Download CHAPTER 11

CHAPTER 11
PERFECT COMPETITION

LAUGHER CURVE
Q. How many economists does it take to screw in a lightbulb?
A. Eight. One to screw it in and seven to hold everything else constant.
______________________________________________________________________________
CHAPTER OVERVIEW: What’s It All About?
This chapter is a rigorous exposition of perfect competition. The features of a perfectly
competitive market discussed in the chapter are: (1) the profit-maximizing condition for perfectly
competitive firms is MC = MR = P, (2) to determine profit or loss at the profit-maximizing level
of output, subtract average total cost at the level of output from price and multiply the result by
the output level, (3) firms will shut down production if the price is equal to or falls below the
minimum of their average variable costs, and (4) a firm is in long-run equilibrium only when it is
earning zero economic profit, or where price equals the minimum long-run average total costs.
CHAPTER OBJECTIVES: Students Should Be Able To …
1. List the six conditions for a perfectly competitive market. The conditions include that both
buyers and sellers are price takers; the number of firms is large; there are no barriers to entry
such as social, political, or economic impediments that prevent other firms from entering the
market; the firms’ products are identical; there is complete information; and the market is
comprised of profit-maximizing entrepreneurial firms.
2. Explain why producing an output at which marginal cost equals price maximizes total profit
for a perfect competitor. The supplier will continue to increase production as long as
marginal cost is less than marginal revenue. If marginal revenue does not equal marginal
cost, a firm can increase profit by changing output. Thus, the profit-maximizing condition of
a competitive firm is MC = MR = P.
3. Demonstrate why the marginal-cost curve is the supply curve for a perfectly competitive firm.
Because the MC curve tells the competitive firm how much it should produce at a given
price, the MC curve is the firm’s supply curve.
4. Determine the output and profit of a perfect competitor graphically and numerically. This is
shown in Figure 11-5 and Table 11-1 respectively.
165
Chapter 11: Perfect Competition
5. Construct a market-supply curve by adding together individual firms’ marginal cost curves.
Since all firms have identical marginal-cost curves, a quick way of summing the quantities is
to multiply the quantities from the marginal-cost curve of a representative firm by the number
of firms in the market at each price.
6. Explain why perfectly competitive firms make zero economic profit in the long run. In the
long run, firms earn zero economic profit since only zero profit will stop entry and exit.
However, zero profit does not mean that the entrepreneur does not get anything for his
efforts.
7. Explain the adjustment process from short-run equilibrium to long-run equilibrium.
Knowing that an increase in demand will mean higher prices, which will lead to higher
profits, competitive firms will increase output. Higher profits lead new firms to enter the
market, increasing output still more. Eventually prices (because market supply increases) fall
until all profit is competed away.
WHAT’S NEW? Revisions to This Edition
The chapter remains much the same with a new concluding example about the shut-down
decision in terms of Kmart’s 2002 decision to shutter nearly 300 stores.
DISCUSSION STARTERS: Get Your Class Rolling
1. What goals might a firm have other than maximizing profit which could cause it to
consciously not produce where MR = MC?
2. Are there any potential drawbacks associated with competitive markets from society’s
perspective?
3. Are competitive firms likely to promote the development of new technologies considering
that research and development is so expensive and economic profits are short-lived in
competitive markets?
4. Assume a market is currently earning economic profit. What are some potential barriers to
entry, which would prevent new competitors from entering the market and competing those
profits away?
TIPS FOR TEACHING LARGE SECTIONS
A Group Assignment on Perfect Competition
166
Chapter 11: Perfect Competition
The following activity is based on an article describing trends in the cranberry market in
the United States. The activity is designed to provide students an opportunity to practice what
they have learned about the perfectly competitive market structure while applying the content to a
real-world situation. The market for cranberries used in this activity could be replaced by any
other specific market. While this activity applies to the market for cranberries, you could to the
same activity for other markets.
Group work can be used in a large lecture setting just as effectively as in a small class
setting, but extra attention must be given to helping students maintain focus. The following
activity, while highly structured, is effective for guiding students through the activity and keeping
them on task in a setting where they might be more inclined to become distracted.
