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
Perfect
Competition
Monopoly
Monopolistic
Competition
Oligopoly
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
A
No. 2 yellow
corn
$2.10/bu
Grain elevator
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
$
Quantity
The competitive firms
demand curve
$
MR = D = P
Quantity
P
m

The competitive firms
demand curve
The optimal level of output for a
competitive firm is determined
where Marginal Revenue (MR)
is equal to Marginal Cost (MC).
$
Quantity
Optimal Output Level
$
MR = D
Quantity
P
*
Optimal Output Level
$
MC
MR = D
Quantity
P
*
Optimal Output Level
$
MC
MR = D
Quantity Q
*

P
*
Optimal Output Level
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.
$
Quantity
Average Total Cost
ATC
$
Quantity
Average Total Cost
Average Total Cost
Price - ATC = Profit per unit of
output
Note: Price > ATC indicates a
profit
$
Quantity

$
MR = D
= P
Quantity
P
*

$
MC
MR = D
= P
Quantity Q*
P
*

$
MC
MR = D
= P
Quantity
ATC
P
*

$
MC
MR = D
= P
Quantity
ATC
Q
*

P
*
Profit
$
MC
MR = D
= P
Quantity
ATC
Q
*

P
*
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
S
D
Quantity
P
e

Q
e

$ or Price
S
D
Quantity
P
e

Q
e

S
Profit
With the increase in Supply, price
will be driven down.
With the lower price, profits will be
driven out.
$
Quantity
$
MR = D
= P
Quantity
P
*
$
MC
MR = D
= P
Quantity
P
*
$
MC
MR = D
= P
Quantity
ATC
P
*
$
MC
MR = D
= P
Quantity
ATC
Q
*

P
*
$
MC
MR = D
= P
Quantity
ATC
Q
*

P
* Loss
$ or Price
S
D
Quantity
P
e

Q
e

$ or Price
S
D
Quantity
P
e

Q
e

S
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
D
Quantity
P
e

Q
e

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
Quantity
P
Q
$ or Price
S
D
Quantity
P
Q
S
1

$ or Price
S
D
Quantity
P
Q
S
1

P
1

Q
1

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
S
D
Quantity
$ or Price
S
D
Quantity
P
Q
$ or Price
S
D
Quantity
P
Q
D
1

$ or Price
S
D
Quantity
P
Q
D
1

P
1

Q
1

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
Perfect
Competition
Monopoly
Monopolistic
Competition
Oligopoly
Imperfect Competition
Monopolistic Competition
Many sellers in market
Differentiated products
Ease of entry or exit
Information is readily available
Monopolistic Competition
Non-price competition usually
occurs
$
Quantity 1 5 10
Monopolistic Competitor Demand
Curve
$
Quantity
D
1 5 10
Monopolistic Competitor Demand
Curve
Monopolistically
Competitive Firms Price,
Quantity, and Profit
Short Run
$
Quantity
1 5 10

22
18
14
10
6
2

Monopolistically Competitive SR
$
Quantity
D
1 5 10

22
18
14
10
6
2

Monopolistically Competitive SR
$
Quantity
D
1 5 10

22
18
14
10
6
2

MR
Monopolistically Competitive SR
$
Quantity
D
1 5 10

22
18
14
10
6
2

MR
MC
Monopolistically Competitive SR
$
Quantity
D
1 5 10

22
18
14
10
6
2

MR
MC
ATC
Monopolistically Competitive SR
$
Quantity
D
1 5 10

22
18
14
10
6
2

MR
MC
ATC
Monopolistically Competitive SR
$
Quantity
D
1 5 10

22
18
14
10
6
2

MR
MC
ATC
Monopolistically Competitive SR
$
Quantity
D
1 5 10

22
18
14
10
6
2

MR
MC
ATC
Monopolistically Competitive SR
Monopolistically
Competitive Firms Price,
Quantity, and Profit
Long Run
$
Quantity
1 5 10

22
18
14
10
6
2
Monopolistically Competitive LR
$
Quantity
D
1 5 10

22
18
14
10
6
2
Monopolistically Competitive LR
$
Quantity
D
1 5 10

22
18
14
10
6
2 MR
Monopolistically Competitive LR
$
Quantity
D
1 5 10

22
18
14
10
6
2 MR
MC
Monopolistically Competitive LR
$
Quantity
D
1 5 10

22
18
14
10
6
2 MR
MC
ATC
Monopolistically Competitive LR
$
Quantity
D
1 5 10

22
18
14
10
6
2 MR
MC
ATC
Monopolistically Competitive LR
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
CR
4
= % of market the largest 4
firms control
Malt beverage industry
CR
4
= 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.
$
Quantity
P
*
1 5 10
Monopolists Demand Curve
$
Quantity
P
*
D
1 5 10
Monopolists Demand Curve
Monopoly Price,
Quantity, and Revenue
Schedules
$
Quantity
1 5 10

22
18
14
10
6
2

Monopoly
$
Quantity
D
1 5 10

22
18
14
10
6
2

Monopoly
$
Quantity
D
1 5 10

22
18
14
10
6
2

MR
Monopoly
$
Quantity
D
1 5 10

22
18
14
10
6
2

MR
MC
Monopoly
$
Quantity
D
1 5 10

22
18
14
10
6
2

MR
MC
ATC
Monopoly
$
Quantity
D
1 5 10

22
18
14
10
6
2

MR
MC
ATC
Monopoly
Monopoly Revenue Schedule
Price Units
sold
Total
Rev.
Marg.
Rev.
$20 1 20 >16
$18 2 36 >12
$16 3 48 >8
$14 4 56 >4


Monopoly Revenue Schedule
Price Units
sold
Total
Rev.
Marg.
Rev.
$12 5 60 >0
$10 6 60 >-4
$8 7 56


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.