Perfect Competition and Why It Matters

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ADB InstituteWorking Paper SeriesNo. 11July 2000The Case of the Missing Market:The Bond Market andWhy It Matters for FinancialDevelopmentRichard J. Herring andNathporn Chatusripitak IIADB INSTITUTE WORKING PAPER 11This paper is part of the Institute’s research project on financial markets and development paradigms. Additionalcopies of the paper are available free from the Asian Development Bank Institute, 8th Floor, Kasumigaseki Building, 3-2-5Kasumigaseki, Chiyoda-ku, Tokyo 100-6008, Japan. Attention: Publications.The Working Paper Series primarily disseminates selected work in progress to facilitate an exchange ofideas within the Institute's constituencies and the wider academic and policy communities. An objective ofthe series is to circulate primary findings promptly, regardless of the degree of finish. The findings,interpretations, and conclusions are the author's own and are not necessarily endorsed by the AsianDevelopment Bank Institute. They should not be attributed to the Asian Development Bank, its Boards, orany of its member countries. They are published under the responsibility of the Dean of the AsianDevelopment Bank Institute. The Institute does not guarantee the accuracy or reasonableness of thecontents herein and accepts no responsibility whatsoever for any consequences of its use. The term"country", as used in the context of the ADB, refers to a member of the ADB and does not imply any view onthe part of the Institute as to sovereignty or independent status. Names of countries or economies mentionedin this series are chosen by the authors, in the exercise of their academic freedom, and the Institute is in noway responsible for such usage.Copyright ©2000 Asian Development Bank Institute and the authors. All rights reserved.Produced by ADBI Publishing.ABOUT THE AUTHORSRichard J. Herring is Jacob Safra Professor of International Banking and Professor of Financeat the Wharton School of the University of Pennsylvania where he has been on the faculty since1972. He received his doctorate at Princeton University. He was the founding Director of theWharton Financial Institutions Center and Vice Dean and Director of the WhartonUndergraduate Division. He is currently Director of The Lauder Institute of Management andInternational Studies and a member of the Shadow Financial Regulatory Committee. Hisresearch interests include international finance, financial regulation, banking and financialcrises.Nathporn Chatusripitak is a Ph.D. candidate in the Finance Department at the Wharton Schoolof the University of Pennsylvania. He completed his undergraduate degree in electricalengineering at Brown University. IIIPREFACEThe ADB Institute aims to explore the most appropriate development paradigms for Asiacomposed of well-balanced combinations of the roles of markets, institutions, and governments in thepost-crisis period.Under this broad research project on development paradigms, the ADB Institute WorkingPaper Series will contribute to disseminating works-in-progress as a building block of the project andwill invite comments and questions.I trust that this series will provoke constructive discussions among policymakers as well asresearchers about where Asian economies Perfect Competition and Why It Matters Perfect Competition and Why It Matters By: OpenStaxCollege Firms are said to be in perfect competition when the following conditions occur: (1) many firms produce identical products; (2) many buyers are available to buy the product, and many sellers are available to sell the product; (3) sellers and buyers have all relevant information to make rational decisions about the product being bought and sold; and (4) firms can enter and leave the market without any restrictions—in other words, there is free entry and exit into and out of the market A perfectly competitive firm is known as a price taker, because the pressure of competing firms forces them to accept the prevailing equilibrium price in the market If a firm in a perfectly competitive market raises the price of its product by so much as a penny, it will lose all of its sales to competitors When a wheat grower, as discussed in the Bring it Home feature, wants to know what the going price of wheat is, he or she has to go to the computer or listen to the radio to check The market price is determined solely by supply and demand in the entire market and not the individual farmer Also, a perfectly competitive firm must be a very small player in the overall market, so that it can increase or decrease output without noticeably affecting the overall quantity supplied and price in the market A perfectly competitive market is a hypothetical extreme; however, producers in a number of industries face many competitor firms selling highly similar goods, in which case they must often act as price takers Agricultural markets are often used as an example The same crops grown by different farmers are largely interchangeable According to the United States Department of Agriculture monthly reports, in 2012, U.S corn farmers received an average price of $6.07 per bushel and wheat farmers received an average price of $7.60 per bushel A corn farmer who attempted to sell at $7.00 per bushel, or a wheat grower who attempted to sell for $8.00 per bushel, would not have found any buyers A perfectly competitive firm will not sell below the equilibrium price either Why should they when they can sell all they want at the