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Chapter 6 Competition Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Market Structure • The number and relative size of firms vary across industries. • Most real-world firms fall somewhere along a spectrum that stretches from one extreme (powerless) to another (powerful). 6-2 Market Structure Five common types of market structure: • Perfect competition. • Monopolistic competition. • Oligopoly. • Duopoly. • Monopoly. 6-3 Figure 6.1 6-4 Competitive Firm • A perfectly competitive firm has no 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. 6-5 Monopoly • A monopoly firm is one that produces the entire market supply of a particular good or service. It has complete market power; it can alter the market price of a good or service. – It is a price setter, not a price taker. – It has no direct competitors. 6-6 Imperfect Competition • Other forms of imperfect competition lie between monopoly and perfect competition, with decreasing market power. – 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. 6-7 Perfect Competition • Perfectly competitive firms 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. 6-8 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. 6-9 Market Demand versus Firm Demand • There is a big difference 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. 6-10 Figure 6.2 6-11 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 6-12 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. 6-13 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. 6-14 Short-Run Decision Rules for a Competitive Firm • Price > MC Increase output rate • Price = MC Maintain output rate (Profits maximized) • Price < MC Decrease output rate 6-15 Total Profit • Profit per unit equals price minus average total cost: – Profit/unit = p – ATC • Total profit equals profit per unit times quantity: – Profit = (p – ATC) x q 6-16 Total Profit • What counts is total profits, not profit per unit. • Total profits are maximized only where p = MC. 6-17 Figure 6.6 6-18 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. 6-19 Figure 6.8 6-20 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. 6-21 Exit • Firms exit the industry when: – Profit opportunities look better elsewhere. – If price falls below average cost (profits turn into losses). • As firms exit the industry, the market supply curve shifts to the left. 6-22 Equilibrium • The existence of profits in a competitive industry induces entry, shifting supply to the right, lowering price, and reducing profits. • The existence of losses in a competitive industry induces exits, shifting supply to the left, increasing price, and reducing losses. 6-23 Long-Run Equilibrium • In long-run competitive market equilibrium: – Price equals minimum average total cost. – Economic profit (or loss) 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. 6-24 Figure 6.9 6-25 Characteristics of a Competitive Market • Many small firms. • Perceived horizontal demand. • Identical products. • Low entry barriers. • Set output where MC = p. • Zero economic profit in the long run. • Perfect information. 6-26 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. 6-27