Competition and the Market

Chapter 7

The function of Price

Price 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 competition
Monopolistic competition

Oligopoly
Monopoly

Forms of Market Competition

Oligopoly

Perfect Monopoly Competition Monopolistic Competition

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 entry
Amount of information available

Factor #1: The number and size distribution of buyers and sellers

Number and Size Distribution

E.g. farmers and consumers 2 million farms in US

1.2 million are small with < $20,000

annual income

Number and Size Distribution

Most farms output is so small,

any ones 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 Grain elevator

A No. 2 yellow corn $2.10/bu

B No. 2 yellow corn $2.11/bu

Product Differentiation
What determines decision? Price!
Identical

product 5000 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 scale Absolute unit cost

advantages Capital access cost

Barriers to Entry
Government policy
Patents Commodity

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 firms demand curve

The competitive firms demand curve

$

Quantity

The competitive firms demand curve

$

Pm

MR = D = P

Quantity

The optimal level of output for a competitive firm is determined where Marginal Revenue (MR) is equal to Marginal Cost (MC).

Optimal Output Level

$

Quantity

Optimal Output Level

$ P* MR = D

Quantity

Optimal Output Level

$ P* MR = D

MC

Quantity

Optimal Output Level

$ MC

P*

MR = D

Q*

Quantity

Average Total Cost (ATC) can be added to the graph to demonstrate the firms profit potential.

Average Total Cost

The per unit cost of producing a

specific good. The difference between ATC and products price equals the profit per unit of product.

Average Total Cost

$

Quantity

Average Total Cost

$
ATC

Quantity

Average Total Cost

Price - ATC = Profit per unit of

output Note: Price > ATC indicates a profit

Quantity

$ P* MR = D =P Quantity

$ P*

MC

MR = D =P
Q*

Quantity

$
P*

MC
ATC MR = D =P Quantity

MC ATC

P*
MR = D =P Q* Quantity

$
P*

MC
ATC Profit MR = D =P

Q*

Quantity

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

Pe D Qe Quantity

$ or Price S S

Pe D
Qe Quantity

Profit
With the increase in Supply, price

will be driven down. With the lower price, profits will be driven out.

Quantity

$ P*

MR = D =P

Quantity

MC

P*

MR = D =P

Quantity

MC ATC MR = D =P

P*

Quantity

MC ATC MR = D =P

P*

Q*

Quantity

MC ATC Loss MR = D =P

P*

Q*

Quantity

$ or Price S

Pe D
Qe Quantity

$ or Price

S S

Pe

D
Qe

Quantity

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

Quantity

$ or Price

D Quantity

$ or Price
S

D Quantity

$ or Price
S

Pe D
Q

Quantity

Specific Results of Competition

Price takers
Optimal output

No product

differentiation

Specific Results of Competition

Market equilibrium
Technological advancements Efficiency

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

Quantity

$ or Price

D
Quantity

$ or Price S

D
Quantity

$ or Price S

D
Q Quantity

$ or Price S
S1 P

D
Q Quantity

$ or Price S
S1 P P1

D
Q Q1 Quantity

Supply Shifters
Input Costs Prices of Related Goods Technology Weather Number of Sellers Taxes Expectations

An Increase in Demand

$ or Price

Quantity

$ or Price

D Quantity

$ or Price

D Quantity

$ or Price

D Q Quantity

$ or Price

D1
D Q Quantity

$ or Price

S
P1 P

D1
D Q Q1 Quantity

An Increase in Demand
Note Demand Curve shifts right Increases price Increases quantity demanded

A Decrease in Demand
Demand Curve would shift left Decreases price Decreases quantity demanded

Demand Shifters
Income Population Tastes and Preferences

Prices of Related Goods

Expectations

Agricultures Competitive Side

2.1 mil farms
Homogeneous products

Freedom of entry and exit

Information is available

Agricultures Departure from Competition

Soviet grain deal of 1973 Marketing cooperatives High land prices Technology 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
Imperfect Competition
Monopolistic Competition Perfect Competition

