Competitive Market For Goods and Services

Competitive markets for goods and service

Competition is not only the basis of protection to the consumer, but is the incentive to progress.

-Herbert Hoover

Slide 1 of 30

A new section of microeconomics…

Slide 2 of 302

We are entering a new section of our studies and we will be here for a while (modules 8-11).

In this section, we’ll explore how businesses (firms) behave, how they make decisions, and how they

compete.

It covers a key learning outcome and if you continue to study economics, you will see it all again.

The question we’ll discuss in this module: 1) How many units does a producer want to produce and

2) How much does he or she want to charge for each one?

The answer: It depends on the producer’s market structure!

The next four modules discuss “the production decision”

Modules 8-11 will answer these two questions for a variety of different market structures. We’ll start

with “Perfect Competition”

We’ll be asking these two questions a lot over the next four

modules! Make sure you can answer them by the time you are

done with Module 11!

Slide 3 of 30

Here are the different types of market structure. Look at it as a spectrum with high

levels of competition on the left and no competition on the right. Click to see the various characteristics of each market

structure.

First, an overview of the types of market structures

Perfect Competition Monopolistic Competition Oligopoly Duopoly Monopoly

Market Structure Overview

Slide 4 of 30

Types of market structures


At the absolute end of this spectrum, competition is fierce.

Characteristics of perfect competition:

Product is homogeneous

This means that each producer makes a very similar product. Examples include blue crab

fisherman and wheat farmers, whose good are similar.There are many, many buyers and sellers

and each firm constitutes a very small fraction of the market

Firms have no control over price

There are no barriers to entry

This means that producers have no impact on the market. If they decide not to produce, market

prices don’t change.

Examples include roadside farmers markets.

This means that producers take the market price for their goods. They do not have enough power

to influence it.

Examples include tomato farmers and fishermen.

This means that anyone can easily engage in this activity. You

could become a fisherman tomorrow if you wanted. It

doesn’t mean you’ll succeed, but you can do it.


Slide 5 of 30



At the other end of this spectrum, there is no competition. Mono means one. Only one firm exists.

Characteristics of a monopoly:

A single firm produces the entire supply of a product

This means that the producer does not face competitors.

Examples might include a cable or power provider in a rural area.

The producer’s product does not have substitute

Firms are price makers

There are substantial, often insurmountable barriers to entry


This means that buyers cannot switch to another product. If you

want to buy it, you must buy it from the monopolist.

Examples include Windows or diamonds.

This means that producers can set the price as high as the

market will bear.

Examples include property owners.

This means that it is very difficult to begin producing this product.

Imagine trying to start a professional sports league.

Examples include the NFL and NBA.

Slide 6 of 30



Most firms are monopolistically competitive

Characteristics of monopolistic competition:

There are a relatively large number of sellers

There are a lot, but not thousands of competitors.

Examples might include grocery stores.

Producers do face a competitors

Widespread non-price competition exists

There are minimal barriers to entry

Nearly all firms operate at some point between the ends.


This means that sellers are in heavy competition and have to

keep prices low.

Examples include gas stations.

Since it is difficult to compete on price, producers differentiate their products to prove they are better.

Examples include fast food chains.

You can open a hamburger or hot dog stand and compete with big

fast food chains.

Examples include a downtown food truck or neighborhood food

vendor.

Slide 7 of 30



In this category, there are only two or a few producers. Firms here are less numerous, but big.

Characteristics of oligopolies and duopolies:

Market has only a few or two sellers

Examples include big box superstores.

Each firm is affected by decisions of others

Barriers to entry exist

Firms are always ‘looking over their shoulder’ for changes in

competitor’s behavior.

Examples include the airlines.

Barriers to entry are not insurmountable, but they are

daunting.

Examples include tobacco companies.

“Du” means two. “Oli” means several. We’ll treat these as one group.


Slide 8 of 30

Examples of firms in different markets


NB

A, M

LB, N

HL, N

FL

Coke and P

epsi

IBM

in the 1980s

Banks

Coffee S

hops

Soap M

anufacturers

Tomato F

armer

Hoover D

am

DeB

eers Diam

onds

TV

Netw

orks in the 1960s

Airlines

Grocery S

tores

Hotels

Catfish F

armer

Wheat F

armer

Aircraft M

anufacturers

Greeting card com

panies

Cigarette m

akers

Cereal M

anufacturers

Operating S

ystem producers


Slide 9 of 30

This module: We’ll analyze perfectly competitive firms in the short run


PerfectCompetition

This is the topic of the module that follows that.

Then we’ll discuss all the firms in the middle.

In the next module, we’ll explore these firms in

the long run.