This activity is based on the attached article, "Forget the Cows and Corn; Let's Bet the
Farm on Cranberry Crops," from the Wednesday, July 23, 1997 edition of The Wall Street
Journal. Answer all questions clearly and completely in the space provided below and submit
before leaving the room today.
1. Describe, (in complete sentence form), two characteristics of the cranberry market that make
it a perfectly competitive market.
2a. Draw a graph for the cranberry market that shows firms in the market earning a positive
economic profit. (Be sure to show the market and a typical firm in that market). (Label the axis
appropriately.)
firm
market
2b. On your graph depicting the firm, shade the region representing economic profit.
3. Why do we say that the marginal cost curve above AVC is the firm's short run supply curve?
4. What is the shut down rule? When should a firm shut down? (Is shutting down the same
thing as "going out of business" completely?)
5a. Draw a graph for the Cranberry market and a typical cranberry farmer that shows the market
in a long run equilibrium.
167
Chapter 11: Perfect Competition
firm
market
5b. What are the four conditions necessary for a perfectly competitive market to be in a long run
equilibrium? (Describe and explain what each condition means. What factor is stable due to
each condition?)
6a. Why has the demand for cranberries in the U.S. increased?
6b. Reproduce your graph from part 5) in the space provided below.
firm
market
On your graph above, show the impact of the increase in the market demand for cranberries,
assuming that cranberry farmers see the increase in demand as being permanent.
c) What is the impact on the market equilibrium price of cranberries in the short-run? Explain.
d) What is the impact on the short-run economic profits of a typical cranberry producer? Explain.
e) What is the impact on the price of cranberries in the long-run? Explain.
f) What is the impact on the long-run economic profits of a typical cranberry farmer? Explain.
g) What is the impact on the long-run market output of cranberries? Explain.
ON THE WEB: Integrating New Media into the Classroom
168
Chapter 11: Perfect Competition
http://ebay.com is the Web site of eBay, the quintessential supply/demand auction site. It is
difficult to imagine what isn’t auctioned here -- categories include everything from toys and
coins to farm equipment and houses. Politics: commercial.
http://www.evenbetter.com is a Web site of German-based Bertelsmann Company, the largest
publisher in the world. By clicking on “books, music, or movies,” you can “compare prices from
all major online shops to track down the best offer.” Politics: none.
http:///www.ams.usda.gov/marketnews.htm is the Web site of the U.S. Department of
Agriculture’s Agricultural Market Service, which “provides current, unbiased price and sales
information to assist in the orderly marketing and distribution of farm commodities. Reports
include information on prices, volume, quality, condition, and other market data on farm
products in specific markets and marketing areas.” These markets include: fruits, vegetables, and
specialty crops; milk, and other dairy products; livestock, meats, grain, and hay; poultry and
eggs; cotton; tobacco; and transportation. Politics: statistical, none.
STUDENT STUMBLING BLOCKS: Common Areas of Difficulty
Short Run and Long Run in the Almond Market
The worldwide consumption of almonds is highly competitive and growing rapidly. For
example, recently India halved its tariff on U.S.-grown almonds. It is a perfect market [this is
actually a lie, since the producer cooperative, Almond Growers Exchange (Blue Diamond),
controls over 40 percent of the U.S. crop, but we’ll pretend]. This exercise is to explain how the
industry has responded, in the short and the long run, to the recent increase in the demand for
almonds.
1. Draw a graph of the almond market in the short run and show an increase in demand on it.
ANS:
Price
S
P1
P0
D2
D1
Q0
Q1
Quantity of Almonds
169
Chapter 11: Perfect Competition
2. Explain what is happening to price, profit, number of firms, each firm's output, and each
firm's marginal cost.
ANS: Price increases. In the short run, the profit of each existing firm rises and there is not time
for new firms to enter the market. (It takes a few years to get new almond trees to crop-bearing
size.) Each existing firm will increase its output until its marginal cost of getting more almonds
equals the new higher price. Thus, marginal cost and output per firm will increase.
3. Now draw a graph of the almond market in the long run. Show what will happen to the
supply in the long run as opposed to the short run.
