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Lecture Essentials of Economics: Chapter 6 - Bradley R. Schiller, Cynthia Hill

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Chapter 6 Competition, after reading this chapter, you should be able to: Identify the unique characteristics of perfectly competitive firms and markets, illustrate how total profits change as output expands, describe how the profit-maximizing rate of output is found, recite the determinants of competitive market supply, explain why profits get eliminated in competitive markets.

Chapter6 Competition Copyrightâ2014McGrawưHillEducation.Allrightsreserved.NoreproductionordistributionwithoutthepriorwrittenconsentofMcGrawưHillEducation MarketStructure ã The number and relative size of firms vary across industries • Most real-world firms fall somewhere along a spectrum that stretches from one extreme (powerless) to another (powerful) 6­2 Market Structure Five common types of market structure: • Perfect competition • Monopolistic competition • Oligopoly • Duopoly • Monopoly 6­3 Figure 6.1 6­4 Competitive Firm  • A perfectly competitive firm has no market power: It is not able to alter the market price of the good it produces – It is a price taker – It competes with many other firms selling homogenous products 6­5 Monopoly  • A monopoly firm is one that produces the entire market supply of a particular good or service It has complete market power; it can alter the market price of a good or service – It is a price setter, not a price taker – It has no direct competitors 6­6 Imperfect Competition  • Other forms of imperfect competition lie between monopoly and perfect competition, with decreasing market power – Duopoly: only two firms supply a product – Oligopoly: a few large firms supply all or most of a particular product – Monopolistic competition: many firms supply essentially the same product but each enjoys significant brand loyalty 6­7 Perfect Competition  • Perfectly competitive firms have no brand image, no real market recognition • A perfectly competitive firm is one whose output is so small in relation to market volume that its output decisions have no perceptible impact on price 6­8 Price Takers  • A perfectly competitive firm is a price taker • An individual firm’s output decisions not affect the market price • An individual firm must take the market price and the best it can within these constraints 6­9 Market Demand  versus Firm Demand • There is a big difference between the market demand curve and the demand curve confronting a particular firm – The market demand curve for a product is always downward-sloping – The demand curve facing a perfectly competitive firm is horizontal 6­10 Revenues  versus Profits  • Profit is the difference between total revenue and total cost – Maximizing output or revenue is not the way to maximize profits – Total profits depend on how both revenue and cost increase as output expands • A business is profitable only within a certain range of output 6­13 Profit­Maximizing  Rate of Output • Never produce anything that costs more than it brings in – it boils down to comparing price and marginal cost • A competitive firm wants to expand the rate of production whenever price exceeds marginal cost • Short-run profits are maximized at the rate of output where price equals marginal cost 6­14 Short­Run Decision Rules  for a Competitive Firm • Price > MCIncrease output rate • Price = MCMaintain output rate (Profits maximized) • Price < MCDecrease output rate 6­15 Total Profit • Profit per unit equals price minus average total cost: – Profit/unit = p – ATC • Total profit equals profit per unit times quantity: – Profit = (p – ATC) x q 6­16 Total Profit • What counts is total profits, not profit per unit • Total profits are maximized only where p = MC 6­17 Figure 6.6 6­18 Entry • Additional firms will enter the industry when profits are plentiful • Economic profits attract firms – More firms enter the industry – The market supply curve shifts to the right – The price decreases • Industry output increases and price falls when firms enter an industry 6­19 Figure 6.8 6­20 Tendency toward  Zero Economic Profits • New firms continue to enter a competitive industry so long as profits exist • Once price falls to the level of minimum average cost, all economic profits disappear 6­21 Exit  • Firms exit the industry when: – Profit opportunities look better elsewhere – If price falls below average cost (profits turn into losses) • As firms exit the industry, the market supply curve shifts to the left 6­22 Equilibrium • The existence of profits in a competitive industry induces entry, shifting supply to the right, lowering price, and reducing profits • The existence of losses in a competitive industry induces exits, shifting supply to the left, increasing price, and reducing losses 6­23 Long­Run Equilibrium • In long-run competitive market equilibrium: – Price equals minimum average total cost – Economic profit (or loss) is eliminated • As long as it is easy for existing producers to expand production or for new firms to enter an industry, economic profits will not last long 6­24 Figure 6.9 6­25 Characteristics of a  Competitive Market  • Many small firms • Perceived horizontal demand • Identical products • Low entry barriers • Set output where MC = p • Zero economic profit in the long run • Perfect information 6­26 The Relentless  Profit Squeeze  • The unrelenting squeeze on prices and profits is a fundamental characteristic of the competitive process • The market mechanism works best in competitive markets 6­27 ... times quantity: – Profit = (p – ATC) x q 6? ? 16 Total Profit • What counts is total profits, not profit per unit • Total profits are maximized only where p = MC 6? ?17 Figure? ?6. 6 6? ?18 Entry • Additional... rate (Profits maximized) • Price < MCDecrease output rate 6? ?15 Total Profit • Profit per unit equals price minus average total cost: – Profit/unit = p – ATC • Total profit equals profit per... an industry 6? ?19 Figure? ?6. 8 6? ?20 Tendency toward  Zero Economic Profits • New firms continue to enter a competitive industry so long as profits exist • Once price falls to the level of minimum

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