Chapter 6: Competition

Chapter 6CompetitionMarket StructureThe number and relative size of firms vary across industries. Most real-world firms fall somewhere along a spectrum that stretches from one extreme (powerless) to another (powerful).6-*Five common types of market structure:Perfect competition.Monopolistic competition.Oligopoly.Duopoly.Monopoly.Market Structure6-*Figure 6.16-*Competitive Firm A perfectly competitive firm has no market power: It is not able to alter the market price of the good it produces.It is a price taker.It competes with many other firms selling homogenous products.6-*Monopoly A monopoly firm is one that produces the entire market supply of a particular good or service. It has complete market power; it can alter the market price of a good or service. It is a price setter, not a price taker. It has no direct competitors.6-*Imperfect Competition Other forms of imperfect competition lie between monopoly and perfect competition, with decreasing market power.Duopoly: only two firms supply a product.Oligopoly: a few large firms supply all or most of a particular product.Monopolistic competition: many firms supply essentially the same product but each enjoys significant brand loyalty.6-*Perfect Competition Perfectly competitive firms have no brand image, no real market recognition.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.6-*Price Takers A perfectly competitive firm is a price taker.An individual firm’s output decisions do not affect the market price.An individual firm must take the market price and do the best it can within these constraints. 6-*Market Demand versus Firm DemandThere is a big difference between the market demand curve and the demand curve confronting a particular firm.The market demand curve for a product is always downward-sloping.The demand curve facing a perfectly competitive firm is horizontal.6-*Figure 6.26-*Output and RevenuesTotal revenue is the price of a product multiplied by the quantity sold in a given time period:Total revenue = Price x Quantity6-*Revenues versus Profits Profit is the difference between total revenue and total cost. Maximizing output or revenue is not the way to maximize profits. Total profits depend on how both revenue and cost increase as output expands.A business is profitable only within a certain range of output.6-*Profit-Maximizing Rate of OutputNever produce anything that costs more than it brings in – it boils down to comparing price and marginal cost.A competitive firm wants to expand the rate of production whenever price exceeds marginal cost.Short-run profits are maximized at the rate of output where price equals marginal cost.6-*Short-Run Decision Rules for a Competitive FirmPrice = MC Maintain output rate (Profits maximized)Price MC Increase output rate6-*Total ProfitProfit per unit equals price minus average total cost:Profit/unit = p – ATCTotal profit equals profit per unit times quantity:Profit = (p – ATC) x q6-*What counts is total profits, not profit per unit.Total profits are maximized only where p = MC.Total Profit6-*Figure 6.66-*EntryAdditional firms will enter the industry when profits are plentiful.Economic profits attract firms.More firms enter the industry.The market supply curve shifts to the right.The price decreases.Industry output increases and price falls when firms enter an industry.6-*Figure 6.86-*Tendency toward Zero Economic ProfitsNew firms continue to enter a competitive industry so long as profits exist.Once price falls to the level of minimum average cost, all economic profits disappear.6-*Exit Firms exit the industry when: Profit opportunities look better elsewhere. If price falls below average cost (profits turn into losses). As firms exit the industry, the market supply curve shifts to the left.6-*EquilibriumThe existence of profits in a competitive industry induces entry, shifting supply to the right, lowering price, and reducing profits.The existence of losses in a competitive industry induces exits, shifting supply to the left, increasing price, and reducing losses.6-*Long-Run EquilibriumIn long-run competitive market equilibrium:Price equals minimum average total cost.Economic profit (or loss) is eliminated.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.6-*Figure 6.96-*Characteristics of a Competitive Market Many small firms.Perceived horizontal demand.Identical products. Low entry barriers.Set output where MC = p.Zero economic profit in the long run.Perfect information.6-*The Relentless Profit Squeeze The unrelenting squeeze on prices and profits is a fundamental characteristic of the competitive process.The market mechanism works best in competitive markets.6-*