Post on 30-Mar-2015
Competition and the Market
Chapter 7
The function of PricePrice brings quantity supplied in
line with quantity demanded.As a good becomes relatively more
scarce, price will go up.How does this impact firms and
consumers?
Markets can be characterized by how prices for goods and services are determined
Major Market Structures
Perfect competitionMonopolistic competitionOligopolyMonopoly
Forms of Market Competition
PerfectCompetition Monopoly
MonopolisticCompetition
Oligopoly
The Competitive Model
The process of competition involves a rivalry among firms and is prevalent throughout our economy.
The Competitive Model
The state of competition is the end result of the competitive process under certain conditions.
Factors Affecting the Form of Market Competition an Industry Expresses
Factors
The number and size distribution of buyers and sellers
The degree of product differentiation
Factors
The extent of barriers to entryAmount of information available
Factor #1: The number and size distribution of buyers and sellers
Number and Size Distribution
E.g. farmers and consumers2 million farms in US1.2 million are small with < $20,000
annual income
Number and Size Distribution
Most farm’s output is so small, any one’s output, compared to total output, is imperceptible.
What one farmer does has no influence on what any other farmer does.
Number and Size Distribution
The same can be said for consumers.
Marketplace has many consumers and the vast majority consume small amounts.
Factor #2: Product Differentiation
Product Differentiation
A competitive market is characterized by undifferentiated or homogeneous products.
Product Differentiation
Homogeneous or undifferentiated products cannot be distinguished from one another.
E.g. No. 2 yellow corn
Product Differentiation
If you feed livestock and have two different corn sellers you can buy from, how do you determine which to buy from?
Product Differentiation
Grain elevator A
No. 2 yellow corn
$2.10/bu
Grain elevator B
No. 2 yellow corn
$2.11/bu
Product Differentiation
What determines decision?Price!
Identical product5000 bu x $.01 less/bu = $50
savings by using elevator A
Factor #3:
Barriers to Entry
Barriers to Entry
Barriers are things that prevent other firms from entering the market.
Barriers to Entry
Economics of scaleAbsolute unit cost
advantagesCapital access cost
Barriers to Entry
Government policyPatentsCommodity programs Import controls
Factor #4:
Perfect Knowledge and Information
Knowledge and Info
In a perfectly competitive market, firms would have same access to new knowledge and information about market prices, quantities, and quality.
Profit Maximizing Entrepreneurial Firms
For perfect competition to exist, firms must have a singular goal of profit maximization.
The Profit Motive and the Results of Competition
The competitive firm’s demand curve
$$
QuantityQuantity
The competitive firm’s The competitive firm’s demand curvedemand curve
$$
MR = D = PMR = D = P
QuantityQuantity
PPmm
The competitive firm’s The competitive firm’s demand curvedemand curve
The optimal level of output for a competitive firm is determined where Marginal Revenue (MR) is equal to Marginal Cost (MC).
$$
QuantityQuantity
Optimal Output Level
$$
MR = DMR = D
QuantityQuantity
PP**
Optimal Output Level
$$ MCMC
MR = DMR = D
QuantityQuantity
PP**
Optimal Output Level
$$ MCMC
MR = DMR = D
QuantityQuantityQQ**
PP**
Optimal Output Level
Average Total Cost (ATC) can be added to the graph to demonstrate the firm’s profit potential.
Average Total Cost
The per unit cost of producing a specific good.
The difference between ATC and product’s price equals the profit per unit of product.
$$
QuantityQuantity
Average Total Cost
ATCATC$$
QuantityQuantity
Average Total Cost
Average Total Cost
Price - ATC = Profit per unit of output
Note: Price > ATC indicates a profit
$$
QuantityQuantity
$$
MR = DMR = D = P= P
QuantityQuantity
PP**
$$ MCMC
MR = DMR = D = P= P
QuantityQuantityQ*Q*
PP**
$$ MCMC
MR = DMR = D = P= P
QuantityQuantity
ATCATCPP**
$$ MCMC
MR = DMR = D = P= P
QuantityQuantity
ATCATC
QQ**
PP**
ProfitProfit
$$ MCMC
MR = DMR = D = P= P
QuantityQuantity
ATCATC
QQ**
PP**
Profit
Price - ATC = Profit per unit of output
Note: Price < ATC indicates a loss
Profit It is important to note that profit in a
perfectly competitive market will lead to firms wanting to enter that market
If enough firms enter, then the market supply curve will shift to the right.
$ or Price$ or PriceSS
DD
QuantityQuantity
PPee
QQee
$ or Price$ or PriceSS
DD
QuantityQuantity
PPee
QQee
SS
Profit
With the increase in Supply, price will be driven down.
