Efficiency in Perfectly Competitive Markets

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Study Meeting on Customer Satisfaction in Competitive Markets 4–7 October 2005 Taipei, Republic of China    Introduction With the increased globalization of markets, competition among market players has become more severe. In this competitive market, one of the most important factors is the achievement of customer satisfaction and excellence in service. Although the concept of customer satisfaction in customer- oriented management is not new, the relationship between customers and corporations has been changing almost daily. Customers are becoming the absolute entity for corporations as the final decision makers for business deals and purchases of products. Peter Drucker, the highly regarded management scholar and writer, stated, “The only valid definition of business purpose is to create a customer.” Successful organizations of the future will be those that can provide goods and services to the customers who want it, where they want it, and in the quantity and at the price they want it, thereby delighting rather than merely satisfying customers. Customer delight will lead to loyalty, which is one of the critical indicators used to measure the success of a marketing strategy. Services cannot, however, be performed without some form of relationship between the producer and the consumer and cannot be stored and retained for later use in the way typical of many tangible goods. Business corporations make efforts to create and provide their customers with higher value added, which consists of elements such as lower prices, additional benefits, and uniqueness in services. With rapid advances in information and communications technology, corporations can take advantage of the emerging IT systems to create infrastructure within the organization to improve responsiveness to customer needs and to track those needs, thereby improving customer satisfaction significantly. Top management should be aware of how to tap the power of IT to enhance customer services, resulting in better service quality and streamlining of processes. With advanced technology, competing organizations can rapidly duplicate another organization’s services and products. This process is now accelerated by the Internet and e-mail and can be achieved in much less time than was possible a few years ago. Organizations are also dealing with more highly educated customers who are aware of the varied services and levels of quality available. There is a myriad of options for the customer. However, competitors cannot duplicate another organization’s customer relationships. Therefore customer satisfaction becomes the key ingredient of continued success. Corporations should identify and focus on the key emotional drivers that lead to customer satisfaction, examine the impact of branding, and formulate value-centered strategies leading to service excellence. The study meeting was aimed at understanding the emerging approaches and methods employed by business corporations in their pursuit of excellence in customer service. The specific objectives were to: 1) share experiences in creative management renovation to achieve greater customer satisfaction; 2) exchange views on systems and structures to deliver quality service; 3) understand the processes for effective policy development in achieving service excellence; and 4) identify successful marketing strategies and service management in business corporations. The scope of the study meeting covered the following: • Customer satisfaction through service quality and service encounters, otherwise known as “moments of truth”; • Various measures, structures, and systems Efficiency in Perfectly Competitive Markets Efficiency in Perfectly Competitive Markets By: OpenStaxCollege When profit-maximizing firms in perfectly competitive markets combine with utilitymaximizing consumers, something remarkable happens: the resulting quantities of outputs of goods and services demonstrate both productive and allocative efficiency (terms that were first introduced in (Choice in a World of Scarcity) Productive efficiency means producing without waste, so that the choice is on the production possibility frontier In the long run in a perfectly competitive market, because of the process of entry and exit, the price in the market is equal to the minimum of the long-run average cost curve In other words, goods are being produced and sold at the lowest possible average cost Allocative efficiency means that among the points on the production possibility frontier, the point that