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EC120 Chapter Notes - Chapter 14: Demand Curve, Dopamine Receptor D2, Average Variable Cost

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School
WLU
Department
Economics
Course
EC120
Professor
Hideki Ariizumi

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Document Summary

Ec120: chapter 14 firms in competitive markets. Competitive market (or perfectly competitive market): market with many buyers and sellers trading identical products so that each buyer and seller is a price taker. Characteristics: many buyers and sellers in the market, goods offered by various sellers are largely the same. Actions of any single buyer or seller in market have negligible impact on market price = each buyer and seller takes market price as given. No single buyer of milk can influence the price b/c each buyer purchases small amount. E. g. anyone can start dairy farm and if any farmer decides to leave dairy business, dairy industry would satisfy this condition. Analysis of competitive firms doesn"t reply on assumption of free entry and exit (not necessary for firms to be price takers) Entry and exit are often powerful forces in shaping long run outcome in competitive markets. Firm in competitive market tries to maximize profit (total revenue total cost)

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Related Questions

Target Statement for Assignment 8

When IT procurement managers do business across a transnational border (or choose which borders to negotiate across) it will be helpful for managers to be aware of what restraints or pressures exist on both sides of the border that will affect the negotiated price of the product or service being acquired. The understanding that Garrett’s entire pricing theory depends on the macroeconomic (and hence also political) environment emerges from considering relations between contract pricing and economic theory, specifically, the “reservation price” and “economic calculation problem”.

A fixed-price strategy in Garrett’s account does not mean a price that is fixed legally; it means a price that is determined by negotiation between free parties, such as is described in Ch. 8, pp. 105-106. That is, in Garrett’s pricing theory there is a transaction pricing calculation performed on each side of the transaction. Contract pricing is a decision, about which what matters is not the type of contract but the locus of the decision, that is, who makes the decision, and under what constraints?

Garrett’s Chapter 8 answers: buyer and seller make the decision. In a free-market economy, the pricing decision would be entirely an outcome of their negotiation. In an interventionist economy, the decision is in part an outcome of the buyer-seller negotiation; however, the cost of such interventions as taxes, regulations, currency instability, or contract impairment by monetary inflation, and any price caps or floors are built into or reflected by the seller’s offering price.

In free market economic planning where there is zero central economic planning, a first approximation to a contract price that is freely set by buyer and seller is the reservation price or “walk-away” price for the buyer. The seller, too, has a “walk-away” price. The negotiation can only occur, resulting in a contract, in the interval between the two. Buyer and seller make a decision through a negotiation based on the seller’s estimate of the cost of performance and the buyer’s estimate of what price the market, established by other potential sellers, would bear -- both estimates being a function of history.

According to the economic calculation problem described by the economist Ludwig Von Mises, a freely agreed upon price that reflects the combination of the buyer’s and seller’s needs or desires is based on a calculation of the type that cannot be performed in a condition of central economic planning by a government. Under central economic planning, or socialism, price determination is not a function of trading history, or of the sellers' willingness to sell or the buyers' willingness to buy at a given price, rather it is either an arbitrary or politically-influenced decision. Such central economic planning, Von Mises observes, replaces economic calculation – the statistical aggregate of all individual actions by buyers and sellers who freely set prices by their own transaction pricing calculations.

Under the free market modeled in the theory of Von Mises, contract pricing relies on the absence of such market intervention so that buyer and seller are totally free to set a price that allows a contract to occur in the interval between the seller's and buyer's respective walkaway prices. This decision of both parties to agree on a price in that interval is one component of economic calculation – a component that applies to a single trade or transaction and contributes to the statistical aggregate which, in turn, tends to govern resource allocation so as to bring supply and demand into alignment.

To a lesser extent, contract pricing described by Garrett in Chapter 8 relies largely on the absence of central economic planning. Why? Because when the state intervenes it either substitutes its decision for that of the buyer and seller, or at a minimum imposes price controls that either foster shortages or surpluses or else tend to preclude the contract from ever happening if the controlled price is below the seller’s cost estimate.