Price
Ssr
P1
P2
P0
Slr
D2
D1
Q0
Q1
Q2
Quantity of Almonds
Note: This graph assumes almonds are an increasing-cost industry.
4. Explain what happens to the number of firms, the total quantity produced, and the profits of
the firms.
ANS: In the long run, all inputs become variable and firms have time to enter the industry.
Because of the higher price, more firms will enter the industry, more acreage will be devoted to
almonds, and the total quantity produced will increase much more than in the short run. Because
more firms will keep entering, expanding production and pushing market price down, as long as
firms can earn profits in the industry, in the long run firms will no longer be earning more than
normal profits. In fact, they will be earning zero profits.
TIES TO THE TOOLS: Bringing the Boxes into the Classroom
Applying the Tools: The Internet and the Perfectly Competitive Model
The Internet replaces the conventional “brick and mortar” retailer and sets the price on the goods
with auction markets. This is especially true for companies buying standardized products such as
lumber, steel, and screws. They will put their specs out on the net and ask suppliers to bid. The
170
Chapter 11: Perfect Competition
Internet allows firms to enter and leave markets at will making them closer to a purely
competitive market.
Applying the Tools: The Broader Importance of the MR = MC Equilibrium Condition
The MR = MC equilibrium condition is simple, but it is enormously powerful. Understanding
this condition is to economics what understanding gravity is to physics. It gives one a sense of if,
how, and why prices and quantities move.
Applying the Tools: Profit Maximization and Real World Firms
Real-world firms are happy to hold down the factors of production, except for the cost of the
decision-maker – his or her profits, wages, or salaries. Thus, we see CEOs of even money-losing
firms receiving enormous bonus packages while the rank-and-file get their usual COLA.
Knowing the Tools: Finding Output, Price, and Profit
This box contains three steps to find a competitive firm’s price, level of output, and profit given a
firm’s marginal-cost curve and average total-cost curve. It’s a great review box.
Applying the Tools: The Shutdown Decision and the Relevant Costs
A firm rents a skip loader. Although usually considered a fixed cost, if the contract contains a
cancellation clause, the rent can be considered a variable cost. But say that the contract can only
be cancelled upon the firm’s shutdown, the rental cost of the skip loader is an invisible set-up
cost. For the shutdown decision, the cost is variable while for other decisions about changing
quantity, it’s a fixed cost. In accounting, one must consider the relevant cost.
Knowing the Tools: A Summary of a Perfectly Competitive Industry
This is a good summary of the chapter.
LECTURE OUTLINE: A Map of the Chapter
I. Perfect competition.
A. The concept of competition is used in two ways in economics.
1. Competition as a process is a rivalry among firms.
a. As a process, competition pervades the economy.
b. It involves one firm trying to take away market share from another firm.
2. The other use of competition is to refer to a perfectly competitive market structure.
171
Chapter 11: Perfect Competition
a. It is possible to imagine something that does not exist -- a perfectly competitive
market in which the invisible hand works unimpeded.
b. These theoretical markets in this chapter exhibit perfect competition.
II. A perfectly competitive market.
A. A perfectly competitive market is one in which economic forces operate unimpeded.
B. To be perfectly competitive, it must meet the following requirements (Chapter Objective
1):
1. Both buyers and sellers are price takers.
a. A price taker is a firm or individual who takes the market price as given.
b. In most markets, households are price takers -- they accept the price offered in stores.
But the store is not a price taker but a price maker, therefore the retailer is not
perfectly competitive.
2. The number of firms is large.
a. Large means that what one firm does has no bearing on what other firms do.
b. Any one firm's output is minuscule when compared with the total market.
3. There are no barriers to entry (social, political, or economic impediments that prevent
other firms from entering the market).
a. Barriers sometimes take the form of patents granted to produce a certain good.
b. Technology may prevent some firms from entering the market.
c. Social forces such as bankers’ lending only to certain people may create barriers.
4. The firms’ products are identical. This requirement means that each firm's output is
indistinguishable from any competitor's product.
5. There is complete information.
a. Firms and consumers know all there is to know about the market – prices, products,
and available technology.
b. Any technological advancement would be instantly known to all in the market.
