Chapter 6: Competition

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Chapter 6 Competition
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• 1. Market Structure

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Market Structure

• The number and relative size of firms in an
  industry.

4
Market Structure

• Market structure ranges from perfect
  competition to monopoly.

• Most real-world firms are along the continuum
  of imperfect competition.

• Market structure affects market outcomes, i.e.,
  the price and quantity of goods supplied.

Perfect Competition
MonopolisticCompetition
Oligopoly
Duopoly
Monopoly
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Competitive Firm

• A perfectly competitive firm is one without
  market power.

• It is not able to alter the market price of the
  good it produces.
• A corn farmer is an example of a perfectly
  competitive firm.

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Competitive Market

• A competitive market is one in which no buyer or
  seller has market power.

• High tech electronics and agricultural goods are
  sold in competitive markets.

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Monopoly

• A monopoly firm is one that produces the entire
  market supply of a particular good or service.

• Comcast is an example of a monopoly firm.

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Market Power

• Market power is the ability to alter the market
  price of a good or service.

• The FSU campus book store has market power.

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Imperfect Competition

• Imperfect competition is between the extremes of
  monopoly and perfect competition.

• In duopoly only two firms supply a particular
  product.
• In oligopoly a few large firms supply all or most
  of a particular product.

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Imperfect Competition

• In monopolistic competition many firms supply
  essentially the same product but each has brand
  loyalty

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• 2. Perfect Competition

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Perfect Competition

• A perfectly competitive firm is one whose output
  is so small in relation to market volume that its
  output decisions have no impact on price.

• A perfectly competitive firm is aprice taker.

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Price Takers

• Individual firms output decisions do not affect
  the market price.

• Individual firms must take the market price and
  do the best they can within these constraints

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Market Demand vs. Firm Demand

• The market demand curve is always downward
  sloping.

• The demand curve facing a perfectly competitive
  firm is horizontal.

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Market Demand vs. Firm Demand

• The demand for any product is downward sloping,
  as here with catfish.

• The equilibrium price pe of catfish is
  established by the intersection of market
  demand and market supply.

• An individual farmer may sell her catfish only
  at the market price as if she charged any more
  consumers would go elsewhere for the identical
  good at the market price. Lower prices would
  not maximize her profit.

• So, the individual farmer faces a horizontal
  demand curve for her own output.

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• 3. The Firms Production Decision

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The Firms Production Decision

• Choosing a rate of output is a firms production
  decision.

• It is the selection of the short-term rate of
  output with existing plant and equipment.

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Output and Revenue

• The more output a competitive firm produces, the
  greater its revenues will be.

• Total revenue is the price of a product
  multiplied by the quantity sold in a given time
  period.

price
quantity

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Revenues vs. Profits

• Profit is the difference between total revenue
  and total cost.

• Maximizing output or revenue is not the same as
  maximizing profits.
• Total profits depend on how costs increase as
  output expands

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• 4. Profit Maximization

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Profit Maximization

• To maximize profit, the firm should produce an
  additional unit of output only if it brings in
  more revenue than it costs.

• Price is determined by the intersection of market
  demand and supply.

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Profit Maximization

• Marginal cost is the increase in total costs
  associated with a one-unit increase in
  production.

• Marginal cost generally increases as rate of
  production increases due to diminishing returns.

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Costs of Production
Costs per basket
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• Here we look at the market for Baskets.

14

• To sketch out the marginal cost curve we look
  at the increase in total cost as the number of
  units increases.

12

• Note how when we increase output from 0 to 1
  unit total cost increases by 5, the marginal
  cost to increase production 0 to 1 unit output
  is 5 dollars.

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8
6

• Note how when we increase output from 1 to 2
  units the marginal cost is 7.

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• . . . and so on.

Outputbaskets per hour
2
1
5
4
3
6
5
7
9
13
17
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Short-Run Profit-Maximization Rules
for Competitive Firm
gt
increase output rate
maintain output rateand maximize profit

lt
decrease output rate
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Maximization of Profits for Competitive Firm
Costs per basket
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• Again we look at the market for Baskets.

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• Lets assume that the market price for baskets
  is 13. At what rate of output should the firm
  set its production?

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10

• If MC is less than price, as it is for output
  levels below 4, then increases in output will
  increase profits.

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• If MC is greater than price, as it is for output
  levels above 4, then decreases in output
  increase profits.

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4

• A competitive firm maximizes its profits by
  setting the output rate where P MC.

Outputbaskets per hour
2
1
5
4
3
6

rate of total total
total marginaloutput price
revenue costs profit price
cost
Here total profits are maximizedby setting
outputequal to 4 where
------
------
------
------
0
10
- 10
5
15
- 2
13
1
7
22
4
2
26
9
39
31
8
3
MC P 13
13
44
8
52
4
lt
17
61
4
5
65
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Profit-Maximizing Rate of Output

• Total profit equals average profit per unit times
  the number of units produced.

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Profit-Maximizing Rate of Output

• The profit-maximizing producer never seeks to
  maximize per-unit profits.

• Total profits are maximized only where p MC

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Illustrating Total Profit
Costs per basket
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• Once again, the market for Baskets.

• First we add the ATC curve.

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• Total profits can be computed as profit per
  unit multiplied times the quantity sold . . .

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• As total profits are maximized at q4, we can
  illustrate total profits as the area
  represented in the shaded rectangle. The
  shaded rectangle is the difference between the
  ATC for that level of output and the price
  received in the market. The area below this
  rectangle is the cost, the area within the
  rectangle is the profit.

