Competition

Competition

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Market Structure

The number and relative size of firms in

an industry.

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Market Structures

Imperfect competition

Perfect Monopolistic Oligopoly Duopoly Monopoly

competition competition

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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.
Your local cable TV company 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.
Your campus book store has market power.

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Imperfect Competition

Imperfect competition is between the

extremes of monopoly and perfect
competition.

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Imperfect 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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Perfect Competition

Perfectly competitive firms are pretty

much faceless.
They have no brand image, no real
market recognition.

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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 perceptible
impact on price.

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Price Takers

A perfectly competitive firm is a price

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

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Price Takers

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
You must distinguish between the
market demand curve and the demand
curve confronting a particular firm.

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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 vs. Firm Demand
The Catfish Market Demand for Individual
PRICE Farmer's Catfish
(per fish) Market
supply

pe Equilibrium Demand facing

price pe
single farmer

Market
demand

QUANTITY (thousand fish per day) QUANTITY (fish per day)

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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 Revenues

The more output a competitive firm

produces, the greater its revenues will
be.

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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

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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.

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Revenues vs. Profits

Total profits depend on how costs

increase as output expands.

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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.

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Price

Since competitive firms are price takers,

they must take whatever price the
market has put on their products.

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Marginal Cost

Marginal cost is the increase in total

costs associated with a one-unit
increase in production.

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Marginal Cost

Marginal cost generally increases as

rate of production increases due to
diminishing returns.

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The Costs of Catfish Production

Rate of Marginal Average

Output Total Cost Cost Cost
0 $10
1 15 $ 5 $15.00
2 22 7 11.00
3 31 9 10.33
4 44 13 11.00
5 61 17 12.20

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 The Costs of Catfish Production
$18 F
16 Marginal cost
COST (dollars per basket)

14 E
12
10 D
8 C
6 B
4
2

0 1 2 3 4 5 6 7
RATE OF OUTPUT (baskets per hour)

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Profit-Maximizing Rate of
Output
Never produce anything that costs more
than it brings in.
Boils down to comparing price and
marginal cost.

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Profit-Maximizing Rate of
Output
A competitive firm wants to expand the
rate of production whenever price
exceeds marginal cost.

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Profit-Maximizing Rate of
Output
Short-run profits are maximized at the
rate of output where price equals
marginal cost.

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Short-Run Profit-Maximization
Rules for Competitive Firm
price > MCincrease output rate
price = MCmaintain output and
maximize profit
price < MCdecrease output rate

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Maximization of Profits for
Competitive Firm

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Maximization of Profits for
Competitive Firm
$18
Marginal cost
16
Profits decreasing
PRICE OR COST (per basket)

14 B p = MC
12 Price
Profits increasing
10
8
6
Profit-maximizing
4 MCB rate of output
2

0 1 2 3 4 5 6 7
QUANTITY (baskets per hour)
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Total Profit

Total profit can be computed in one of

two ways:

Total profit = total revenue total cost

Total profit = average profit x quantity sold

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Total Profit

Profit per unit = price minus average

total cost
Profit per unit = p ATC

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Total Profit

Total profits = profit per unit times

quantity
Total profits = (p ATC) X q

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Total Profit

The profit-maximizing producer never

seeks to maximize per-unit profits.

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Total Profit

The profit-maximizing producer has no

particular desire to produce at that rate
of output where ATC is at a minimum.

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Total Profit

Total profits are maximized only where

p = MC

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 Illustrating Total Profit
$18
16 Average
total cost
14
Price
COST (per basket)

12 TOTAL PROFIT
Profit per unit
10
8
6 Cost per unit
4 Marginal cost
2

0 1 2 3 4 5 6 7
RATE OF OUTPUT (baskets per hour)

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Supply Behavior

How firms make production decisions

helps us to explain how the market
establishes prices and quantities.

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A Firms Supply

Supply is the ability and willingness to

sell specific quantities of a good at
alternative prices in a given time period.

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Supply Behavior

To be competitive, quantity supplied is

adjusted until MC = price.
The marginal cost curve is the short-run
supply curve for a competitive firm.

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Supply Shifts

Marginal costs determine the supply

decisions of a firm.
Anything that alters marginal cost will
change supply behavior.

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Supply Shifts

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.

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Market Supply

The market supply curve is the sum of

marginal cost curves of all firms.