6. Firms are profit maximizers.
a. The goal of all firms in a perfectly competitive market is profit and only profit.
b. Firm owners receive only profit as compensation, not salaries.
172
Chapter 11: Perfect Competition
C. Only perfectly competitive firms have supply curves.
1. If all the necessary conditions hold, we can talk formally about the supply of a produced
good.
2. This follows from the definition of supply -- supply is a schedule of quantities of goods
that will be offered to the market at various prices.
a. This definition requires the supplier to be a price taker (the first condition). Since
most suppliers are price makers, any analysis must be modified accordingly.
b. That the number of suppliers be large (the second condition), means that they do not
have the ability to collude.
c. Conditions 3 through 5 make it impossible for any firm to forget about the hundreds
of other firms just itching to replace their supply.
d. Condition 6 specifies a firm's goal -- profit.
3. Even if we cannot technically specify a supply function, supply forces are still strong
and many of the insights of the competitive model can be applied to firm behavior in
other market structures.
D. The demand curves facing the firm is different from the industry demand curve.
1. A perfectly competitive firm's demand schedule is perfectly elastic even though the
demand curve for the market is downward sloping.
2. This means that firms will increase their output in response to an increase in market
demand even though that will cause the price to fall thus making all firms collectively
worse off.
III. Profit maximizing level of output.
A. The goal of the firm is to maximize profits.
B. When it decides what quantity to produce it will continually ask: what will changes in
quantity do to profit?
1. Since profit is the difference between total revenue and total cost, what happens to profit
in response to a change in output is determined by:
a. Marginal revenue (MR) –.the change in total revenue associated with a change in
quantity -- and
b. Marginal cost (MC) -- the change in total cost associated with a change in quantity.
2. All we need to know to determine the profit-maximizing level of output are MC and
MR. Also, a firm maximizes profit when MC = MR.
173
Chapter 11: Perfect Competition
C. Marginal revenue. Since a perfect competitor accepts the market price as given, for a
competitive firm, marginal revenue is price (MR = P). See Figure 11-2.
D. Initially, marginal cost falls and then begins to rise. Marginal concepts are best defined
between the numbers.
E. Profit maximization occurs where: MC = MR. See Figure 2b.
1. The supplier will increase production as long as marginal cost is less than marginal
revenue.
2. If marginal revenue does not equal marginal cost, a firm can increase profit by changing
output (Chapter Objective 2).
3. Thus, the profit-maximizing condition of a competitive firm is MC = MR = P.
F. The marginal-cost curve is the supply curve (Chapter Objective 3). See Figure 11-3.
1. The MC curve tells the competitive firm how much it should produce at a given price.
2. Later we will sharpen this up. The marginal-cost curve is the firm’s supply curve only if
price exceeds average variable cost.
G. Firms maximize total profit.
1. When we speak of maximizing profit, we refer to maximizing total profit, not profit per
unit.
2. Firms do not care about profit per unit; as long as an increase in output will increase
total profits, a profit-maximizing firm should increase output.
H. Profit maximization level of output can also be determined by using total revenue and total
cost. See Figure 11-4.
1. The level of profits is determined by total revenue minus total cost.
2. Total profit is maximized when the vertical distance between total revenue and total
cost is greatest.
IV. Total profit at the profit-maximizing level of output.
A. Profit can be calculated from a table of costs and revenues (Chapter Objective 4b).
174
Chapter 11: Perfect Competition
1. While the P = MR = MC condition tells us how much output a competitive firm should
produce to maximize profit, it does not tell us the profit the firm makes.
2. Profit is determined by total revenue less total cost. See Table 11-1.
B. Profit can be calculated from a graph (Chapter Objective 4a). See Figure 11-5.
1. Find output where MC = MR. The intersection of MC = MR (P) determines the
quantity the firm will produce if it wishes to maximize profits.
2. Find profit per unit where MC = MR. To determine maximum profit, you must first
determine what output the firm will choose to produce. See where MC equals MR, and
then drop a line down to the ATC curve. This is the profit per unit.