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8
6
4
Outputbaskets per hour
2
1
5
4
3
6

rate of total total
total marginaloutput price
revenue costs profit
cost
ATC
Recall, total profits are maximizedby setting
outputequal to 4 where
------
------
------
------
0
10
- 10
5
15.00
15
- 2
13
13
1
7
11.00
22
4
2
26
13
9
10.33
39
31
8
13
3
MC P 13
11.00
13
44
8
52
13
4
17
12.20
61
4
5
65
13
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• 5. Supply Behavior

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Supply Behavior

• A Firms Supply

• Supply is the ability and willingness to sell
  specific quantities of a good at alternative
  prices in a given time period.
• The marginal cost curve is the short-run supply
  curve for a competitive firm.

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A Firms Supply

• Important influences on marginal cost and supply
  behavior are

• Price of factor inputs
• Technology
• Expectations

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Market Supply

• Market supply is the total quantities of a good
  that sellers are willing and able to sell at
  alternative prices in a given time period.

• The market supply curve is the sum of marginal
  cost curves of all firms.

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Market Supply Curve

• The MC curve is a competitive firms short-run
  supply curve.

• The MCA tells us that Farmer A will produce 50
  lbs. of catfish per day if the market price
  is 3 a lb..

MCB tells
us that Farmer B will produce 110 lbs.
MCC tells us that Farmer C will produce 30 lbs.
of catfish per day if the market price is 3 a
lb..

• To determine the market supply we add up the
  quantities supplied by each farmer. The
  total quantity supplied to market at 3 a
  lb.would be 190 lbs. ( A B C).

• Market supply depends on the of firms and
  their respective marginal costs.

MCB
MCC
MCA
5
5
5
4
4
4
3
3
3
2
2
2
1
1
1
10
50
10
50
70
30
70
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Farmer C
Farmer A
Farmer B
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Market Supply

• Determinants of Market Supply

• Price of factor inputs
• Technology
• Expectations
• Number of firms in industry

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• 6. Industry Entry and Exit

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Industry Entry and Exit

• The number of firms in a competitive industry is
  not fixed.

• Additional firms will enter the industry when
  profits are plentiful.
• Firms exit the industry when profit opportunities
  look better elsewhere

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Entry

• Economic profits attract firms.

• Industry output increases.
• Market supply curve shifts right as entry
  increases.
• Price falls.

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Market Entry
Price

• We begin in equilibrium (E1), where market
  demand market supply.

• If more firms enter an industry, the market
  supply curve (S1) shifts to the right (S2).

p1

• This creates a new equilibrium (E2), where
  output is higher and the price level is lower.

p2
q2
q1
Quantity
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The Tendency Toward Zero Economic Profits

• Entry is the force driving down market prices.

• Price falls until there are no economic profits.
• At that point, average cost is at a minimum.

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Market Supply Curve

• Consider the market below. Recall that where
  ever the market supply curve crosses the
  market demand curve, the market price level will
  exist. Further, recall that any price level
  established in the market that exceeds ATC for
  the competitive firm will result in positive
  profits to the firm.

• If the market begins with S1, the price level of
  P1 will persist.

• P1 will result in profits as represented by the
  shaded box below, that area below the market
  price level and above the ATC for that output
  level.

• Positive economic profits will result in drawing
  other suppliers into the market.

The Market
The Competitive Firm
Price
Price
p1
MarketDemand
q1
Quantity (hundreds)
Quantity (millions)
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Market Supply Curve

• As profits exist, the market supply increases as
  firms decide to enter the market.

• As firms enter the price level in the market
  falls and which in turn reduces the output
  level of the competitive firm as they will
  produce up to the point where their marginal
  costs are equal to the now lower market price
  level.

• The new market price level, P2, will result in
  profits as represented by the shaded box
  below, that area below the now lower market price
  level and above the ATC for that output
  level. Note that profits have shrunk a bit, but
  still exist.

• Positive economic profits will result in drawing
  other suppliers into the market.

The Market
The Competitive Firm
Price
Price
p1
p2
MarketDemand
q1
q2
Quantity (hundreds)
Quantity (millions)
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Market Supply Curve

• As profits exist, the market supply increases as
  firms decide to enter the market.

• As firms enter the price level in the market
  falls and which in turn reduces the output
  level of the competitive firm as they will
  produce up to the point where their marginal
  costs are equal to the now lower market price
  level.

• The new market price level, P3, will result in a
  situation where P MC ATC where all profits
  have disappeared and thus entry will cease.

The Market
The Competitive Firm
Price
Price
p1
p2
p3
MarketDemand
q1
q2
q3
Quantity (hundreds)
Quantity (millions)
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Exit

• Firms leave the industry if price falls below
  average cost.

• As firms exit the industry, the market supply
  curve shifts to the left.
• Price rises until there are no economic losses.
• At that point, average cost is at a minimum.

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Long-Run Equilibrium

• Profits induce entry.

• Losses induce exit.
• Economic profit is eliminated.
• Price equals minimum average cost in the end.

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Low Barriers to Entry

• There are no significant barriers to entry in
  competitive markets.

• Barriers to entry make it difficult or impossible
  for would-be producers to enter a market.
• Examples of barriers to entry include patents,
  brand loyalty, and price controls.

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Characteristics of a Competitive Market

• Many firms

• Identical products
• MC p
• Low barriers to entry
• Zero economic profit
• Perfect information

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End of Chapter 6 Lecture