Download Unit 4, Lesson 10 Competition

AOF
Business Economics
Unit 4, Lesson 10
Competition
Copyright © 2008–2011 National Academy Foundation. All rights reserved.
Economics looks at characteristics and outcomes
when considering competitive markets
Characteristics
• Large number of buyers and sellers
• Products are alike
• Low or no barriers to entry
Outcomes
• Firms and consumers are “price
takers” (the market sets prices)
• Zero profits, after allowing for the
opportunity cost of capital
• Consumers get low prices
• Economically efficient (low price,
better suppliers gain market share)
Similar products and lots of
choices
Many firms competing
What economic forces are at work here?
There’s no economic profit in a perfectly competitive
market
If a firm begins to make
profit (total revenue >
total cost) providing a
product or service,
competitors soon enter to
take a piece of the pie
Competition lowers the
price until it just covers
the costs (opportunity
cost of capital included)
More competitors means
lower profits for each firm
With “no profit,” how can firms continue to exist?
There are advantages to a highly competitive market
• It’s efficient: Society’s
resources are used
well to produce the
products customers
want
• Firms have to operate
at the lowest possible
per-unit cost
• Consumers get the
lowest possible price
Who benefits more from a
competitive market: consumers or
producers?
There are disadvantages to a highly competitive
market
• No profit means no
money for research and
development
Research goes down
while pollution goes up
• Doesn’t consider social
costs and benefits (only
“private” costs are
considered)
• Smoke from packing
facility pollutes the air
• Pretty avocado trees
benefit neighbors
Is this a good tradeoff for lower prices?
Monopolies share certain attributes
Characteristics
• Single seller (high barriers to entry)
• A unique product with no close
substitutes
• Price maker
Outcomes
• Monopoly maximizes profits by
limiting production and setting
prices well above the cost of
What are possible
production
barriers to entry?
• New firms cannot enter to increase
supply and decrease costs
• Inefficient use of resources
Monopolies have some advantages to the consumer
• Monopoly profits provide discretionary funds,
above the cost of production and the
opportunity cost of capital. These can be used
to pay for research and development
• Under some circumstances, monopolies are
more economically efficient than alternatives:
High fixed costs + low marginal costs =
Extreme economies of scale
Who benefits more from a monopoly:
producers or consumers?
Monopolies also have disadvantages
• Price generally higher, and quantity
lower, than with competition:
• Less produced than in a
competitive market
• Price can be substantially higher
than the per-unit cost of
production
• Often economically inefficient:
• Consumers willing and able to
pay more than the full cost of
production can’t do so
• Firms willing to produce at a
lower price can’t do so
Prices are often higher
in a monopolistic
market than they
would be in a
competitive market
Why does a monopoly
have limited incentives
to produce more?
Patents create monopolies
• Patents grant firms
an exclusive right to a
new product,
technology or
process, for a period
of time
• Monopoly profits
provide an incentive
to invest in research
and development
(R&D)
The longer the patent right,
the greater the incentive for
research and development
How is illegal downloading of songs like a patent
infringement?
Are monopolies good or bad?
Good
• Incentivizes companies
to engage in R&D and
helps them pay for it
• Patents reward the
entrepreneurial
innovation in new
products and
technology
Bad
• Monopolies often mean
higher prices, and fewer
goods produced, than
with competition
• The supplier gains, but
consumers pay high
prices
• Barriers to entry lead to
inefficiencies
Are the economic costs of creating a monopoly worth
the benefits of R&D?
Markets are constantly shifting
Markets change for many reasons,
including:
• New products are
invented, which make
old ones obsolete
• Government regulations
change the playing field
• Consumer needs and
tastes change
• The cost of resources
rises or falls
The business economist
must understand local and
global economic shifts