3. Firms can also earn zero profit or even a loss where MC = MR.
a. Even though economic profit is zero, all resources, including entrepreneurs, are being
paid their opportunity costs.
b. In all three cases (profit, loss, zero profit), determining the profit-maximizing output
level does not depend on fixed cost or average total cost, but only where marginal
cost equals price.
C. The firm will shut down if it cannot cover average variable costs. See Figure 11-6.
1. A firm should continue to produce as long as price exceeds average variable cost.
2. Once price falls below that point it makes sense to shut down temporarily and save the
variable costs.
3. The shutdown point is the point at which the firm will gain more by shutting down
than it will by staying in business.
4. However, as long as total revenue is more than total variable cost (or P>AVC),
temporarily producing at a loss is the firm's best strategy since it is taking less of a loss
than it would by shutting down.
V. Short-run market supply and demand.
A. While the firm's demand curve is perfectly elastic, the industry's is downward sloping.
B. For the industry's supply curve we use a market supply curve. In the short run when the
number of firms in the market is fixed, the market supply curve is just the horizontal sum
of all the firms' marginal-cost curves, taking account of any changes in input prices that
might occur (Chapter Objective 5).
175
Chapter 11: Perfect Competition
C. Since all firms have identical marginal-cost curves, a quick way of summing the quantities
is to multiply the quantities from the marginal-cost curve of a representative firm by the
number of firms in the market.
VI. Long-run competitive equilibrium.
A. In the short run, discussed above, the number of firms is fixed and the firm can earn either
economic profit or incur economic loss.
B. In the long run, firms earn zero economic profit (Chapter Objective 6). See Figure 11-6b.
C. Only zero profit will stop entry and exit.
1. Zero profit does not mean that the entrepreneur gets nothing for his efforts.
2. In order to stay in business the entrepreneur must receive his opportunity cost or
normal profits the owners of business would have received in the next-best alternative.
3. Normal profits are included as a cost and are not included in economic profit.
Economic profits are profits above normal profits.
4. Just because a firm has super-efficient workers and machinery does not mean it will
make a profit over the long run.
a. Other firms will analyze the situation and bid up the price of this specialized input –
called rent -- until all profits are eliminated.
b. To remind you, a rent is an income received by a specialized factor of production.
5. The zero-profit condition is enormously powerful. It makes the analysis of competitive
markets far more applicable to the real world than does a strict application of the
assumption of perfect competition.
VII. Adjustment from the long run to the short run (Chapter Objective 7).
A. An increase in demand will lead to profits and eventually entry by other firms.
1. Knowing that an increase in demand will mean higher prices, which will lead to higher
profits, competitive firms will increase output. See Figure 11-7.
2. Existing firms increase output and new firms will enter the market, increasing output
still more; price will fall until all profit is competed away.
3. The long-run industry supply curve in a constant-cost industry will be perfectly elastic,
with a new equilibrium at the same price but with a higher output. Economists call this
market a constant-cost industry.
176
Chapter 11: Perfect Competition
4. Two other possibilities exist: an increasing-cost industry where factor prices rise as new
firms enter the market and existing firms expand capacity, and a decreasing-cost
industry where factor prices fall as industry output expands.
a. An increasing-cost industry.
(1) If inputs are specialized, factor prices are likely to rise when the increase in the
industry-wide demand for inputs to production increases.
(2) This rise in factor costs would force costs up for each firm in the industry and
increases the price at which firms earn zero profit.
(3) Thus, in increasing-cost industries, the long-run supply curve is upward sloping.
b. A decreasing-cost industry.
(1) If input prices decline when industry output expands, individual firms’ marginalcost curves shift down and the long-run supply curve is downward sloping.
(2) Input prices may decline to the zero-profit condition when output rises and when
new entrants make it more cost effective for other firms to provide services to all
firms in the market.
5. In the short run, the price does more of the adjusting. In the long run, more of the
adjustment is done by quantity.
B. An example in the real world. See Figure 11-8.
1. Owners of the Ames chain of department stores decide to close over 100 stores after
experiencing two years of losses (a shutdown decision).
