Download Profit Maximazization in Pure Competition

Profit Maximization in
Pure Competition
Perfect Competition
• Situation:
• Yves and Zoe are neighboring farmers and both
grow organic tomatoes.
• Both sell to the same grocery store chains that
carry organic foods.
• Do Yves and Zoe compete with each other?
• YES!
• Should Yves try to stop Zoe from growing
tomatoes or should Yves and Zoe form an
agreement to grow less?
• NO!
Perfect Competition
• In the real world (real in Economic Class
world), there are tons upon tons of organic
tomatoes farmers.
• Yves and Zoe compete with each other but
with all those other farmers
• If one of them produced more or less, there
would be no measurable effect on market
prices!
Perfect Competition
• Yves and Zoe are price-taking producers
– A producers whose actions have no effect on the
market price of the good or service it sells
• Yves and Zoe are price-taking producers
because their actions cannot affect the
market price of the good or service they sell
• When there is enough competition (when
competition is “perfect”) every producer is a
price-taker
Perfect Competition
• Now, what about consumers?
• A consumer whose actions have no
effect on the market price of the good
or service he buys is a price-taking
consumer.
• The market price is unaffected by how
much or how little of the good the
consumer buys
Defining Perfect Competition
• In a perfectly competitive market, all market
participants, both consumers and producers,
are price-takers.
– Neither consumption decisions by individual
consumers nor production decisions by individual
producers affect the market price of the good
• The supply and demand model is a model of
a perfectly competitive market.
– Depends on the assumption that no individual
buyer or seller of a good believes it is possible to
individually affect the price at which he or she
can buy or sell the good
Defining Perfect Competition
• General rule: consumers are price-takers
• Industry in which producers are price-takers
is called a perfectly competitive industry
– This is an industry in which producers are pricetakers
• When are all producers price-takers?
• There are two necessary conditions!
Two Necessary Conditions for Perfect
Competition
• 1. Must contain many producers but
none of which whom have a large
market share
• 2. An industry can be perfectly
competitive only if consumers regard
the products of all producers as
equivalent
Two Necessary Conditions for Perfect
Competition
• Example for explanation is the market for major
grains, like wheat and corn
• The market is perfectly competitive – individual
wheat and corn farmers, as well as individual
buyers of wheat and corn, take market prices as
given
• The markets for some of the good items make
from these grains – breakfast cereals – are by no
mean perfectly competitive
• There is intense competition among cereal
brands, but NOT PERFECT COMPETITION
1. Must contain many producers but none of
which whom have a large market share
• A producer’s market share is the fraction of the
total industry output accounted for by that
producer’s output
• The distribution of the market share constitutes
a major difference between the grain industry
and the breakfast cereal industry
– Thousands of wheat producers but four producers
dominate the breakfast cereal industry (Kellogg’s –
hold 1/3 of the market --, General Mills, Post, and
Quaker Foods)
– The breakfast producers know their actions influence
market prices
2. An industry can be perfectly competitive
only if consumers regard the products of all
producers as equivalent
• Not true in the case of the breakfast cereal market –
consumers don’t consider Cap’n Crunch to be a good
substitute for Wheaties
– Maker of Wheaties has some ability to increase its price
without fear that it will lose all its customers to the
maker of Cap’n Crunch
• Standardized Product is when a product that
consumers regard as the same good even when it
comes from a different producers, sometimes known
as a commodity (something that is indistinguishable)
– Example: Corn, Wheat, Pencils, Pen, lined paper, copy
paper
2. An industry can be perfectly competitive
only if consumers regard the products of all
producers as equivalent
• With wheat being a standardized product,
consumers regard the output of one wheat
producer as a perfect substitute for that of
another producer
• BUT….one farmer cannot increase the price for
his wheat without losing all sales to other wheat
farmers
→ second necessary condition for a competitive
industry is that the industry output is a
standardized product
Free Entry and Exit
• Most perfectly competitive industries are also
characterized by one more feature: it is easy for
new firms to enter the industry and for firms
already in the industry to leave
• No obstacles in the form of government
regulations or limited access to key resources
prevent new producers from entering the
market
• No additional costs are associated with shutting
down a company and leaving the industry
Free Entry and Exit
• Free Entry and Exit in an industry is when new
producers can easily enter into an industry and
existing producers can easily leave that industry
• This is a key factor in most competitive
industries
• It make sure that the numbers of producers in
an industry can adjust to changing market
conditions
• Also ensures that producers in an industry
cannot act to keep other firms out!