1 chapter 9 price takers and the competitive process

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Chapter 9Chapter 9

Price Takers and the Price Takers and the Competitive ProcessCompetitive Process

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OverviewOverview

The difference between a price taker The difference between a price taker and a price searcherand a price searcher

The characteristics of price takersThe characteristics of price takers Marginal revenueMarginal revenue The profit maximizing ruleThe profit maximizing rule Profits and losses Profits and losses Long-Run equilibriumLong-Run equilibrium

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Price TakersPrice Takers

Price Takers: Price Takers: The sellers who must The sellers who must take the market price in order to sell take the market price in order to sell their product their product

Ex. Wheat farmers, cattle ranchersEx. Wheat farmers, cattle ranchers

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Price SearchersPrice Searchers

Price SearchersPrice Searchers: firms that choose : firms that choose the price they charge for their the price they charge for their product, but the quantity they are product, but the quantity they are able to sell is inversely related to able to sell is inversely related to priceprice

Ex. Nike, Sony, NintendoEx. Nike, Sony, Nintendo

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Characteristics of Price Taker Characteristics of Price Taker MarketsMarkets

1. There are a large number of firms 1. There are a large number of firms in the marketin the market

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2. Each firm produces identical 2. Each firm produces identical productsproducts

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3. Their output is small relative to the 3. Their output is small relative to the total markettotal market

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4. They are able to sell all of their 4. They are able to sell all of their output at the market price output at the market price

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5. There are no barriers to entry or exit of 5. There are no barriers to entry or exit of firms in the marketfirms in the market

Barriers to EntryBarriers to Entry: Obstacles that limit the : Obstacles that limit the freedom of potential rivals to enter and freedom of potential rivals to enter and compete in an industry or market compete in an industry or market

Ex. Excessive licensing Ex. Excessive licensing

and regulationsand regulations

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Graphing Price Taker MarketsGraphing Price Taker Markets

The market forces of supply and The market forces of supply and demand determine price. demand determine price.

Price takers have no control over this Price takers have no control over this price, so the demand for the product price, so the demand for the product of the firm is perfectly elastic of the firm is perfectly elastic

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Graphing Price Taker MarketsGraphing Price Taker Markets

Price takers will be unable to sell any Price takers will be unable to sell any goods at a higher pricegoods at a higher price

Price takers have no incentive to lower Price takers have no incentive to lower priceprice

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Marginal RevenueMarginal Revenue

Marginal Revenue (MR)Marginal Revenue (MR): The change : The change in total revenue derived from the in total revenue derived from the sale of one additional unit of a sale of one additional unit of a productproduct

For a price taker:For a price taker:

Marginal Revenue (MR) = Price (P)Marginal Revenue (MR) = Price (P)

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Maximizing ProfitsMaximizing Profits

To maximize profits, a firm should increase To maximize profits, a firm should increase output until marginal revenue is equal to output until marginal revenue is equal to marginal cost. marginal cost.

Profit maximizing rule: MR = MCProfit maximizing rule: MR = MC

*Note: *Note: A firm should produce when MR > MCA firm should produce when MR > MC A firm should never produce when MC > MRA firm should never produce when MC > MR

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Maximizing ProfitsMaximizing Profits

Graphically, firms should produce Graphically, firms should produce where the marginal cost curve where the marginal cost curve intersects the marginal revenue intersects the marginal revenue curve.curve.

MR = MCMR = MC

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Profits and LossesProfits and Losses

1. If MR = MC occurs above the ATC 1. If MR = MC occurs above the ATC curve then the firm is making an curve then the firm is making an economic profiteconomic profit

2. If MR = MC occurs below the ATC 2. If MR = MC occurs below the ATC curve then the firm is making an curve then the firm is making an economic loss economic loss

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Remaining Open in the Short-RunRemaining Open in the Short-Run

A firm making losses will remain open A firm making losses will remain open in the short run if:in the short run if:

1.1. It can cover its variable costs nowIt can cover its variable costs now

2.2. Expects price to be high enough in Expects price to be high enough in the future to cover all of its coststhe future to cover all of its costs

Otherwise, it will shut down.Otherwise, it will shut down.

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Entry and Exit in the Long-RunEntry and Exit in the Long-Run

1.1. If firms are making an economic If firms are making an economic profit: New firms will enter and profit: New firms will enter and drive price downdrive price down

2.2. If firms are making an economic If firms are making an economic loss: Firms will leave the market loss: Firms will leave the market and drive price upand drive price up

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Long-run EquilibriumLong-run Equilibrium

Long-run equilibrium will occur when Long-run equilibrium will occur when all firms in the industry are making all firms in the industry are making zero economic profitzero economic profit

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The Role of Profits and LossesThe Role of Profits and Losses

Why economists love competition:Why economists love competition:

1.1. Keeps costs and prices lowKeeps costs and prices low

2.2. Firms have the incentive to be Firms have the incentive to be efficient and innovativeefficient and innovative

3.3. Good firms stay, bad firms leave! Good firms stay, bad firms leave!

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Why economists love Walmart!Why economists love Walmart!

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ReviewReview

1. Know the difference between a price 1. Know the difference between a price taker and a price searcher.taker and a price searcher.

2. Know the characteristics of a price taker2. Know the characteristics of a price taker

3. Know what marginal revenue is and how 3. Know what marginal revenue is and how to maximize profitsto maximize profits

4. Be able to graphically analyze what 4. Be able to graphically analyze what quantity a firm should produce, whether quantity a firm should produce, whether they are making profits and losses, and they are making profits and losses, and whether or not they should remain open whether or not they should remain open in the short runin the short run

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ReviewReview

5. Know when firms will enter and exit 5. Know when firms will enter and exit the market and how long-run the market and how long-run equilibrium is maintained.equilibrium is maintained.

1 chapter 9 price takers and the competitive process

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