2. Initially, Ames thought the losses were temporary.
a. Since price exceeded average variable cost, it continued to produce even though it
was losing money.
b. After two years of losses, its prospective changed.
c. The company moved from the short run to the long run. They began to think that
demand was not temporarily low, but permanently low.
d. At that point they shut down those stores for which P < AVC.
CHAPTER SUPPLEMENTS: Other Classroom Aids to Use
 Classic Readings in Economics: In "Economics and Knowledge," pp. 144-146, Nobel
Laureate Friedrich A. Hayek, discusses the usefulness of markets in their ability to process
knowledge and push towards equilibrium, not because they actually achieve equilibrium.
177
Chapter 11: Perfect Competition
 Classic Readings in Economics: "Competition and Custom," pp. 150-151. John Stuart Mill
broadened the reach of political economy by placing the competitive process in the center of
our understanding of a society's culture and customs. "Competition," pp. 147-149. Alfred
Marshall discusses competition in modern society.
 Experiments in Teaching and in Understanding Economics, pp. 15-19: A Double Auction
Market Experiment.
 Economics: An Honors Companion: "Applying the Competitive Model," pp. 227-228, for a
firm's profit-maximizing decisions for perfect competition.
178
Chapter 11: Perfect Competition
POP QUIZ
NAME: __________________________________
COURSE: ________________________________
1. A price taker:
a. is the same thing as a rice maker.
b. can be the seller but not the buyer.
c. can be the buyer but not the seller.
d. takes the price determined by the market as given.
2. Which of the following does not characterize perfect competition?
a. Competitive firms sell an identical product.
b. There are so many firms selling output in the market that no one individual firm has the
ability to control the market price.
c. Economic profits cannot be earned in the long run.
d. The demand curve facing the competitive firm is downward sloping.
3. For a perfectly competitive firm:
a. the demand curve is perfectly inelastic at the market price and is one and the same with its
marginal-revenue curve.
b. economic profits can be earned in the long run but not in the short run.
c. the profit-maximizing quantity to produce occurs at that output level in which price equals
marginal cost.
d. its total-revenue function is linear (a straight line), with a slope equal to the quantity
demanded.
4. In order to maximize profits (or minimize losses) a firm should produce at the output level
which:
a. maximizes per-unit profit.
b. maximizes total revenue.
c. minimizes total cost.
d. causes marginal revenue to equal marginal cost.
5. If a firm is producing at an output level in which:
a. marginal revenue exceeds marginal cost, then the firm should reduce its output level to
maximize profits.
b. marginal revenue is less than marginal cost, then the firm should expand its output level to
maximize profits.
c. price exceeds average total costs, then the firm is earning an economic profit.
d. price is less than minimum average total cost but greater than average variable cost, then
the firm should shut down.
179
Chapter 11: Perfect Competition
6. The shutdown point:
a. is when the firm will be better off if it shuts down than it will be if it stays in business.
b. always means bankruptcy.
c. is when price< ATC.
d. is when price = fixed cost.
7. If economic profits are currently being earned by firms in a perfectly competitive market, in
the long run we can expect:
a. new firms to enter the business.
b. the market supply curve to shift to the left.
c. the market price to rise.
d. a substantial economic profit to be earned by firms.
8. In a perfectly competitive market over the long run,
a. an increase in market demand or a decrease in firms’ costs will lead to a decrease in the
number of firms operating within the market.
b. an improvement in production technology will increase profits at first, but those profits
will be competed away over time as more firms enter the industry and reduce market price.
c. market price will equal maximum possible average total cost in long-run equilibrium.
d. an increase in demand will cause the final market equilibrium to be at the original price but
at a lower output level.
9. Zero profits mean that:
a. the entrepreneur gets nothing for his or her efforts.
b. if a firm has super-efficient machinery, zero profit can be avoided.
c. if a firm has super-efficient workers, zero profit can be avoided.
d. only at this point does market entry and exit stop.
10. In a market, factor prices do not increase as industry output increases. Economists call this
market:
a. a constant-cost industry.
b. an increasing-cost industry.
c. a decreasing-cost industry.
d. a capital-intensive industry.
