Download short-run supply curve

Chapter 8
Competition
CoreEconomics 2nd edition by Gerald W. Stone
© 2011 Worth Publishers ▪ CoreEconomics
▪ Stone
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Chapter Outline
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•
•
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Market Structure Analysis
Competition: Short-Run Decisions
Nobel Prize: Herbert Simon
Competition: Long-Run Adjustments
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Learning Objectives
• At the end of this chapter, the student will 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.
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Learning Objectives
• At the end of this chapter, the student will be
able to:
– Analyze the conditions for profit maximization,
loss minimization, and plant shutdown.
– Derive the firm’s short-run supply curve.
– Use the short-run competitive model to
determine long-run equilibrium.
– Describe why competition is in the public
interest.
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Market Structure Analysis
• Economists use market structure analysis to
categorize industries based on a few key
characteristics, such as:
– Number of firms
– Nature of product
– Barriers to entry
– Extent of control over price
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Primary Market Structures
•
•
•
•
Competition
Monopolistic Competition
Oligopoly
Monopoly
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Competitive Markets
• Characteristics of competitive markets:
– They have many buyers and sellers, each one so
small that none can individually influence the
price.
– Firms in the industry produce a homogeneous or
standardized product.
– Buyers and sellers have all the information about
prices and product quality they need to make
informed decisions.
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Competitive Markets
• In competition, each individual firm is a
price taker.
• This means that the firm can sell as much as
it would like at the going market price.
• The firm’s total revenue will be equal to
price x quantity sold.
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Competitive Markets
• Characteristics of competitive markets:
– Barriers to entry or exit are
insignificant in the long run;
new firms are free to enter
the industry if so doing
appears profitable, while
firms are free to exit
if they anticipate losses.
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Panel A
Industry
S
Panel B
Firm
Price ($)
Price ($)
Competition
d=MR=P=$200
200
200
D
Qe
q1
Industry Output
q2
Firm’s Output
The individual firm takes the market price as given.
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Short Run and 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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Market Structure Analysis
 Market structures include
 competition (many buyers and sellers)
 monopolistic competition
(differentiated product)
 oligopoly
(only a few firms that are interdependent)
 monopoly (a one-firm industry)
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Summary of Competition
 Competition is defined by four attributes:
 many buyers and sellers who are so small that
none individually can influence price
 firms produce and sell a homogeneous
(standardized) product
 buyers and sellers have all the information
necessary to make informed decisions
 barriers to entry and exit are insignificant
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Summary of Competition
• Firms in competitive markets get the product
price from national or global markets.
Therefore, competitive firms are price takers.
• In the short run, one factor (usually plant
size) is fixed. In the long run, all factors are
variable, and firms can enter or leave the
industry.
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Marginal Revenue
• Marginal revenue is the change in total
revenue that results from the sale of one
added unit of a product.
• Total revenue is price
times quantity sold.
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The Profit-Maximizing Rule
• A firm maximizes profit by producing at the
point where marginal revenue equals
marginal cost.
• 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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Economic Profits
MC
ATC
Costs ($)
200
d=MR=P=$200
Profit
180
AVC
Output of Sails
84
Profit = (P – ATC) x Quantity
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Figure 3
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Economic Profits
• In the long run, we expect that firms
within a competitive industry
will earn zero economic profit.
• This means that price will
equal average total cost.
• Follow the example of the
firm producing sails
for windsurfing.
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Economic Profits
Costs ($)
MC
ATC
177.60
AVC
Output of Sails
75
Price falls to $177.60 per sail
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Short Run Decisions
• Marginal revenue is the change in total
revenue from selling an additional unit of a
product.
• Competitive firms are price takers, so they
can sell all they want at the going market
price. As a result, their marginal revenue is
equal to product price.
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Short Run Decisions
• The demand curve facing the competitive
firm is a straight line demand at market price.
• Competitive firms will maximize profit by
producing that output where marginal
revenue equals marginal cost (MR = MC).
• When price is greater than the minimum
point of average total cost, firms earn
economic profits.
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Short Run Decisions
• When price is just equal to the minimum
point of average total cost, firms earn normal
profits.
• When price is below the minimum point of
average total cost, but above the minimum
point of average variable costs, the firm
continues to operate at a loss.