higher price? Other examples of agricultural markets that operate in close to perfectly competitive markets are small roadside produce markets and small organic farmers 1/3 Perfect Competition and Why It Matters Visit this website that reveals the current value of various commodities This chapter examines how profit-seeking firms decide how much to produce in perfectly competitive markets Such firms will analyze their costs as discussed in the chapter on Cost and Industry Structure In the short run, the perfectly competitive firm will seek the quantity of output where profits are highest or, if profits are not possible, where losses are lowest In this example, the “short run” refers to a situation in which firms are producing with one fixed input and incur fixed costs of production (In the real world, firms can have many fixed inputs.) In the long run, perfectly competitive firms will react to profits by increasing production They will respond to losses by reducing production or exiting the market Ultimately, a long-run equilibrium will be attained when no new firms want to enter the market and existing firms not want to leave the market, as economic profits have been driven down to zero Key Concepts and Summary A perfectly competitive firm is a price taker, which means that it must accept the equilibrium price at which it sells goods If a perfectly competitive firm attempts to charge even a tiny amount more than the market price, it will be unable to make any sales In a perfectly competitive market there are thousands of sellers, easy entry, and identical products A short-run production period is when firms are producing with some fixed inputs Long-run equilibrium in a perfectly competitive industry occurs after all firms have entered and exited the industry and seller profits are driven to zero Perfect competition means that there are many sellers, there is easy entry and exiting of firms, products are identical from one seller to another, and sellers are price takers Self-Check Questions Firms in a perfectly competitive market are said to be “price takers”—that is, once the market determines an equilibrium price for the product, firms must accept this price If you sell a product in a perfectly competitive market, but you are not happy with its price, would you raise the price, even by a cent? 2/3 Perfect Competition and Why It Matters No, you would not raise the price Your product is exactly the same as the product of the many other firms in the market If your price is greater than that of your competitors, then your customers would switch to them and stop buying from you You would lose all your sales Would independent trucking fit the characteristics of a perfectly competitive industry? Possibly Independent truckers are by ...Reputation Why it matters and how you can manage it From banking to oil, technology to automobiles, industry reputations have been hard hit in recent years. Some were deserved and others were not. All had financial implications for the companies involved – and their shareholders. Key findings: • Organisational reputations have currency as evidenced in share value, operational costs and market opportunities. • Social networking has reduced the organisation’s control over its reputation. As a result, the pressure on organisations to understand how they are being presented and what they need to do internally has increased significantly. • Reputation is created from within. As such, its definition and quantification can and need to be incorporated into both strategic and operational planning and oversight. • Assessed correctly, reputation is an innovation driver and can open the organisation to new markets and market opportunities. • Quantification of reputation comes, most easily, from an analysis of errors of omission and commission – which, when addressed, provide clear direction for organisational improvement and increased employee morale and productivity leading to greater shareholder value and broader market opportunities. 1 | Reputation: why it matters and how you can manage it About CIMA CIMA, the Chartered Institute of Management Accountants, founded in 1919, is the world’s leading and largest professional body of management accountants. With more than 172,000 members and students operating in 168 countries, CIMA works at the heart of business, in industry, commerce, public sector and other not-for-profit organisations. Partnering directly with employers, CIMA sponsors leading-edge research, constantly updating its qualification, professional experience requirements and continuing professional development to ensure that it remains the employers’ choice when recruiting financially trained business leaders. CIMA is committed to upholding the highest ethical and professional standards of members and students and to maintaining public confidence in management accountancy. For more information about CIMA, please visit www.cimaglobal.com About the author Leslie L. Kossoff FRSA is an internationally renowned executive advisor, writer and speaker specialising in strategic alignment and corporate turnaround. For over 20 years, she has assisted organisations ranging from start-ups to Fortune 50s in the US, EU and Japan across industries and sectors. Some of her clients include Fidelity Investments, Sony, Kraft Foods, Seiko/Epson, the UK National Health Service and the US Department of the Navy. Leslie has held executive positions in the aerospace/defence and pharmaceutical industries. She is the author of Leadership Quantified, two books, over 100 articles in journals including the Financial Times, Investor’s Business Daily and CEO and is a highly regarded speaker at conferences worldwide. Dr W. Edwards Deming, the founder/creator of the Western Quality Movement said of her, ‘She is, quite simply, one of the best at implementation.’ Leslie is the founder and former director of the Institute for Quality and Productivity Improvement at California State University, Long Beach and was a founding board member of the Global Women’s Leadership Center at the Leavey School of Business at Santa Clara University. She currently sits on the Boards of the Enterprise Trust, Cordville Capital, the Russia Research Network and is a fellow of the Royal Society of Arts (www.kossoff.com). 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QuickTime™ and a decompressor are needed to see this picture QuickTime™ and a decompressor are needed to see this picture L AW ’ S O R D E R L AW ’ S O R D E R W H AT E C ONOM I C S H A S T O D O W I T H L AW A N D W HY I T M AT T E R S David D Friedman PRINCETON UNIVERSITY PRESS PRINCETON, NEW JERSEY Copyright  2000 by Princeton University Press Published by Princeton University Press, 41 William Street Princeton, New Jersey 08540 In the United Kingdom: Princeton University Press Chichester, West Sussex All Rights Reserved Library of Congress Cataloging-in-Publication Data Friedman, David D Law’s order : what economics has to with law and why it matters / David D Friedman p cm Includes bibliographical references and index ISBN 0-691-01016-1 (alk paper) Economics Law I Title HB171.F768 2000 330.1—dc21 99-058555 This book has been composed in Sabon The paper used in this publication meets the minimum requirements of ANSI/NISO Z39.48-1992 (R 1997) (Permanence of Paper) www.pup.princeton.edu Printed in the United States of America 10 T H I S B OO K I S D E D I C AT E D W I T H R ES P EC T A N D AF F E C T I ON T O Aaron Director and Ronald Coase CONTENTS Introduction What Does Economics Have to Do with Law? Efficiency and All That 18 What’s Wrong with the World, Part 28 What’s Wrong with the World, Part 36 Defining and Enforcing Rights: Property, Liability, and Spaghetti 47 Of Burning Houses and Exploding Coke Bottles 63 Coin Flips and Car Crashes: Ex Post versus Ex Ante 74 Games, Bargains, Bluffs, and Other Really Hard Stuff 84 As Much as Your Life Is Worth 95 Intermezzo The American Legal System in Brief 103 10 Mine, Thine, and Ours: The Economics of Property Law 112 11 Clouds and Barbed Wire: The Economics of Intellectual Property 128 12 The Economics of Contract 145 13 Marriage, Sex, and Babies 171 14 Tort Law 189 15 Criminal Law 223 16 Antitrust 244 17 Other Paths 263 18 The Crime/Tort Puzzle 281 19 Is the Common Law Efficient? 297 Epilogue 309 Index 319 L AW ’ S O R D E R E P ILOGU E 315 information Where possible, create institutions that make it in someone’s interest to use such information to generate the appropriate rules I have described one direction in which the analysis can be applied— figuring out what legal rules would be efficient Running the project in the opposite direction, what comes out is a way of understanding the legal system we have—on the conjecture that it, or at least large parts of it, can be explained as a system of efficient rules An important thing to remember in either version of the project is that utopia is not an option As Coase argued, in the same essay that gave us the Coasian approach to externalities, in the real world all solutions are imperfect Our project is not to eliminate costs but to minimize them, to find the least bad system of legal rules Even that we can only imperfectly; we not know enough to reduce legal design to mathematical calculation What we can is to understand the advantages and disadvantages of alternative rules as a first step toward choosing among them For example, strict liability in tort law compensates the victim and so gives him no incentive to take precautions to reduce the cost or probability of accidents Negligence solves that problem at the cost of eliminating the incentive for the tortfeasor to take those precautions that the court cannot observe or cannot judge Hence strict liability is most attractive where victim precautions are unimportant and unobservable precautions by the tortfeasor important, negligence under the opposite circumstances A rule of caveat venditor in product liability eliminates the consumer’s incentive to minimize risk and cost and produces litigation and associated costs; a rule of caveat emptor eliminates the litigation, restores the consumer’s incentive, but eliminates the producer’s incentive to control risks that customers are unaware of Hence the choice between the rules hinges on who can best control the risk (putting the incentive where it does the most good), on how costly and accurate litigation is, and on how well informed consumers are with .. .Perfect Competition and Why It Matters Visit this website that reveals the current value of various commodities This chapter examines how profit-seeking firms decide how much to produce in perfectly... you sell a product in a perfectly competitive market, but you are not happy with its price, would you raise the price, even by a cent? 2/3 Perfect Competition and Why It Matters No, you would not... after all firms have entered and exited the industry and seller profits are driven to zero Perfect competition means that there are many sellers, there is easy entry and exiting of firms, products