With the lower price, profits will be driven out.
$$
QuantityQuantity
$$
MR = D MR = D = P= P
QuantityQuantity
PP**
$$MCMC
MR = D MR = D = P= P
QuantityQuantity
PP**
$$MCMC
MR = D MR = D = P= P
QuantityQuantity
ATCATC
PP**
$$MCMC
MR = D MR = D = P= P
QuantityQuantity
ATCATC
QQ**
PP**
$$MCMC
MR = D MR = D = P= P
QuantityQuantity
ATCATC
QQ**
PP** LossLoss
$ or Price$ or PriceSS
DD
QuantityQuantity
PPee
QQee
$ or Price$ or PriceSS
DD
QuantityQuantity
PPee
QQee
SS
Profit
With the decrease in Supply, price will be driven up.
With the higher price, the losses will be driven out.
Market Price and Quantity
What are the factors that generate the market price that firms use to make their production decisions?
The interaction of the Market Supply and Market Demand curves will determine the price consumers will pay and producers will receive.
Market Supply and Demand Relationship for a Competitive Market
$ or Price$ or Price
QuantityQuantity
$ or Price$ or Price
DD
QuantityQuantity
$ or Price$ or PriceSS
DD
QuantityQuantity
$ or Price$ or PriceSS
DD
QuantityQuantity
PPee
QQee
Specific Results of Competition
Price takersOptimal outputNo product
differentiation
Specific Results of Competition
Market equilibriumTechnological advancementsEfficiency
Changes in Supply or Demand
An Increase in Supply
An Increase in Supply
Note the supply curve shifts to the right. This lowers price and increases quantity
supplied.
An Increase in Supply
A decrease in supply would be represented by a shift of the supply curve to the left.
$ or Price$ or Price
QuantityQuantity
$ or Price$ or Price
DD
QuantityQuantity
$ or Price$ or PriceSS
DD
QuantityQuantity
$ or Price$ or PriceSS
DD
QuantityQuantity
PP
$ or Price$ or PriceSS
DD
QuantityQuantity
PP
SS11
$ or Price$ or PriceSS
DD
QuantityQuantity
PP
SS11
PP11
QQ11
Supply Shifters
Input CostsPrices of Related GoodsTechnologyWeatherNumber of SellersTaxesExpectations
An Increase in Demand
$ or Price$ or Price
QuantityQuantity
$ or Price$ or Price
DD
QuantityQuantity
$ or Price$ or PriceSS
DD
QuantityQuantity
$ or Price$ or PriceSS
DD
QuantityQuantity
PP
$ or Price$ or PriceSS
DD
QuantityQuantity
PP
DD11
$ or Price$ or PriceSS
DD
QuantityQuantity
PP
DD11
PP11
QQ11
An Increase in Demand
Note Demand Curve shifts rightIncreases priceIncreases quantity demanded
A Decrease in Demand
Demand Curve would shift leftDecreases priceDecreases quantity demanded
Demand Shifters
Income PopulationTastes and PreferencesPrices of Related GoodsExpectations
Agriculture’s Competitive Side
2.1 mil farmsHomogeneous productsFreedom of entry and exitInformation is available
Agriculture’s Departure from Competition
Soviet grain deal of 1973Marketing cooperativesHigh land pricesTechnology availability
Models of Imperfect Competition
Imperfect competition exists whenever a firm has some control over the price it charges for its product.