Slide 10 of 30

Perfectly competitive industries have unique qualities

• The product is standard (homogenous)

• There are a large number of firms

• Firms are “price takers”• There are virtually no barriers

to entry• Producers face a horizontal

demand curve

The next slide will provide an example for these.

The Characteristics of a Perfectly Competitive Industry

This characteristic will be described afterwards.

PerfectCompetition

Slide 11 of 30

The used text book market has perfectly competitive characteristics

At the end of the semester, you will likely try to sell some of your textbooks. Your textbook is like all others for that

subject-it is homogenous…everyone’s book looks the same.

Thousands of students will try to sell them at the same time.

You either take the price the market offers or you choose not to sell.

Have you ever tried to ask for more? I bet that did not work well.

Anyone can sell a book-even non students.

• The product is standard (homogenous)

• There are a large number of firms• Firms are “price takers”• There are virtually no barriers to entry• Producers face a horizontal demand

curve Let’s discuss this characteristic using the wheat market

PerfectCompetition

Slide 12 of 30

A perfectly competitive producer faces a horizontal (i.e. perfectly elastic) demand curve

The Wheat Market: Perfectly Competitive

Wheat is sold on a global market.

It is a homogenous good.

Individual farmers have little impact on the total quantity sold

and price.

Prices are determined by commodity traders.

Producers can sell as much or as little as they want, but they must sell it at the price determined by the market. If they ask a higher

price, no one will buy it.

PerfectCompetition

Slide 13 of 30

A perfectly competitive producer faces a horizontal (i.e. perfectly elastic) demand curve

The price for wheat is determined by supply and demand of wheat in a global

market (by commodity traders).

S

D

P

Once that price is set, the market will buy as much of any one producer’s output as they can produce, but only at that price

If this farmer produces one unit, it will be demanded at the market price.

If this farmer produces two units, they will be demanded at the market price.

If this farmer produces three units, they will be demanded at the market price.

If this farmer produces 100 units, they will be demanded at the market price. Connecting these dots gives us the

demand curve that the individual farmer faces. Notice it is perfectly elastic.

D

PerfectCompetition

Slide 14 of 30

Let’s look a perfectly competitive industry example

Joe is in a perfectly competitive industry• Joe is a price taker• Joe is one of many, many firms• Joe’s product is standard• There are little to no barriers to entry

Meet Joe.He is a catfish farmer.He can sell as much product as he can make, but only at market price. He is a “Price

Taker”.

There are 1,450 catfish farms in the U.S. (2005)

This picture may be deceiving, but Joe’s catfish are just like any other producer’s catfish. Their goods are homogenous.

You can compete with Joe at any time. All you need to do is dig up some land, fill it full of

water, and stock it.

PerfectCompetition

Slide 15 of 30

Joe’s Demand Schedule

Let’s assume that the market sets price of catfish at $131 per unit.

Consumers will demand as many catfish as Joe can produce but will

only pay $131 per unit.

Above that price, they will not demand any.

Before we look at demand for Joe’s product, lets

introduce the concept of marginal revenue.

PerfectCompetition

Slide 16 of 30

Joe’s marginal revenue data

If Joe sells one unit, his total revenue is $131.

His marginal revenue or “additional revenue” for

that unit is $131.

If Joe sells two units, his total revenue is $262.

His marginal revenue or “additional revenue” for the second unit is $131.

If Joe sells three units, his total revenue is $393.

His marginal revenue or “additional revenue” for the third unit is $131.

Note: Marginal revenue for each unit is $131.

PerfectCompetition

Slide 17 of 30

Joe’s revenue data, seen graphically

As would make sense, to

tal revenue

continues to clim

b as output increases.

But Marginal Revenue is constant- Each unit brings in as much revenue as the last.

PerfectCompetition

Slide 18 of 30

If Joe wants to sell one unit, the market will demand it, at

$131 per unit.

If Joe wants to sell two units, the market will demand them,

at $131 per unit.

The market demands as many units as Joe can produce, but

only at the market price.

Joe’s demand curve is perfectly elastic

This is Joe’s Demand Curve

This is the Price Joe faces

This is Joe’s MR curve

For a perfectly competitive firm, Demand = Price =

Marginal Revenue

Quantity demanded

PerfectCompetition

Slide 19 of 30

Again, perfectly competitive firms have a horizontal demand curve

Joe is a “price taker”. Here the price of Catfish is $131 per bushel. He can take

it or leave it. He has no MARKET POWER!

The price of catfish is determined by the market as shown below. The

supply curve includes all sellers, the demand curve includes all buyers.

Price is set at $131

PerfectCompetition

Slide 20 of 30

How does Joe decide how much to produce…

A producer could maximize revenue by producing as many units as possible…. Right???

