Download Competition - Macmillan Learning

Competition
8
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Overview
• After studying this chapter, you should 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.
• Analyze the conditions for profit maximization, loss
minimization, and plant shutdown for a firm.
• Derive the firm’s short-run supply curve.
• Use the short-run competitive model to determine longrun equilibrium.
• Describe why competition is in the public interest.
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Food for Thought….
Some good blogs and other sites to get the juices flowing:
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Market Structure Analysis
• By observing a few industry characteristics,
we can predict pricing and output behavior
of the firm.
• These factors are important:
•
•
•
•
Number of firms
Nature of product
Barriers to entry
Extent of control over price
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Primary Market Structures
1.
2.
3.
4.
Competition
Monopolistic Competition
Oligopoly
Monopoly
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Competition
Wheat Industry
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Competitive Markets
• Characteristics of Competitive
Markets:
• Many buyers and sellers
• Homogeneous (standardized)
products
• No barriers to market entry or exit
• No long-run economic profits
• No control over price
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Monopolistic Competition
Restaurant Industry
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Monopolistic Competition
• Characteristics of Monopolistic
Competition:
• Many buyers and sellers
• Differentiated products
• No barriers to market entry or exit
• No long-run economic profits
• Some control over price
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Oligopoly
Auto Industry
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Oligopoly
• Characteristics of Oligopoly:
• Fewer firms
• Mutually interdependent decisions
• Substantial barriers to entry
• Potential for long-run economic
profits
• Shared market power and
considerable control over price
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Monopoly
Diamond Industry
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Monopoly
• Characteristics of Monopoly:
• One firm
• No close substitutes for product
• Nearly insuperable barriers to entry
• Potential for long-run economic
profits
• Substantial market power and
control over price
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Competitive Markets
• In a competitive market, each firm
is a price taker.
• Price taker: Individual firms in
competitive markets get their prices from
the market since they are so small they
cannot influence market price.
• Each firm’s total revenue will be
equal to
price x quantity sold = (PxQ)
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Marginal Revenue
• Marginal revenue = change in total
revenue that results from the sale
of one added unit of a product.
• Reminder: Total revenue = P x Q
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A Firm in a Competitive Market
Panel B
(Industry)
S
200
Price ($)
Price ($)
Panel A
(Firm)
200
d=MR=P=$200
D
Qe
Industry Output
q1
q2
Firm’s Output
The individual firm takes the market price as given.
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The Short Run and the Long Run
• Reminder: in the short run, plant
size is fixed…
• We focus here on short-run profit
maximization (at a given plant size)
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The Profit-Maximizing Rule
• A firm maximizes profit by
producing at the point where
marginal revenue equals marginal
cost, MR = MC
• If a firm is earning zero economic profits
at this point, it means that it is earning a
normal rate of accounting profit.
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Costs ($)
Economic Profits
MC
ATC
200
d=MR=P=$200
Profit
180
AVC
84
Output
Profit = (P – ATC) x Quantity
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The Short Run and the Long Run
• In the short run, one factor of
production is fixed, usually the plant
size.
• Firms cannot enter or leave the industry.
• In the long run, all factors are variable.
• Firms will enter the industry in response to
profits.
• Firms will leave the industry in response to
losses.
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Normal Profits
Costs ($)
The firm earns zero economic profit. This is a normal rate of return.
MC
ATC
200
180
PL
AVC
75
d=MR=P=$177.60
Output
Normal profits: equal to zero economic profits, where P = ATC
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Loss Minimization
• If price falls below average total cost,
the firm will incur a loss.
• The firm can minimize the loss by
following this rule:
• Continue to produce (in the short run) as long
as price covers average variable cost.
• Shut down in the short run if price falls below
average variable cost.
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Costs ($)
Loss Minimization
If price falls to $170…
MC
ATC
$177.85
$170
AVC
Loss
d=MR=P=$170
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Output
Loss = Negative Profit = (P – ATC) x Quantity= -$510.25
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Costs ($)
When to Shut Down?
