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Chapter 6

Chapter 6 EC260.docx

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Karen Huff

EC260 Chapter 6 – Perfect Competition Week 6 -You will still face the supply-side challenges of efficient production and cost control. From the demand side, managers must choose the profit maximizing output when the price is given. -Managers cannot overrule the price set by the interaction of the aggregate market demand and supply curves -An individual managers cannot influence the market price Market Structure -The situation of a price-taking producer is one of four general categories of market structure we investigate -Perfect competition – when there are many firms that are small relative to the entire market and produce similar products -Monopolistic competition – when there are many firms and consumers, just as in perfect competition however, each firm produces a product that is slightly different from the products produced by the other firms -Monopoly – markets with a single seller -Oligopoly – markets with a few sellers -Market structures vary substantially in the extent to which managers can control price -Managers in perfectly competitive markets have no control over price -A manager operating under monopolistic competition or oligopoly is likely to have less control over rice than a monopolist and more control over price than a manager in a perfectly competitive market -These market structures also vary in the extent to which the firms in an industry produce standardized products -Firms in a perfectly competitive market produce identical products -Barrier to entry – barriers that determine how easily firms can enter an industry, depending on the market structure -How easily firms can enter an industry differs from one market structure to another -In perfect competition barriers to entry are low -Market structures also differ in the extent to which managers compete on the basis of advertising, public relations, and different product characteristics, rather than price -In perfect competition there is no nonprice competition Characteristics Summarized Market Examples Number of Type of Power of Firm Barriers to Nonprice Structure Producers Product over Price Entry Competition Perfect Some sectors Many Standardized None Low None competition of agriculture Monopolistic Retail trade Many Differentiated Some Low Advertising competition and product differentiation Oligopoly Computers, Few Standardized Some High Advertising oil, steel or and product differentiated differentiation Monopoly Public utilitieOne Unique Considerable Very high Advertising product Market Price in Perfect Competition -Market price is determined by the intersection o the market demand and supply curves -Even though both total quantity demanded and total quantity supplied depend on price, this does not EC260 Chapter 6 – Perfect Competition Week 6 mean an individual manager can affect price Shifts in Supply and Demand Curves -Shifts in the market supply or demand curves result in price changes -Shifts in market supply and demand curves have significant consequences for firm performance, and managers must try to anticipate them and respond as best they can -Two of the most important factors causing shits in supply curves are technological advancements and changes in input prices The Output Decision of a Perfectly Competitive Firm -The vertical distance between the total revenue and total cost curves is the profit at the corresponding output -Because a manager in a perfectly competitive firm takes the price as given, the slope of the total revenue is always the market price -The nature of competition is to grind the price down to marginal cost – the competitive pressure is relentless -It is worthwhile to present the marginal revenue and marginal cost curves as well as the total revenue and total cost curves -Because the manager takes the price as given, it is constant for all output levels -The marginal revenue curve is also the firm’s demand curve, which is horizontal -Managers maximize profit at the output where the price equals the marginal cost Setting the Marginal Cost Equal to the Price -If managers want to maximize firm value, they should set price equal to marginal cost when marginal cost is increasing -Managers in perfectly competitive markets often accrue negative profits, even if they satisfy the preceding rules -Because the short run is too short to permit the manager to alter the scale o the plant, all she can do is to produce at loss or discontinue the production -The decision to close a plan should answer one question: Does the product’s price cover the average variable costs? For any output where price exceeds average variable costs managers should produce, even though the price does not cover average total costs -If there is not output rate at which price exceeds the average variable cost, the manager is better of shutting the plant -If managers shut a plant, they still incur fixed costs -If the loss from produ
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