ECON 10010 Lecture Notes - Lecture 2: Root Mean Square, Market Power, Perfect Competition

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5 Feb 2016

School

Department

Economics

Course

ECON 10010

Professor

Cody Forsberg

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Document Summary

Examine how rms make production decisions in competitive markets. A competitive market, or perfectly competitive market, has two characteristics: there are many buyers and many sellers in the market, the goods offered by the various sellers are largely the same. Third condition is sometimes thought to characterize perfectly competitive markets: firms can freely enter or exit the market. Actions of single buyer or seller in the market have a negligible impact on the market price. Each buyer and seller takes the market price as given. No single consumer can in uence the price of milk because each buys a small amount. Each dairy farmer also has limited control over the price because many other dairy sellers are offering an identical product. Because each seller can sell all he wants at the going price, he does not charge less, and if he charges more, buyers will go to other sellers.

Related Questions

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.

amberfly263

"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."

Can someone explain the following three questions?

1) How could we argue that these markets are not competitive?

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 the price of 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; the 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.

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

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.

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

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 the 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.

orangehamster127

How could we argue that these markets are not competitive?

Select one:

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.

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:

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.

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?

ECON 10010 Lecture Notes - Lecture 2: Root Mean Square, Market Power, Perfect Competition

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