mcgraw-hill/irwin ©2009 the mcgraw-hill companies, all rights reserved competitive markets chapter...

McGraw-Hill/Irwin

©2009 The McGraw-Hill Companies, All Rights Reserved

Competitive MarketsCompetitive Markets

Chapter 23Chapter 23

2

The Market Supply Curve

The market supply curve determines the equilibrium price faced by an individual producer.

Equilibrium price – The price at which the quantity of a good demanded in a given time period equals the quantity supplied.

Market supply – The total quantities of a good that sellers are willing and able to sell at alternative prices in a given time period, ceteris paribus.

3


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

Marginal cost (MC) – The increase in total cost associated with a one-unit increase in production.

4


Whatever determines marginal cost also determines the competitive firm’s supply response.

5


The market supply of a competitive industry is determined by:

The price of factor inputs.

Technology.

Expectations.

Taxes.

The number of firms in the industry.

Competitive Market Supply

0 20 40 60

1

2

3

4

$5

Pric

e

Farmer A

Quantity

a

MCA

0 20 40 60

Farmer B

Quantity

b

MCB

0 20 40 60

Farmer C

Quantity

c

MCC

0 100 200

Market supply

Quantity

d

+ =+

7

Entry and Exit

Investment decisions shift the market supply curve to the right.

Investment decision - The decision to build, buy, or lease plant and equipment; to enter or exit an industry.

LO1

8

Entry and Exit

The profit motive drives these investment decisions.

If there are economic profits, more firms will enter the industry increasing market supply.

The typical firm will respond to the resulting lower price and profits by reducing output.

LO1

9

Quantity

Pri

ce

Quantity

Market Entry

Market demand

S2

S1

E1

E2

p1

p2

Market entry pushes price down and . . .

New firms enter

ATCMCf1

f1

p1

p2

q1 q2

Reduces profits of competitive firm

LO1

10

Tendency Toward Zero Profits

An increase in market supply causes the economic profits to disappear.

Economic profits – The difference between total revenues and total economic costs.

LO2

11


When economic profits disappear, entry ceases and the market price stabilizes.

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

LO2

12


As long as it is easy for existing producers to expand production or for new firms to enter an industry, economic profits will not last long.

LO2

13

Low Barriers to Entry

Barriers to entry are obstacles that make it difficult or impossible for would-be producers to enter a particular market.

LO2

14

Low Barriers to Entry

Barriers to entry may include:Patents.

Control of essential factors of production.

Control of distribution outlets.

Well-established brand loyalty.

Government regulation.

LO2

15

Market Characteristics of Perfect Competition

Some of the structures, behaviors and outcomes of a competitive market are:

Many firms - none of which has a significant share of total output.

Perfect information - buyers and sellers have complete information on supply, demand, and prices.

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16



Identical products - products are homogeneous; one firm’s products is the same as any other’s.

MC = p - all competitive firms seek to expand output until marginal cost equals the product’s market price.

LO1

17



Low barriers to entry - entry barriers are low, economic profits will attract more firms.

Zero economic profit - market supply expands as long as there are economic profits, pushing prices and economic profits down.

LO1

18

Competition at Work: Microcomputers

Few, if any, product markets are perfectly competitive.

Many industries function much like a competitive market.

The microcomputer market illustrates how the process of competition works.

19

Market Evolution

As in other industries, the computer industry has evolved over time.

It was never a monopoly, nor was it ever perfect competition.

20

Initial Conditions: The Apple I

Steve Jobs and Steven Wozniak created the Apple Computer Corporation in 1977.

Other companies noted the profits and, due to the low barriers to entry, followed Apple’s lead.

21

The Production Decision

Each competitive firm seeks to make the best short-run production decision.

Production decision - The selection of the short-run rate of output (with existing plant and equipment).

22

The Production Decision

To maximize profit, each competitive firm seeks the rate of output at which marginal cost equals price.

23

Initial Equilibrium in the Computer Market

1200

1000

800

600

400

200

0 200 400 600 800 1000

Market price

Profits

mD Average

total cost

P = MR

Quantity

C

PR

ICE

OR

CO

ST

The typical firm

$1200

1000

800

600

400

200

0 20 40 60 80

Market demand

Market equilibrium

Market supply

Quantity (thousands)

Pri

ce (

per

com

pute

r)

The computer industry

LO2

24

Profit Calculations

A profit-maximizing producer seeks to maximize total profit.

Profit per unit is total profit divided by the quantity produced in a given time period; price minus average total cost.

Total profit = profit per unit X quantity sold

LO2

25

Computer Revenues, Costs and Profits

LO2

26

Computer Revenues, Costs and Profits

Output per

Month

Price = Marginal Revenue

Marginal Cost

Average Total Cost

Profit per Unit

0

100 $1,000 $ 300 $ 900 $ 100

200 1,000 400 650 350

300 1,000 500 600 400

400 1,000 600 600 400

500 1,000 800 640 360

600 1,000 1,00 700 300

700 1,000 1,260 780 220

800 1,000 1,740 900 100

900 1,000 1,998 1,022 –22 LO2

27

The Lure of Profits

In competitive markets, economic profits attract new entrants.

LO2

28

Low Entry Barriers

Low entry barriers permit new firms to enter competitive markets.

LO2

29

A Shift of Market Supply

The entry of new firms shifts the market supply curve to the right.

Firms will continue to enter as long as there are economic profits.