is chosen is socially preferred—at least in a particular and specific sense In a perfectly competitive market, price will be equal to the marginal cost of production Think about the price that is paid for a good as a measure of the social benefit received for that good; after all, willingness to pay conveys what the good is worth to a buyer Then think about the marginal cost of producing the good as representing not just the cost for the firm, but more broadly as the social cost of producing that good When perfectly competitive firms follow the rule that profits are maximized by producing at the quantity where price is equal to marginal cost, they are thus ensuring that the social benefits received from producing a good are in line with the social costs of production To explore what is meant by allocative efficiency, it is useful to walk through an example Begin by assuming that the market for wholesale flowers is perfectly competitive, and so P = MC Now, consider what it would mean if firms in that market produced a lesser quantity of flowers At a lesser quantity, marginal costs will not yet have increased as much, so that price will exceed marginal cost; that is, P > MC In that situation, the benefit to society as a whole of producing additional goods, as measured by the willingness of consumers to pay for marginal units of a good, would be higher than the cost of the inputs of labor and physical capital needed to produce the marginal 1/4 Efficiency in Perfectly Competitive Markets good In other words, the gains to society as a whole from producing additional marginal units will be greater than the costs Conversely, consider what it would mean if, compared to the level of output at the allocatively efficient choice when P = MC, firms produced a greater quantity of flowers At a greater quantity, marginal costs of production will have increased so that P < MC In that case, the marginal costs of producing additional flowers is greater than the benefit to society as measured by what people are willing to pay For society as a whole, since the costs are outstripping the benefits, it will make sense to produce a lower quantity of such goods When perfectly competitive firms maximize their profits by producing the quantity where P = MC, they also assure that the benefits to consumers of what they are buying, as measured by the price they are willing to pay, is equal to the costs to society of producing the marginal units, as measured by the marginal costs the firm must pay—and thus that allocative efficiency holds The statements that a perfectly competitive market in the long run will feature both productive and allocative efficiency need to be taken with a few grains of salt Remember, economists are using the concept of “efficiency” in a particular and specific sense, not as a synonym for “desirable in every way.” For one thing, consumers’ ability to pay reflects the income distribution in a particular society Thus, a homeless person may have no ability to pay for housing because they have insufficient income Perfect competition, in the long run, is a hypothetical benchmark For market structures such as monopoly, monopolistic competition, and oligopoly, which are more frequently observed in the real world than perfect competition, firms will not always produce at the minimum of average cost, nor will they always set price equal to marginal cost Thus, these other competitive situations will not produce productive and allocative efficiency Moreover, real-world markets include many issues that are assumed away in the model of perfect competition, including pollution, inventions of new technology, poverty which may make some people unable to pay for basic necessities of life, government programs like national defense or education, discrimination in labor markets, and buyers and sellers who must deal with imperfect and unclear information These issues are explored in other chapters However, the theoretical efficiency of perfect competition does provide a useful benchmark for comparing the issues that arise from these realworld ...[...]