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Competition
Chapter 6
McGraw-Hill/Irwin
Copyright © 2011 by The McGraw-Hill Companies, Inc. All Rights Reserved.
Market Structure
• The number and relative size of firms
in an industry.
• Most real-world firms fall somewhere
along a spectrum that stretches from
one extreme (powerless) to another
(powerful).
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Market Structure
Five common types of market structure:
• Perfect Competition
• Monopolistic Competition
• Oligopoly
• Duopoly
• Monopoly
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Figure 6.1
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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.
– It competes with many other firms selling
homogenous products.
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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.
– It has no direct competitors.
– It has complete market power; it can alter
the market price of a good or service.
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Imperfect Competition
• Other forms of imperfect competition lie
between the extremes of monopoly
and perfect competition.
– Duopoly: only two firms supply a product.
– Oligopoly: a few large firms supply all or most of
a particular product.
– Monopolistic competition: many firms supply
essentially the same product but each enjoys
significant brand loyalty.
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Perfect Competition
• Perfectly competitive firms are pretty
much faceless.
• They have no brand image, no real
market recognition.
• 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 perfectly
competitive firm is so small relative to
market supply that it has no significant
effect on the total quantity or price in
the market.
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Price Takers
• A perfectly competitive firm is a price
taker.
• An individual firm’s output decisions do
not affect the market price.
• An individual firm must take the market
price and do the best it can within
these constraints.
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Market Demand
versus Firm Demand
• We must distinguish between the
market demand curve and the demand
curve confronting a particular firm.
– The market demand curve for a product is
always downward-sloping.
– The demand curve facing a perfectly
competitive firm is horizontal.
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Figure 6.2
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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
versus Profits
• Profit is the difference between total
revenue and total cost.
• Maximizing output or revenue is not the
way to maximize profits.
• Total profits depend on how both
revenue and cost increase as output
expands.
• A business is profitable only within a
certain range of output.
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Profit Maximization
and Price
• To maximize profit, the firm should
produce an additional unit of output
only if it brings in revenue that is
greater than the cost of producing it.
• Since competitive firms are price
takers, they must take whatever price
the market has determined for their
products.
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Figure 6.5
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Profit-Maximizing
Rate of Output
• Never produce anything that costs
more than it brings in – it boils down to
comparing price and marginal cost.
• A competitive firm wants to expand the
rate of production whenever price
exceeds marginal cost.
• 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
o Price > MC
Increase output rate
o Price = MC
Maintain output rate
(Profits maximized)
o Price < MC
Decrease output rate
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Total Profit
• Total profit can be computed in one of
two ways:
Total profit = total revenue – total cost
OR
Total profit = average profit (profit per
unit) 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 profit equals profit per unit times
quantity:
Total profit = (p – ATC) x q
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Total Profit
• The profit-maximizing producer doesn’t
seek to maximize per-unit profits.
• The profit-maximizing producer has no
particular desire to produce at that rate
of output where ATC is at a minimum.
• Total profits are maximized only where
p = MC.
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Figure 6.6
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Supply Behavior
• How firms make production decisions
helps explain how the market
establishes prices and quantities.
• 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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A Firm’s Supply
• Competitive firms adjust the quantity
supplied until MC = price.
• The marginal cost curve is the shortrun supply curve for a competitive firm.
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Figure 6.7 (a) & (b)
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Figure 6.7 (c) & (d)
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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:
– The price of factor inputs
– Technology
– Expectations
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Market Supply
• Market supply is the total quantity of a
good that sellers are willing and able to
sell at alternative prices in a given time
period, ceteris paribus.
• The market supply curve is the sum of
the marginal cost curves of all the
firms.
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Competitive
Market Supply
• Determinants of the market supply of a
competitive industry:
– The price of factor inputs
– Technology
– Expectations
– The 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 a static
equilibrium.
• The number of firms in a competitive
industry is not fixed.
• Industry entry and exit is a driving force
affecting market equilibrium.
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Entry
• Additional firms will enter the industry when
profits are plentiful.
• Economic profits attract firms.
– More firms enter the industry.
– The market supply curve shifts to the
right.
– The price decreases.
• Industry output increases and price falls
when firms enter an industry.
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Figure 6.8
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Tendency Toward
Zero Economic Profits
• New firms continue to enter a
competitive industry so long as profits
exist.
• Once price falls to the level of minimum
average cost, all economic profits
disappear.
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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 total cost is at a
minimum.
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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 total 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 total cost.
– Economic profit is eliminated.
• 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.
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Figure 6.9
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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, like
patents.
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Characteristics of a
Competitive Market
• Many firms
• MC = p
• Identical products • Zero economic
• Low entry barriers profit
• Perfect
information
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The Relentless
Profit Squeeze
• The unrelenting squeeze on prices and
profits is a fundamental characteristic
of the competitive process.
• 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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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
• Competitive markets present a strong
argument for laissez faire.
• Government should promote
competition because markets do a
good job of allocating resources.
• This means keeping markets open and
accessible to new entrants by
dismantling entry barriers.
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End of
Chapter 6