But that is not a producer’s goal. A producer wants to maximize

PROFIT!

Total Revenue = Price X Quantity

PerfectCompetition

Slide 21 of 30

So how many units does a perfectly competitive producer want to make?

A producer should continue to expand output as long as

MR>MC

Rule: A producer in a perfectly competitive industry will maximize profits by producing where

MR=MC

We are finally arriving at the questions: how many units does a producer want to produce and how much does

he or she want to charge for each one?

PerfectCompetition

Slide 22 of 30

How many units does Joe want to produce?

For Joe’s first unit, his MR=$131 and his MC=$90. This is an attractive unit to

produce as it brings in more than it costs.

For Joe’s second unit, his MR=$131 and his MC=$80. This is an attractive unit to


For Joe’s third unit, his MR=$131 and his MC=$70. This is an attractive unit to


Joe should continue to expand output until he reaches the 9th unit. In that case,

MR=$131 and MC = $130. This is the last unit that Joe should be willing to make.

Joe should not produce a 10th unit. In that case, MR=$131 and MC = $150. This unit costs Joe more to make then he will earn in

revenue.

PerfectCompetition

Technically, what is Joe’s short run profit maximizing output, assuming he is perfectly competitive?

Slide 23 of 30

Let’s examine the data in graphical form

To see the profit maximizing output graphically, we need to add some

data. Here we have added average total cost (ATC) data.

Recall:

PerfectCompetition

Slide 24 of 30

Therefore, Joe will earn a profit of about $33 per unit

for a total of $299.

We can see that MR is greater than MC for each of

the first 8 units. They intersect around the 9th unit. That means Joe’s PROFIT

MAXIMIZING RATE OF OUTPUT is 9 units.

Joe can use the rule MR=MC to determine his “Profit maximizing rate of output”

Profit = $299

Profit =($131-$97.78)*9

At that rate of output, Joe’s Average Total Cost (ATC)

per unit is around $98.

We know price is $131. It was set by the market. Joe either takes it or leaves it.

Or graphically, his profit is this area, which we’ll call the

“profit box”.

PerfectCompetition

Slide 25 of 30

Here we see a perfectly competitive firm make a decision based on marginal benefit (revenue) –

marginal cost analysis.

That is a key learning outcome! We will spend a lot of time on this idea as we explore it for perfectly

competitive firms, monopolies, and many others…

MR>MC for the first 9 units. Note that at 9 units of production, price per unit is $131 and ATC is $98. That means Joe earns

about $33 per unit or $299. This is his profit maximizing rate of output.

Does a different rate of output provide more profit?

Profit = $299

=($131-$97.78)*9

Profit = $185

'=($131-$94)*5

If Joe chose to produce 5 units, the price per unit is $131 and ATC is $94. That means Joe earns about $37 per unit but only

earns $185 in profit.

Profit=$53

'=($131-$113.33)*3

If Joe chose to produce 3 units, the price per unit is $131 and ATC is $113. That means Joe earns about $37 per unit but only

earns $53 in profit.

PerfectCompetition

Slide 26 of 30

Joe, or any producer, wants to maximize profits

PerfectCompetition

If I only produce 8 units, I forego some profits.

If I produce 10 units, the last on costs me more to make than it earns me.

I’ll stop at 9!

Slide 27 of 30

A recap of the production decision (Technically, the short run production decision for a perfectly competitive firm)

If MR>MC Increase output rate

If MR

=M

C M

aintain

ou

tpu

t rate

If MR<MC Decrease

output rate

This method of determining profit maximizing output for a perfectly

competitive firm is called the

Marginal Revenue Marginal Cost Approach

PerfectCompetition

Slide 28 of 30

Individual Exercise

Please fill out the cells and determine the short run profit maximizing rate of output for this firm. You will see these on the test in graphical and tabular form.

Click to see the answers.

What is the profit maximizing rate of output and what is the profit at that rate?

7 units, $325

PerfectCompetition

Slide 29 of 30

Individual Exercise

Please plot price, MR, MC, and ATC curves from the last slide and shade in the “profit box”. Click to see the answers.

Pric

e

Output

PerfectCompetition

Slide 30 of 30

In Summary

Perfectly competitive industries have certain characteristics: for example, there

are many, many sellers and gods are homogenous.

Because of that, perfectly competitive firms are price takers…they can either take or leave the price the market is

offering.

They, like all business people, are seeking to maximize profit.

And the do so by finding where Marginal Revenue equals Marginal

Cost (MR=MC)!MR=MC

Slide 31 of 30

Competitive Market For Goods and Services

Education

Transcript of Competitive Market For Goods and Services