... PROTECTION AGENCY 11 Inherent Difficulties in Evaluating Research, 11 Research Terms at the Environmental Protection Agency, 12 Evaluating Research under the Government Performance and Results Act, 13 The Rationale and Function of the Program Assessment Rating Tool, 14 The Application of the Program Assessment Rating Tool to Research, 14 The Organization and Performance of Research and Development at the Environmental. .. judged “inefficient” by some metrics In addition, much of the work of researchers involves building on, integrating, and replicating previous results and this might also appear “inefficient.” RESEARCH TERMS AT THE ENVIRONMENTAL PROTECTION AGENCY The Environmental Protection Agency (EPA) uses a particular nomenclature to describe its research, including the terms core research and problemdriven research. .. BIOGRAPHIC INFORMATION ON THE COMMITTEE ON EVALUATING THE EFFICIENCY OF RESEARCH AND DEVELOPMENT PROGRAMS AT THE U.S ENVIRONMENTAL PROTECTION AGENCY 69 APPENDIX B: EVALUATING THE EFFICIENCY OF RESEARCH AND DEVELOPMENT PROGRAMS AT THE U.S ENVIRONMENTAL PROTECTION AGENCY: WORKSHOP SUMMARY 75 APPENDIX C: PROGRAM ASSESSMENT RATING TOOL (PART) QUESTIONS 86 APPENDIX D: THE ENVIRONEMENTAL PROTECTION. .. plotted against milestones 8 Evaluating Research Efficiency in EPA process by adding individual trackable items and a larger body of knowledge for decision-making Recommendation 2 EPA and other agencies should use expert-review panels to evaluate the investment efficiency of research programs The process should begin by evaluating the relevance, quality, and performance7 of the research Investment efficiency. .. Environmental Protection Agency, 16 Uses of Results of Environmental Protection Agency Research, 18 Summary, 18 References, 19 2 EFFICIENCY METRICS USED BY THE ENVIRONMENTAL PROTECTION AGENCY AND OTHER FEDERAL RESEARCH AND DEVELOPMENT PROGRAMS 21 Evaluating Research and Development, 22 The Program Assessment Rating Tool and Efficiency, 22 Applying Efficiency to Inputs, Outputs, and Outcomes, 22 The Program... focused on evaluating the efficiency of programs Evaluation of R&D programs has proved challenging for federal agencies, including Chapter 14/Firms in Competitive Markets ✦ 149 Chapter 14 Firms in Competitive Markets MULTIPLE CHOICE 1. A market is competitive if (i) firms have the flexibility to price their own product. (ii) each buyer is small compared to the market. (iii) each seller is small compared to the market. a. (i) and (ii) only b. (i) and (iii) only c. (ii) and (iii) only d. All of the above are correct. ANSWER: c. (ii) and (iii) only TYPE: M DIFFICULTY: 2 SECTION: 14.1 2. When a firm has little ability to influence market prices it is said to be in what kind of a market? a. a competitive market b. a strategic market c. a thin market d. a power market ANSWER: a. a competitive market TYPE: M DIFFICULTY: 1 SECTION: 14.1 3. In a competitive market, the actions of any single buyer or seller will a. have a negligible impact on the market price. b. have little effect on overall production but will ultimately change final product price. c. cause a noticeable change in overall production and a change in final product price. d. adversely affect the profitability of more than one firm in the market. ANSWER: a. have a negligible impact on the market price. TYPE: M DIFFICULTY: 2 SECTION: 14.1 Use the information in the table below to answer questions 4 through 7. Quantity Price 1 13 2 13 3 13 4 13 5 13 6 13 7 13 8 13 9 13 4. The price and quantity relationship in the table is most likely that faced by a firm in a a. monopoly. b. concentrated market. c. competitive market. d. strategic market. ANSWER: c. competitive market. TYPE: M DIFFICULTY: 1 SECTION: 14.1 150 ✦ Chapter 14/Firms in Competitive Markets 5. Over which range of output is average revenue equal to price? a. 1 to 5 b. 3 to 7 c. 5 to 9 d. Average revenue is equal to price over the whole range of output. ANSWER: d. Average revenue is equal to price over the whole range of output. TYPE: M DIFFICULTY: 1 SECTION: 14.1 6. Over what range of output is marginal revenue declining? a. 1 to 6 b. 3 to 7 c. 7 to 9 d. None; marginal revenue is constant over the whole range of output. ANSWER: d. None; marginal revenue is constant over the whole range of output. TYPE: M DIFFICULTY: 2 SECTION: 14.1 7. If the firm doubles its output from 3 to 6 units, total revenue will a. increase by less than $39. b. increase by exactly $39. c. increase by more than $39. d. It cannot be determined from the information provided. ANSWER: b. increase by exactly $39. TYPE: M DIFFICULTY: 1 SECTION: 14.1 8. For a firm in a perfectly competitive market, the price of the good is always a. equal to marginal revenue. b. equal to total revenue. c. greater than average revenue. d. All of the above are correct. ANSWER: a. equal to marginal revenue. TYPE: M DIFFICULTY: 1 SECTION: 14.1 9. If a firm in a perfectly competitive market triples the number of units of output sold, then total revenue will a. more than triple. b. less than triple. c. exactly triple. d. All of the above are potentially true. ANSWER: c. exactly triple. TYPE: M DIFFICULTY: 1 SECTION: 14.1 10. Because the goods offered for sale in a competitive market are largely the same, a. there will be few sellers in the market. b. there will be few buyers in the market. c. buyers will have market power. d. sellers will have little reason to charge less than the going market price. ANSWER: d. sellers will have little reason to charge less than the going market price. TYPE: M DIFFICULTY: 1 SECTION: 14.1 11. Which of the following is NOT a characteristic of a perfectly competitive market? a. Firms are price takers. b. Firms have difficulty entering the market. c. There are many sellers in the market. d. Goods offered for sale are largely the same. ANSWER: b. Firms have difficulty entering the market. TYPE: M DIFFICULTY: 1 SECTION: 14.1 Chapter 14/Firms in Competitive Markets ✦ 151 12. When buyers in a competitive market take the selling price as given, they are said to be a. market entrants. b. monopolists. c. free riders. d. price takers. ANSWER: d. price takers. TYPE: M DIFFICULTY: Session IX Firms in Competitive Markets Principles of Economics Overview What is a perfectly competitive market? What is marginal revenue? How is it related to total and average revenue? How does a competitive firm determine the quantity that maximizes profits? When might a competitive firm shut down in the short run? Exit the market in the long run? What does the market supply curve look like in the short run? In the long run? 1 Learning Objectives By the end of this session, students should understand: – what characteristics make a market competitive – competitive firms decide how much output to produce. – how competitive firms decide when to shut down production temporarily. – how competitive firms decide whether to exit or enter a market. – how firm behavior determines a market’s short-run and long-run supply curves. 2 Firms in Competitive Markets Part I Perfect Competition 4 Introduction: A Scenario Three years after graduating, you run your own business. You must decide how much to produce, what price to charge, how many workers to hire, etc. What factors should affect these decisions? –Your costs (studied in preceding session) –How much competition you face We begin by studying the behavior of firms in perfectly competitive markets. Source: Mankiw (2011) 5 Characteristics of Perfect Competition 1. Many buyers and many sellers. 2. The goods offered for sale are largely the same (homogenous). 3. Firms can freely enter or exit the market.  Because of 1 & 2, each buyer and seller is a “price taker” – takes the price as given. 6 The Revenue of a Competitive Firm Total revenue (TR) Average revenue (AR) Marginal revenue (MR): The change in TR from selling one more unit. ∆TR ∆Q MR = TR = P x Q TR Q AR = = P Exercise IX-1: Calculating Total, Average, and Marginal Revenue 7 Fill in the empty spaces of the table. $50 $10 5 $40 $10 4 $10 3 $10 2 $10 $10 1 n/a $10 0 TR P Q MR AR $10 Source: Mankiw (2011) 9 MR = P for a Competitive Firm A competitive firm can keep increasing its output without affecting the market price. So, each one-unit increase in Q causes revenue to rise by P, i.e., MR = P. MR = P is only true for firms in competitive markets. 10 Profit Maximization What Q maximizes the firm’s profit? To find the answer, “think at the margin.” If increase Q by one unit, revenue rises by MR, cost rises by MC. If MR > MC, then increase Q to raise profit. If MR < MC, then reduce Q to raise profit. [...]... Rise as Firms Enter the Market In some industries, the supply of a key input is limited (e.g., amount of land suitable for farming is fixed) The entry of new firms increases demand for this input, causing its price to rise This increases all firms costs: increasing-cost industries Hence, an increase in P is required to increase the market quantity supplied, so the supply curve is upward-sloping 36... are earning positive profits, then firms will enter the industry, market supply will increase, and price will fall to the long-run equilibrium level SR & LR Effects of an Increase in Demand …but then an increase A firm begins in …driving profits to zerodemand raises P,… …leading to SR Over time, in profits induce entry, long-run eq’m… and restoring long-run eq’m profits for the firm shifting S to... supply shifts right – P falls, reducing profits and slowing entry If existing firms incur losses, – some firms exit, SR market supply shifts left – P rises, reducing remaining firms losses 29 The Zero-Profit Condition Long-run equilibrium: The process of entry or exit is complete – remaining firms earn zero economic profit