Monopoly

Oligopoly

Monopolistic Competition
Many sellers in market
Differentiated products

Ease of entry or exit

Information is readily available

Monopolistic Competition
Non-price competition usually

occurs

Monopolistic Competitor Demand Curve

$

10 Quantity

Monopolistic Competitor Demand Curve

$

D 1 5 10 Quantity

Monopolistically Competitive Firms Price, Quantity, and Profit

Short Run

Monopolistically Competitive SR
$
22 18 14 10 6 2 1 5 10

Quantity

Monopolistically Competitive SR
$
22 18 14 10 6 2 1 5

10

Quantity

Monopolistically Competitive SR
$
22 18 14 10 6 2 1 5

MR
10

Quantity

Monopolistically Competitive SR
$
22 18 14 10 6 2 1 5

MC

MR
10

Quantity

Monopolistically Competitive SR
$
22 18 14 10 6 2 1 5

MC ATC D

MR
10

Quantity

Monopolistically Competitive SR
$
22 18 14 10 6 2 1 5

MC ATC D

MR
10

Quantity

Monopolistically Competitive SR
$
22 18 14 10 6 2 1 5

MC ATC D

MR
10

Quantity

Monopolistically Competitive SR
$
22 18 14 10 6 2 1 5

MC ATC D

MR
10

Quantity

Monopolistically Competitive Firms Price, Quantity, and Profit

Long Run

Monopolistically Competitive LR
$
22 18 14 10 6 2

10 Quantity

Monopolistically Competitive LR
$
22 18 14 10 6 2

10 Quantity

Monopolistically Competitive LR
$
22 18 14 10 6 2

D MR
1 5 10 Quantity

Monopolistically Competitive LR
$
22 18 14 10 6 2

MC

D MR
1 5 10 Quantity

Monopolistically Competitive LR
$
22 18 14 10 6 2

MC

ATC
D MR
1 5 10 Quantity

Monopolistically Competitive LR
$
22 18 14 10 6 2

MC

ATC
D

MR
1 5 10 Quantity

Oligopoly
A few large firms

Products standardized or

differentiated Difficult entry Knowledge not available to all firms

Oligopoly Industries
Sugar Light bulbs

Gas
Steel

Glass

Oligopoly Industries
Autos Breakfast cereals

Cigarette makers
Soap

Beer

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 industry CR4 = 90%

Pure Monopoly
Only one seller in market
Product totally differentiated

No free entry or exit

Imperfect information

Pure Monopoly
Where a perfectly competitive

firm is a price taker, the monopolist is a price searcher.

Monopolists Demand Curve

P*

10Quantity

Monopolists Demand Curve

P*

$ D
1 5 10Quantity

Monopoly Price, Quantity, and Revenue Schedules

Monopoly
$
22 18 14 10 6 2 1 5 10Quantity

Monopoly
$
22 18 14 10 6 2 1 5

D
10Quantity

Monopoly
$
22 18 14 10 6 2 1

MR
5 10Quantity

Monopoly
$
22 18 14 10 6 2 1

MC

MR
5 10Quantity

Monopoly
$
22 18 14 10 6 2 1

MC ATC
D

MR
5 10Quantity

Monopoly
$
22 18 14 10 6 2 1

MC ATC
D

MR
5 10Quantity

Monopoly Revenue Schedule

Price Units sold Total Rev. Marg. Rev.

$20 $18
$16 $14

1 2
3 4

20 36
48 56

>16 >12
>8 >4

Monopoly Revenue Schedule

Price Units sold Total Rev. Marg. Rev.

$12 $10 $8

5 6 7

60 60 56

>0 >-4

Efficiency Comparisons

The Growth of Firms

Internal Growth External 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 Laws
Sherman 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 Bargaining
The 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 Bargaining
Clayton 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 cant use their market power to enhance prices.