LO2

30


As supply increases, price drops toward the minimum of ATC.

In long-run equilibrium, entry and exit cease, and zero economic profit (that is, normal profit) prevails.

Long-run equilibrium: p = MC = minimum ATC

LO2

31


Once reached, long-run market equilibrium will continue until something changes.

Long-run equilibrium will change if market demand shifts or if technological improvements reduce production costs.

LO2

32

500 6000

800

$1000

Price

or C

ost (

per c

ompu

ter)

Quantity (computers per month)

0 20,000

$1000

800


Price

(per

com

pute

r)The Competitive Price and Profit

Squeeze

Profits

S1S2

Market demand

An expanded market supply . . .

MCOld price

G

Hm

ATC

Lowers price and profits for the typical firm

Newprice

LO2

33

500 6000

800

$1000

Price

or C

ost (

per c

ompu

ter)


0 20,000

$1000

800


Price

(per

com

pute

r)The Competitive Squeeze

Approaching Its Limit

Profits

S2

Market demand

The computer industry

MC

Old priceJ

Km

ATC

The typical firm

Newprice

S3

700620

LO2

34

Short- vs. Long-Run Equilibrium

MCATC

pS

qS

Pric

e or

Cos

t

Quantity

Short-run equilibrium (p = MC)

pS

Pric

e or

Cos

t pL

qL

Quantity

MCATC

Long-run equilibrium (p = MC = ATC)

LO2

35

Long-Run Rules for Entry and Exit

Price Level Result for typical firm Market Response

P > ATC Profits New firms enterindustry, Existing firmsexpand

P < ATC Loss Firms exit industry,Existing firms contract

P = ATC Break even No exit or entry,Existing firms maintaincurrent capacity

LO2

36

Home Computers vs. Personal Computers

Once long-run equilibrium was reached in the microcomputer market, producers were forced either:

To develop a better product (to increase demand), or

To reduce costs of production.

37

Home Computers vs. Personal Computers

Manufacturers of computers did both -separating the market into home computers and personal computers.

38

Price Competition in Home Computers

The home computer market confronted the fiercest form of price competition.

For most firms, the only option to make an extra buck was to push the cost curve down.

39

Price Competition in Home Computers

Costs were pushed down by reducing the number of components and using more powerful computer chips.

LO3

40

Further Supply Shifts

With strong competition, often the only way for a firm to improve profitability is to reduce costs.

Cost reductions were accomplished through technological improvements.

LO3

41

Further Supply Shifts

Technological improvements are illustrated by a downward shift of the ATC and MC curves.

LO3

42

Pric

e (p

er c

ompu

ter)


Lower Costs Shifts the Supply Curve Downward

OldMC

NewMC

OldATC

NewATC

J N

R

430 600

$700

LO3

43

Shutdowns

Once a firm is no longer able to cover variable costs, it should shut down production.

The shutdown point is the rate of output at which price equals minimum AVC.

44

Exits

Most firms withdrew from the home computer market due to low profits.

The exit rate in 1983-85 matched the entry rate of 1979-82.

45

The Personal Computer Market

Firms initially competed on the basis of product improvements.

Eventually, firms could not sell all the PCs they produced at prevailing prices.

They were forced to cut their prices.

Many shut down.

46

The Competitive Process

Competitive market pressures were a driving force in the spectacular growth of the computer industry.

Consumers reaped substantial benefit from competition in computer markets.

LO3

47

Allocative Efficiency: The Right Output Mix

The market mechanism works best in competitive markets.

Market mechanism – the use of market prices and sales to signal desired output (or resource allocations).

LO3

48


High profits in a particular industry indicate consumers want a different mix of output.

A competitive market determines the opportunity cost of producing different goods.

LO3

49


The price signal the consumer gets in a competitive market is an accurate reflection of opportunity cost.

Opportunity cost – The most desired goods or services that are forgone in order to obtain something else.

LO3

50


Marginal cost pricing efficiently answers the WHAT-to-produce question.

Marginal cost pricing – The offer (supply) of goods at prices equal to their marginal cost.

LO3

51


The amount consumers are willing to pay for a good (its price) equals its opportunity cost (marginal cost).

LO3

52

Production Efficiency

Production efficiency means that we are producing at minimum average total cost.

Efficiency – Maximum output of a good from the resources used to produce it.

LO3

53

Production Efficiency

Competitive pressure on prices force producers to produce at the lowest possible cost.

Society is getting the most it can from its available (scarce) resources.

LO3

54

Zero Economic Profit

In the long-run, all economic profit is eliminated.

LO3

55

Quantity (units per time period)

Pric

e (d

olla

rs p

er u

nit)

Summary of Competitive Process

Industry ATCIndustry MC

Market demand

Short-runequilibrium

Long-run equilibrium

a

bc

LO3

56

Relentless Profit Squeeze

The sequence of events common to a competitive market situation includes the following:

High prices and profits signal consumers’ demand for more output.

Economic profit attracts new suppliers.

The market supply shifts to the right.

LO3

57



Prices slide down the market demand curve.

A new equilibrium is reached with increased quantities being produced and sold and economic profit approaching zero.

LO3

58



Throughout the process, producers experienced great pressure to keep ahead of the profit squeeze by reducing costs.

LO3

59


The potential threat of other firms expanding production or of new firms entering the industry keeps existing firms on their toes.

LO3

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