Competition and the Market Chapter 7. The function of Price Price brings quantity supplied in line...

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


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.


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.


Homogeneous or undifferentiated products cannot be distinguished from one another.

E.g. No. 2 yellow corn


If you feed livestock and have two different corn sellers you can buy from, how do you determine which to buy from?


Grain elevator A

No. 2 yellow corn

$2.10/bu

Grain elevator B

No. 2 yellow corn

$2.11/bu


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**


$$ MCMC

MR = DMR = D

QuantityQuantity

PP**


$$ MCMC

MR = DMR = D

QuantityQuantityQQ**

PP**


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


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


QuantityQuantity

PP**

$$MCMC


QuantityQuantity

ATCATC

PP**

$$MCMC


QuantityQuantity

ATCATC

QQ**

PP**

$$MCMC


QuantityQuantity

ATCATC

QQ**

PP** LossLoss


DD

QuantityQuantity

PPee

QQee


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


DD

QuantityQuantity


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


Note the supply curve shifts to the right. This lowers price and increases quantity

supplied.


A decrease in supply would be represented by a shift of the supply curve to the left.


QuantityQuantity


DD

QuantityQuantity


DD

QuantityQuantity

PP

QQ


DD

QuantityQuantity

PP

QQ

SS11


DD

QuantityQuantity

PP

QQ

SS11

PP11

QQ11

Supply Shifters

Input CostsPrices of Related GoodsTechnologyWeatherNumber of SellersTaxesExpectations

An Increase in Demand


QuantityQuantity


DD

QuantityQuantity


DD

QuantityQuantity

PP

QQ


DD

QuantityQuantity

PP

QQ

DD11


DD

QuantityQuantity

PP

QQ

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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$$

QuantityQuantity

DD

1 5 101 5 10

22221818141410106622 MRMR


$$

QuantityQuantity

DD

1 5 101 5 10

22221818141410106622 MRMR

MCMC


$$

QuantityQuantity

DD

1 5 101 5 10

22221818141410106622 MRMR

MCMC

ATCATC


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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$$

QuantityQuantity

DD

1 5 10 1 5 10

22221818141410106622 MRMR


$$

QuantityQuantity

DD

1 5 10 1 5 10

22221818141410106622 MRMR

MCMC


$$

QuantityQuantity

DD

1 5 10 1 5 10

22221818141410106622 MRMR

MCMCATCATC


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

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.

Competition and the Market Chapter 7. The function of Price Price brings quantity supplied in line...

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