Zero economic profit occurs when P = ATC Since firms produce where P = MR = MC,... zero-profit condition is P = MC = ATC Recall that MC intersects ATC at minimum ATC Hence, in the long run, P = minimum ATC 30 Why Do Firms Stay in Business if Profit is The Perfectly Competitive Market Economics 11 UPLB Market Economy    the market is a system where buyers and sellers exchange goods or services market is actually a very logical mechanism that helps answer the basic economic questions of what, how much and for whom to produce different commodities system continually allocates goods and services to various units with the help of a pricing mechanism The Market System    a market for commodities - rice, milk, water, coffee, clothes and many others a market for the inputs used in the production of these commodities like steel, minerals and labor Each market may have a different structure: the number of sellers or buyers  demand for the commodity  control in the market  Two General Types of Markets the Perfectly Competitive Market [5 main features] the imperfect market I II    Monopoly – one firm Oligopoly – two or more, but few firms Monopolistic competition – many firms selling differentiated products Features of Perfectly Competitive Market Smallness of buyers and sellers relative to the market Homogeneous product Absence of artificial restraints or controls Perfect mobility of goods and resources Perfect information The Demand Curve Faced by the Firm   since the firm cannot control the market price, owing to its smallness relative to the market, the firm can actually sell as much output as it wants without influencing the price the firm in perfect competition faces a perfectly elastic demand curve P d Q  the equilibrium price is still determined in the market by the forces of demand and supply Revenues of the Firm  Total revenue (TR) is the firm's gross income from the sale of its product TR=P.Q  Marginal revenue (MR) is the additional revenue earned from each additional unit of output sold MR=∆TR/∆Q  Average revenue (AR) is total revenue divided by output AR=TR/Q Market Firm Price D S P* d P* Q Equilibrium price is determined in the market Q Once determined, a firm can sell as much as it wants at that price Market Price Firm D2 D S P2 P2 d2 P* P* d Q Equilibrium price is determined in the market Q Once determined, a firm can sell as much as it wants at that price P P Price Price Supply P* P* Demand Q Output (A) Market Q Output (B) Firm FIGURE 6.1 The market and firm demand curves for a perfectly competitive good In the left panel of this diagram, we find a downward sloping market demand curve for the good Its intersection with the market supply curve determines the equilibrium price (P*) that will prevail in the market Since a perfectly competitive firm can sell all that it wants at P*, the firm’s demand curve is the horizontal line shown at the right panel of this diagram P D MC SAC P0 S1 LAC MR, AR P1 S0 P0 P1 Q1 Q0 At Po, firms are reaping profits New firms are attracted as long as profits are positive Supply curve shifts to the right, so price falls The entry or exit of firms will stop only when profit is reduced to zero This is at the lowest point of the LAC curve LMC COST LAC SMC1 SAC1 P MR, AR Q Long Run Equilibrium of the Industry: P = LMC = SMC, P = LAC = SAC Constant cost industry     Suppose that the industry’s initial long-run equilibrium corresponds to price and output levels P0 and Q0, respectively With an increase demand from D0 to D1 “short-run” equilibrium price and quantity increase The higher price makes the industry profitable Firms will be encouraged to enter the industry This causes a rightward shift in the market supply curve We have a constant cost industry if the shift in the supply curve leads to a long-run equilibrium wherein the market price goes back to P0 P D0 D1 S0 S1 P1 P0 Price Long Run Supply Curve Q0 Q1 Quantity Q LMC COST LAC SMC1 P1 P0 SAC1 MR1 MR0 Q The increase in price will make the industry profitable This will result in entry of new firms The increased supply ... a perfectly competitive market to be allocatively efficient 3/4 Efficiency in Perfectly Competitive Markets Think of the market price as representing the gain to society from a purchase, since... 2/4 Efficiency in Perfectly Competitive Markets two to three times as many bushels per acre as wheat, it is obvious there has been a significant increase in bushels of corn Why the increase in. . .Efficiency in Perfectly Competitive Markets good In other words, the gains to society as a whole from producing additional marginal units will be greater than