibrium.
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Entry
• Additional firms will enter the industry
when profits are plentiful.
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Entry
• Economic profits attract firms.
– Industry output increases.
– Market supply curve shifts right as entry
increases.
– Price falls.
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Entry
• Industry output increases and price falls
when firms enter an industry.
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Market Entry
PRICE (per pound)
S1
p1
E1
Entry of
new
firms
p2
S2
E2
Market
Demand
q1
q2
QUANTITY (thousands of pounds per day)
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The Tendency Toward Zero
Economic Profits
• New firms continue to enter a
competitive industry so long as profits
exist.
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The Tendency Toward Zero
Economic Profits
• Once price falls to the level of minimum
average cost, all economic profits
disappear.
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The Tendency Toward Zero
Economic Profits
• Entry is the force driving down market
prices.
• Price falls until there are no economic
profits.
• At that point, average cost is at a
minimum.
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The Lure of Profits
Market entry pushes price down and . . .Reduces profits of competitive firm
S1
E1
S2
MC
S3
p1
p1
p2
p2
p3
p3
ATC
Market demand
QUANTITY (thousands of pounds per day)
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QUANTITY (pounds per day)
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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.
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Exit
• Price rises until there are no economic
losses.
• At that point, average cost is at a
minimum.
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Equilibrium
• The existence of profits in a competitive
industry induces entry.
• The existence of losses in a competitive
industry induces exits.
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Long-Run Equilibrium
• In long-run competitive market
equilibrium:
– Price equals minimum average cost.
– Economic profit is eliminated.
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Long-Run Equilibrium
• Economic profits will not last long as
long as it is easy:
– For existing producers to expand
production, or
– For new firms to enter an industry.
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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 wouldbe producers to enter a market.
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Characteristics of a Competitive
Market
• Many firms
• Identical products
• Low barriers to
entry
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• MC = p
• Zero economic
profit
• Perfect
information
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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.
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The Relentless Profit Squeeze
• The unrelenting squeeze on prices and
profits is a fundamental characteristic of
the competitive process.
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The Relentless Profit Squeeze
• The market mechanism works best in
competitive markets.
– Market mechanism – the use of market
prices and sales to signal desired outputs.
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The Relentless Profit Squeeze
• High profits in a particular industry
indicate that consumers want a different
mix of output.
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The Relentless Profit Squeeze
• As more firms enter the industry,
consumers get their desired mix of
output.
• They get more of the goods they desire
at a lower price.
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Maximum Efficiency
• Competitive pressure on prices forces
suppliers to produce at the least
possible cost.
• Society gets the most it can from its
available (scarce) resources.
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Zero Economic Profits
• All economic profits are eliminated at
the limit of the competitive process.
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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.
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Policy Perspective
• Government should promote
competition because competitive
markets do best what society wants.
• This means keeping markets open and
accessible to new entrants.
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Competition
End of Chapter 6
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