Under contract pricing as described by Garrett, the parties to the contract are still able to perform calculations of reservation (walkaway) prices and determine whether they can do the deal at some price in the interval that does not cause either to walk away. However, in a market that is only partially free, interventions such as regulations, taxes, currency exchange fluctuations, or monetary inflation that increase the seller’s cost do alter the pricing calculation and tend to narrow the interval within which the buyer and seller can come to agreement. That still-intact possibility of agreeing on a price sensitive to market conditions is the essence of the relationship between the economic theory of Von Mises and the contract pricing theory of Garrett.

1. Characteristics of competitive markets

The model of competitive markets relies on these three core assumptions:

1. There must be many buyers and sellers a few players can't dominate the market.
2. Firms must produce an identical product buyer must regard all sellers' products as equivalent.
3. Firms and resources must be fully mobile, allowing for free entry into and exit from the industry.

The first two conditions imply that all consumers and firms are price takers. While the third is not necessary for price-taking behaviour, assume for this problem that a market cannot maintain competition in the long run without free entry.

Identify whether or not each of the following scenarios describes a competitive market, along with the correct explanation of why or why not.

Is the scenario Competitive?
Dozens of companies produce plain white socks. Consumers regard plain white socks as identical and don't care who manufactures their socks.  
In a major metropolitan area, one chain of coffee shops has gained a large market share because customers feel its coffee tastes better than that of its competitors.  
Scholastik Inc. owns the U.S. copyright to a popular book series. It is the only company with the legal right to publish books in the series in the United States.  
In a small town, there are two providers of broadband Internet access: a cable company and the phone company. The Internet access offered by both providers is of the same speed.  

"Grocery stores and gasoline stations in a large city would appear to be examples of competitive markets: there are numerous relatively small sellers, each seller is a price-taker, and the products are quite similar."

How could we argue that these markets are not competitive?

Select one:

a. Most grocery stores and gas stations have a relatively small geographic range; they do not attract consumers from very far away, and thus do not compete with the grocery stores or gas stations across town.

b. The individual grocery stores or gas stations do not have the power to control price on many items that they sell, so they are not able to compete on price.

c. They usually purchase products from the same distributor: i.e., all grocery stores and gas stations buy their Coke products from the same Coke distributor. Thus, individual grocery stores do not really compete with each other; same for individual gas stations.

d. Each grocery store or gas station is so small relative to the size of the market that their actions do not affect the rest of the market, therefore they do not have to behave in a competitive way.

Could each firm face a demand curve that is not perfectly elastic?

Select one:

a. No; since customers aren't willing to spend their morning visiting each grocery store or gas station in a large city to find the best deal, then each firm's demand curve will be perfectly elastic since consumers do not have full information.

b. No; the conditions mentioned (many small sellers, price-takers, homogeneous products) guarantee that each of these industries will be perfectly competitive. Demand will always be perfectly elastic.

c. Yes; if they have some degree of market power (e.g., they can charge slightly higher prices since consumers will not stop at every grocery store in town to find the cheapest beef jerky), then they will not face perfectly elastic demand.

d. Yes; if the individual firm demand curve is horizontal, then demand is not perfectly elastic. This will often be true for small sellers.

How profitable do you expect grocery stores and gasoline stations to be in the long run?

Select one:

a. Even with a small amount of market power, it is still relatively easy to enter and exit these industries. Long-run profits will likely be driven down close to zero.

b. Because of rising prices of both food and gasoline, each of these industries is expected to suffer long-run losses for the foreseeable future.

c. Grocery stores would be expected to enjoy long-run positive profits since they sell a wider variety of products; gasoline stations would be expected to break even or take losses in the long run because of their more limited range of products.

d. Since these firms retain considerable market power (ability to set price), then they are expected to enjoy long-run positive profitability for the foreseeable future.

Can you explain to me the reasoning behind the answers?