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 Competitive Market Supply

(a) Farmer A (b) Farmer B (c) Farmer C

$5 $5 $5
MCA MCB 4 MCC
PRICE (per pound)

4 4
a b c
3 3 3

2 + 2 +2
1 1 1

0 20 40 60 0 20 40 60 0 20 40 60
QUANTITY (pounds per day)

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Competitive Market Supply
(d) Market supply
$5

4
PRICE (per pound)

d
3
=
2

0 50 100 150 200 250 300

QUANTITY (pounds per day)

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Competitive Market Supply

Determinants of Market Supply

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

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Industry Entry and Exit

To understand how competitive markets

work, we have to focus on changes in
equilibrium rather than on equilibrium
itself.

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Industry Entry and Exit

The number of firms in a competitive

industry is not fixed.
Industry entry and exit is a driving force effecting market
equilibrium.

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Entry

Additional firms will enter the industry

when profits are plentiful.

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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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Entry

Industry output increases and price falls

when firms enter an industry.

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Market Entry
S1
S2
Entry of
E1 new firms
PRICE (per pound)

p1

p2 E2

Market
Demand

q1 q2
QUANTITY (thousands of pounds per day)

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The Tendency Toward Zero
Economic Profits
New firms continue to enter a
competitive industry so long as profits
exist.

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The Tendency Toward Zero
Economic Profits
Once price falls to the level of minimum
average cost, all economic profits
disappear.

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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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 The Lure of Profits
Market entry pushes price down and . . .Reduces profits of competitive firm

S1
S2 MC
S3 ATC
E1
p1 p1
p2 p2
p3 p3
Market demand

QUANTITY (thousands of pounds per day) QUANTITY (pounds per day)

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Exit

Firms exit the industry when profit

opportunities look better elsewhere.
Firms leave the industry if price falls
below average cost.
As firms exit the industry, the market
supply curve shifts to the left.

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Exit

Price rises until there are no economic

losses.
At that point, average cost is at a
minimum.

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Equilibrium

The existence of profits in a competitive

industry induces entry.
The existence of losses in a competitive
industry induces exits.

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Long-Run Equilibrium

In long-run competitive market

equilibrium:
Price equals minimum average cost.
Economic profit is eliminated.

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Long-Run Equilibrium

Economic profits will not last long as

long as it is easy:
For existing producers to expand production, or
For new firms to enter an industry.

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Low Barriers to Entry

There are no significant barriers to entry

in competitive markets.

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Low Barriers to Entry

Barriers to entry are obstacles that

make it difficult or impossible for would-
be producers to enter a market.

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Low Barriers to Entry

Examples of barriers to entry include

patents, brand loyalty, price controls
and control of essential factors of
production.

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Characteristics of a Competitive
Market
Many firms MC = p
Identical products Zero economic
Low barriers to profit
entry Perfect
information

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The Virtues of Competition

The market helps signal what should

and should not be produced.
The market sends signals which
reallocate resources to other products.

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The Relentless Profit Squeeze

The unrelenting squeeze on prices and

profits is a fundamental characteristic of
the competitive process.

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The Relentless Profit Squeeze

The market mechanism works best in

competitive markets.
Market mechanism the use of market prices and sales
to signal desired outputs.

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The Relentless Profit Squeeze

High profits in a particular industry

indicate that consumers want a different
mix of output.

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The Relentless Profit Squeeze

Economic profit attracts new suppliers.

The market supply shifts to the right.
Prices slide down the market demand curve.

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The Relentless Profit Squeeze

A new equilibrium is reached at which

increased quantity of the desired
product is produced and its price is
lower.

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The Relentless Profit Squeeze

Throughout the process producers

experience great pressure to keep
ahead of the profit squeeze by reducing
costs.

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The Social Value of Losses

Economic losses are a signal to

producers that they are not using
societys scarce resources in the best
way.

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Unique Traits of Competitive
Markets
Two unique traits of competitive
markets are noteworthy:
Minimum average costs of production
(HOW)
Marginal cost pricing (WHAT)

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Minimum Average Costs of
Production
Efficiency (technical) is the maximum
output of a good from the resources
used in production.

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Minimum Average Costs of
Production
Competition drives producers to
produce at the minimum average cost
of production in the long run.

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Marginal Cost Pricing

The amount of resources used to

produce one more unit of a good is its
marginal cost.
Marginal cost reflects the opportunity
cost of that good.

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Marginal Cost Pricing

The amount the consumer is willing to

pay for the good is its price.

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Marginal Cost Pricing

When the prices of goods equal their

marginal costs, the mix of resources
produced and consumed is efficient.

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Policy Perspective

Public policy should promote

competition because competitive
markets do best what society wants.
This means keeping markets open and
accessible to new entrants.

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 Competition
Competition
End of Chapter 6

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