If price falls below $162.50
(minimum AVC)…
MC
ATC
AVC
Loss
$162.50
d=MR=P=$162.50
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Output
Losses begin to exceed fixed costs. The firm will do better
to close down and limit losses to fixed costs.
Shutdown rule: when the price falls below minimum AVC,
8firm should shut down immediately.
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Short-Run Supply Curve
• The firm’s short-run supply curve is its
marginal cost curve above the
minimum point on the average variable
cost curve.
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Who’s Who
Nobel Prize 1978: Herbert Simon (19162001)
• Professor of Computer Science and
Psychology
• Argued that firms are NOT always perfectly
rational, because realistically:
• They do not possess perfect information
• They do not always strive to maximize profits
• Instead, firms recognize limitations and form
an “acceptable solution to acute problems”
• Attacked the assumption of profit
maximization as too simple…
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Long Run Adjustments
• If firms in the industry are earning short run
economic profits, new firms can be
expected to enter the industry in the long
run, or existing firms may increase the
scale of their operations.
• Losses will lead to the exit of some firms.
• Final equilibrium in the long run is the point
at which industry price is just tangent to the
minimum point on the ATC curve.
• P = MR = MC = LRATCmin
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Economic profits attract more
supply…
(Industry)
S0
S1
Panel B
Costs ($)
Price ($)
Panel A
P0
P0
P1
P1
MC
(Firm)
ATC
Profit
AVC
D
Q0 QL
Industry Output
Firm’s Output
As long as there are above-normal profits, industry supply
increases and market price falls. Profits decline toward zero
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economic profits.
Losses cause firms to exit
Supply decreases, price rises and profits must rise
(or losses must decrease).
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Competition and the Public
Interest
• The long-run outcome in
competitive markets will have:
• Productive Efficiency: Goods are
supplied at the lowest possible
opportunity cost.
• Allocative Efficiency: The mix of goods
and services produced are just what
society desires. The price that consumers
pay is equal to marginal cost and is also
equal to the least average total cost.
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Long Run Industry Supply
Long run industry supply:
• How much does the expansion of an
industry influences resource prices?
• When an industry expands, this new
demand for raw materials and labor
may push up the price of some inputs.
•Increasing cost industry: an industry that
faces higher prices and costs as industry
output expands.
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Decreasing Cost Industries
• Decreasing cost industry: An industry that
experiences lower costs as it expands.
• Semiconductor industry:
• As the demand for semiconductors has risen over the
past few decades, their price has fallen dramatically.
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Constant Cost Industries
• Constant cost industries. expand in
the long run without significant
changes in average cost.
• Some fast food restaurants re-create
their operations from market to market
without a noticeable rise in costs.
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Increasing, Constant and
Decreasing Cost Industries
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Key Concepts
• Market Structure
Analysis
• Competition
• Price taker
• Marginal revenue
• Profit maximizing
rule
• Normal profits
• Shutdown point
• Short-run supply
curve
• Productive efficiency
• Allocative efficiency
• Increasing cost
industry
• Decreasing cost
industry
• Constant cost
industry
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If a Gnomes-R-Us (a competitive firm)
produces at the where the marginal cost
curve intersects with the average total cost
curve at its minimum point, the firm will earn:
a) Economic profits
b) Normal profits
c) A short-run loss
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Should a competitive firm keep producing
even if it faces short run losses (and is
producing at a point on its MC curve that is
above the minimum AVC curve)?
a)
b)
c)
Yes, it is earning normal profits
Yes, because it covers its variable costs
and has some revenue left to pay for fixed
costs
No, it should never incur losses
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If the market price is 20, a) 50
about how much will this b) 60
c) 75
firm produce?
d) 95
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If the market price is 5, about how much will this firm
produce?
a) 0
b) 30
c) 60
d) 95
e) As much as it can
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Which of the following markets is
likely to be the most competitive?
a) Cable television
b) Automobiles and trucks
c) Oil refining
d) Farm commodities
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