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Chapter 9

Chapter 9 Competitive Markets.docx

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Economics (Arts)
ECON 208
Mayssun El- Attar Vilalta

Chapter 9 Competitive Markets 9.1 Market Structure and Firm Behaviour  Market structure: all features of a market that affect the behaviour and performance of firms in that market, such as the number and size of sellers or the type of product they sell, the extent of knowledge about one another’s actions, the degree of freedom of entry, and the degree of product differentiation Competitive Market Structure  Market power: the ability of a firm to influence the price of a product or the terms under which it is sold  competitiveness of the market is the degree to which individual firms lack such market power  A market is said to have a competitive structure when its firms have little or market power. The more market power the firms have, the less competitive is the market structure.  Extreme form of competitive market structure occurs when each firm has zero market power = there are so many firms in the market that each must accept the price set by the forces of market demand and market supply. Firms can sell as much as they choose at the prevailing market price and as having no power to influence that price. Cant sell at higher price  Perfectly competitive market structure / perfectly competitive market = no need for individual firms to compete actively with one another since none has any power over the market; one firms ability to sell its product doesn’t depend on the behaviour of any other firm Competitive Behaviour  The degree to which individual firms actively vie with one another for business  Visa and American express = each has the power to decide the fees that people will pay for the use of their credit cars, within limits set by buyers’ tastes and the fees of competing cards; either firm could raise its fees and still continue to attract some customers; even tho they actively compete with each other, they do so in a market that doesn’t have perfectly competitive structure;  wheat farmers are perfectly competitive markets since they don’t actively compete with each other since the only way they can affect their profits is by changing their own outputs of wheat or their own productions costs. The Significance of Market Structure  when a firms decides how much output to produce to maximize profits, it needs to know the demand for its product and its costs of production  details of market structure determine how we get from the industry demand curve to the demand curve facing any individual firm in that industry 9.2 The Theory of Perfect Competition  Perfect competition: a market structure in which all firms in an industry are price takers and in which there is freedom of entry into and exit from the industry The Assumptions of Perfect Competition  1) All the firsms in the industry sell an identical product. Economists say that the firms sell a homogeneous product (in the eyes of purchases, every unit of the product is identical to every other unit) 1  2) Consumers know the nature of the product being sold and the prices charged by each firm  3) the level of each firm’s output at which its LRAC reaches a minimum is small relative to the industry’s total output. (This is a precise way of saying that each firm is small relative to the size of the industry.)  4)The industry is characterized by freedom of entry and exit; that is, any new firm is free to enter the industry and start producing if it so wishes, and any existing firm is free to cease production and leaved the industry. Existing firms cannot block the entry of new firms, and there are no legal prohibitions or other barriers to entering or exiting the industry.  1-3 imply that each firm in a perfectly competitive industry is a price taker (a firm that can alter its rate of production and sales without affecting the market price of its product); no market power, must accept market price but it can sell as much as it wants at that price  Difference between the wheat farmers and the credit card companies is the degree of market power. Each firm that is producing wheat is an insignificant part of the whole market and has no power to influence the price of wheat. American express and Visa have power to influence the credit card market because each firm’s sales represent a significant part of the total sales of credit card services. The Demand Curve for a Perfectly Competitive Firm  Even though the demand curve for the entire industry is negatively sloped, each firm in a perfectly competitive market faces a horizontal demand curve (perfectly elastic) because variations in the firm’s output have no significant effect on price because their effect on total industry output will be negligible Total, Avg, and Marginal Revenue  Total revenue (TR): total amount received by the firm from the sale of a product; TR=p x Q  Average revenue (AR): total revenue divided by quantity sold; this is the market price when all units are sold at the same price; AR = TR/Q = (p x Q)/Q = p  Marginal revenue (MR): the change in a firm’s total revenue resulting from a change in its sale by 1 unit; whenever output changes by more than 1 unit, the change in revenue must be divided by the change in output to calculate the approximate MR; MR=ΔTR/ΔQ  as long as the firm’s own level of output cannot affect the price of the product it sells, then the firm’s MR = AR = price (horizontal line at market price = the firms demand curve) for a price- taking firm; the horizontal line shows that any quantity the firm chooses to sell will be associated with this same market price  If the market price is unaffected by variations in the firm’s output, the firm’s demand curve, its avg revenue curve, and its marginal revenue curve all coincide in the same horizontal line  For a firm in perfect competition, price equals marginal revenue 9.3 Short-Run Decisions Should the Firm Produce at All?  If the firm chooses to produce nothing, it will have an operating loss equal to its fixed costs. If it produces, it will add the variable cost of production to its costs and the receipts from the sale of its product to its revenue. 2  Since fixed costs have to be paid no matter what, the firm should produce as long as it can find some level of output for which revenue exceeds variable cost. But, if its revenue MC), the firm should expand its output. If the last unit produced ^revenues by less than it ^costs (MR
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