Forms of Competition
PerfectPerfectCompetitionCompetition
MonopolyMonopolyMonopolisticMonopolisticCompetitionCompetition
OligopolyOligopoly
Imperfect CompetitionImperfect Competition
Monopolistic Competition
Many sellers in marketDifferentiated productsEase of entry or exitInformation is readily available
Monopolistic Competition
Non-price competition usually occurs
$$
QuantityQuantity1 5 101 5 10
Monopolistic Competitor Demand Curve
$$
QuantityQuantity
DD
1 5 101 5 10
Monopolistic Competitor Demand Curve
Monopolistically Competitive Firm’s Price, Quantity, and Profit
Short Run
$$
QuantityQuantity1 5 101 5 10
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Monopolistically Competitive SR
$$
QuantityQuantity
DD
1 5 101 5 10
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Monopolistically Competitive SR
$$
QuantityQuantity
DD
1 5 101 5 10
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Monopolistically Competitive SR
$$
QuantityQuantity
DD
1 5 101 5 10
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MCMC
Monopolistically Competitive SR
$$
QuantityQuantity
DD
1 5 101 5 10
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MCMC
ATCATC
Monopolistically Competitive SR
$$
QuantityQuantity
DD
1 5 101 5 10
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MCMC
ATCATC
Monopolistically Competitive SR
$$
QuantityQuantity
DD
1 5 101 5 10
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MCMC
ATCATC
Monopolistically Competitive SR
$$
QuantityQuantity
DD
1 5 101 5 10
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MCMC
ATCATC
Monopolistically Competitive SR
Monopolistically Competitive Firm’s Price, Quantity, and Profit
Long Run
$$
QuantityQuantity1 5 10 1 5 10
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Monopolistically Competitive LR
$$
QuantityQuantity
DD
1 5 10 1 5 10
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Monopolistically Competitive LR
$$
QuantityQuantity
DD
1 5 10 1 5 10
22221818141410106622 MRMR
Monopolistically Competitive LR
$$
QuantityQuantity
DD
1 5 10 1 5 10
22221818141410106622 MRMR
MCMC
Monopolistically Competitive LR
$$
QuantityQuantity
DD
1 5 10 1 5 10
22221818141410106622 MRMR
MCMCATCATC
Monopolistically Competitive LR
$$
QuantityQuantity
DD
1 5 10 1 5 10
22221818141410106622 MRMR
MCMCATCATC
Monopolistically Competitive LR
OligopolyA few large firmsProducts standardized or
differentiatedDifficult entryKnowledge not available to all firms
Oligopoly Industries
SugarLight bulbsGasSteelGlass
Oligopoly Industries
AutosBreakfast cerealsCigarette makersSoapBeer
Concentration Ratio
A rough measure to gauge whether or not an industry is an oligopoly
% of market the largest firms control
Usually 4-8 firms
CR Example
CR4 = % of market the largest 4 firms control
Malt beverage industryCR4 = 90%
Pure Monopoly
Only one seller in marketProduct totally differentiatedNo free entry or exitImperfect information
Pure Monopoly
Where a perfectly competitive firm is a price taker, the monopolist is a price searcher.
$$
QuantityQuantity
PP**
1 5 101 5 10
Monopolist’s Demand Curve
$$
QuantityQuantity
PP**
DD
1 5 101 5 10
Monopolist’s Demand Curve
Monopoly Price, Quantity, and Revenue Schedules
$$
QuantityQuantity1 5 10 1 5 10
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Monopoly
$$
QuantityQuantity
DD
1 5 10 1 5 10
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Monopoly
$$
QuantityQuantity
DD
1 5 10 1 5 10
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MRMR
Monopoly
$$
QuantityQuantity
DD
1 5 10 1 5 10
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MRMR
MCMC
Monopoly
$$
QuantityQuantity
DD
1 5 10 1 5 10
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MRMR
MCMC
ATCATC
Monopoly
$$
QuantityQuantity
DD
1 5 10 1 5 10
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MRMR
MCMC
ATCATC
Monopoly
Monopoly Revenue Schedule
Price Units sold
Total Rev.
Marg. Rev.
$20 1 20 >16 $18 2 36 >12 $16 3 48 >8 $14 4 56 >4
Monopoly Revenue Schedule
Price Units sold
Total Rev.
Marg. Rev.
$12 5 60 >0
$10 6 60 >-4
$8 7 56
Efficiency Comparisons
The Growth of Firms
Internal GrowthExternal Growth
The Growth of Firms Horizontal Mergers
Combinations of firms in the same industry
Vertical Mergers Two or more firms in different production
or marketing stages within the same industry.
Conglomerate mergers Combinations of firms in unlike
industries
Antitrust LawsSherman Antitrust Act
Section 1 makes it Illegal to act in restraint of trade
Section 2 makes it illegal to monopolize interstate trade, forbidding the use of economic power.
Agricultural BargainingThe more the market is
concentrated, the more power the larger firms have.
A large number of farmers facing a single buyer could be an example.
Farmers can resolve this situation by organizing themselves into an agricultural bargaining group.
Agricultural BargainingClayton Act started the process of
giving farm groups immunity from Sherman Act.
These farm groups must form as non-profit groups, and could not have capital stock.
Agricultural Bargaining Capper Volstead Act of 1922 was sought to clarify
that section of the Clayton act that applied to agriculture.
CV 1922 provided stock or nonstock corporations to operate provided:
They operated for the mutual benefit of their membership
They did not deal in the products of non-members to an amount greater in value than such as are handled by it for its members.
No member is allowed more than one vote Association does not pay dividends on stock or
membership capital in excess of 8 percent a year. They can’t use their market power to enhance prices.