180
Chapter 11: Perfect Competition
ANSWERS TO POP QUIZ
1. d 2. d 3. c 4. d 5. c 6. a 7. a 8. b 9. d 10. a
CASE STUDIES: Real-World Cases of Textbook Concepts
Case Study 11-1: World Coffee Prices
It is estimated that while world coffee prices hover around 50¢ per pound, production costs are
around 80¢ per pound. According to a report issued in September 2002 by the relief agency
Oxfam, prices are at their lowest in 100 years, thereby leaving 25 million farmers in crisis.
Banks dependent on the industry are collapsing.
It is ironic that in a world of designer coffees – mochas and lattes – a worldwide glut of coffee
beans has farmers and pickers suffering. One of the hardest hit places is Nicaragua, where the
coffee crop is wilting and the people are beginning to starve.
Oxfam accuses the roasting companies – Proctor & Gamble, Nestle SA, Kraft Foods Inc., Sara
Lee Corp., and Tchibo Holding AG are the biggest – of profiting from the crisis and urges them
to pay higher prices. The companies reply that they cannot be blamed for the oversupply, and
that paying higher prices would encourage farmers to produce more coffee that nobody wants.
The company taking the most heat is Starbucks Corp., the designer-coffee maven, among the top
ten coffee buyers in the world. This world-wide chain has a lot to lose if their customers,
especially those of college age, see it as a Third World profiteer.
“But the plight of the world’s financially struggling coffee farmer is a complicated one – and not
all the fault of corporate coffee buyers. Farmers are caught up in the harsh world of commodity
markets, where prices are based on supply and demand in a highly fragmented industry. A
chronic coffee surplus has resulted in years of low prices.”
Sources: “For Coffee Growers, Not Even a Whiff of Profits,” Business Week, September 9, 2002,
p. 110; and World Coffee Prices at 100-Year Low,” New York Times, September 18, 2002.
Questions:
1. Is the market for coffee perfectly competitive?
2. Does the coffee market meet all six conditions of a perfectly competitive market?
3. Which factor is not represented?
4. Do you buy the Starbuck’s argument that paying higher coffee prices will increase demand
and will ultimately increase the glut?
5. Are the coffee growers operating at zero economic profit in the sense in which the chapter
defines it?
181
Chapter 11: Perfect Competition
Case Study 11-2: Setting up Your Own Web Business
Entrepreneurs need very little money and technical know-how to launch a Web business. It’s
actually a three-step process:
1. Build a Web site to display the merchandise and take orders electronically. That’s not as easy
as sending an email, but almost.
2. Unless you have the programming skills and megabucks needed to buy and operate a Web
site server of your own, you need to find someone to “host” your site. There are a number of
alternative home-page setups you can buy and, for a monthly or yearly charge, maintain.
a. Yahoo, Santa Clara, California, offers a package of Yahoo Store templates designed to
get the online retailer onto the web in 30 minutes or less. More than 5,800 online stores
have been set up using Yahoo Store.
b. IBM’s Home Page Creator usually costs less than $100 or less to set up a site, and about
the same per month for support services.
c. Netopia, Inc., of Alameda, California, charges $59.95 per month for the templates,
instructions, site-building tools and hosting services retailers need to do business on the
Internet.
3. You need to advertise and promote the store. That’s what all those monthly charges are for.
Microsoft Corporation’s LinkExchange, www.linkexchange.com, in San Francisco, is a onestop shop for all the marketing needs of small retailers on the net. For $60 per year, Microsoft
will register a site with as many as 400 search engines and directories. They also provide
services that let the online retailer collect customer email addresses and manage online
mailing lists, and that help online merchants operate “affiliate” programs, which provide
referral fees to other websites sites in return for sales leads from them.
Source: Joelle Tessler, “Small Investment, Big Results,” The Wall Street Journal, November 22,
1999.
Questions:
1. Is this an example of a perfectly competitive market?
2. Would it be difficult to calculate MC and MR for these small online retailers?
3. Will competition be enhanced domestically with these online businesses? How about
globally?
4. Are the retailers price takers?
5. Are the customers price takers?
182
Chapter 11: Perfect Competition