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Short Run Decisions
• When price falls below the minimum point
on the average variable cost curve, the firm
will shut down and incur a loss equal to the
amount of total fixed costs.
• The short run supply curve of the firm is the
marginal cost curve above the minimum
point on the average variable cost curve.
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Economic Profits
Costs ($)
MC
ATC
AVC
162.50
Shutdown point
65
Output of Sails
Price falls to $162.50 per sail
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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.
• The short run supply curve for an industry is
simply the horizontal summation of the
supply curves of all the individual firms.
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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.
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Long Run Adjustments
In long run equilibrium, the firm will earn zero
economic profit, and the market will produce
the maximum possible consumer and producer
surplus.
MC
P
Consumer
Surplus
P
ATC
P=ATC
Producer
Surplus
Industry
Firm
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The Public Interest
• The long-run outcome in competitive
markets will be:
– Productively Efficient
• Goods are supplied at the lowest possible opportunity
cost.
– Allocatively Efficient
• The market is directing scarce resources to the goods
where they are most highly valued.
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Increasing Cost Industry
• Economies or diseconomies of scale
determine the shape of the long-run average
total cost curve for individual firms.
• When all firms in an industry expand, this
new demand for raw materials and labor may
push up the price of some inputs. When this
happens, it gives rise to an increasing cost
industry.
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Decreasing Cost Industries
• A decreasing cost industry arises when
economies of scale present themselves with
the entry of more firms:
– Perhaps raw materials suppliers enjoy economies
of scale as this industry’s demand for their
product increases.
– The semiconductor industry seems to fit this
profile: 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 with no significant rise in average cost.
– Some fast food franchises
and retail stores re-create
their operations from
market to market without
any upward gravitation of
the average cost curve.
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Long-Run Adjustments
• When competitive firms are earning short
run economic profits, these profits attract
firms into the industry.
– Supply increases and market price falls until
firms are earning zero economic profits.
• Losses mean that some firms will leave the
industry. This reduces supply, increasing
prices until profits return to normal.
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Long-Run Adjustments
• Competitive markets are efficient because
P = MR = MC = SRATCmin = LRATCmin.
• Competitive markets are productively
efficient because products are produced at
their lowest possible opportunity cost.
• Competitive markets are allocatively
efficient because P = MC and consumer
and producer surplus is at a maximum.
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Long-Run Adjustments
• An industry where prices rise as the
industry grows is an increasing cost
industry.
• Decreasing cost industries see their prices
fall as the industry expands.
• Constant cost industries seem to be able to
expand without facing higher or lower
operating costs.
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Globalization and “The Box”
• The development of shipping containers has
facilitated the expansion of trade.
– Firms producing products in
foreign countries can fill a
container and send it
directly to the customer
or wholesaler in the
United States.
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Globalization and “The Box”
• A 40-foot container with 32 tons of cargo
shipped from China to the United States costs
roughly $5,000, or 7 cents a pound.
– This efficiency has facilitated the expansion of
trade worldwide and increased the
competitiveness of many industries.
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Try It!
• In the long run, a firm in a competitive
industry will produce at the point where
– A) price equals average total cost.
– B) price equals average variable cost.
– C) average variable cost is minimized.
– D) marginal cost is minimized.
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Try It!
• In the long run, a firm in a competitive
industry will produce at the point where
– A) price equals average total cost.
Correct!
– B) price equals average variable cost
– C) average variable cost is minimized
– D) marginal cost is minimized
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Chapter Summary
• Competition is a market structure in which
industries contain many sellers and buyers,
each so small that they ignore the others’
behavior and sell a homogeneous product.
• Sellers maximize profits by producing at the
point where price equals marginal cost.
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Chapter Summary
• In the long run, firms will produce output
where P = MR = MC = LRATCmin and profits
are enough to keep capital in the industry.
• This output level is efficient because it gives
consumers just the goods they want and
provides these goods at the lowest possible
opportunity costs.
• Competitive market efficiency represents the
benchmark for comparing other market
structures.
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Chapter Summary
• Most business you encounter such as barber
shops, salons, bars, restaurants, coffee
houses, gas stations, fast food, cleaners,
grocery stores, shoe and clothing stores all
operate like competitive firms.
• While their products (and locations) are
slightly different, they basically take their
prices from the market and earn normal
profits over the long term.
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