Chapter 9: Price Takers and the Competitive Process

Why do we study price-taker markets? The competitive price-taker model ...

+applies to some markets, such as agricultural products. +helps us understand the relationship between individual firms and market supply. +increases our knowledge of competition as a dynamic process.

2 conditions to get us into equilibrium long run in a price-taker market are

-The quantity supplied and quantity demanded must be equal in the market -firms in the industry must earn zero economic profit (P = ATC).

The long-run market supply curve in a ........... is horizontal in these markets.

...constant-cost industry

...In a price-taker market, marginal revenue (MR) will be equal to ........, because all units are sold at the same price (market price)

.market price

2 conditions to get us into equilibrium long run in a price-taker market are slide 23

1 Ps=Pd Qs= Qd 2 all firms make exactly zero economic profit The quantity supplied and quantity demanded must be equal in the market, as shown here at P1 with output Q1. Given the market price, firms in the industry must earn zero economic profit (P = ATC).

monoply

1)one firm 2)high barriers/no entry

Use TR and TC to find Q*

1. Table: find Q* where TR-TC is greatest 2. Graph: find Q* where distance between TR and TC is greatest 3. Calculate profits

Use MR and MC to find Q*

1. find MR=MC 2. Table: find Q* where MR>or equal to MC 3. Graph: find Q* where MC and MR intersect

The firm's short-run supply curve:

A firm maximizes profits when it produces at P = MC and its variable costs are covered. A firm's short-run supply curve is that segment of its marginal cost curve above average variable cost.

regulating monopolys

ATC pricing quantity requirements -only allowed to produce if they provide a certain quantity

pg 184-185 graphs

Adjusting to Expansion in Demand new equilibrium will be met at higher output and original price Adjusting to a Decline in Demand new equilibrium will be met at lower output and original price

Total Revenue / Total Cost Approach

An alternative way of viewing the profit maximization problem focuses on total revenue (TR) & total cost (TC). At low levels of output TC > TR and, hence, profits are negative. After some point, TR may exceed TC. Profits are largest where the difference is maximized.

MR / MC Approach

At low output levels MR > MC. After some point, additional units cost more than the MR realized from selling them. Profit is maximized at P = MR = MC.

MC = ATC

ECONOMIC Profit of 0

Economic profit induces both:

Economic profit induces both: the entry of new firms, and, expansion in the scale of operation of existing firms.

Supply Curve for the Firm and Market slide 17

Given resource prices, the firm's marginal cost curve (above AVC) is the firm's supply curve. As price rises above the short-run shutdown price P1, the firm will supply additional units of the good. The short-run market supply curve (Ssr) is merely the sum of the firms' supply (MC) curves. Note that below P1 no quantity is supplied as P < AVC.

Supply Elasticity and the Role of Time

In the short run, fixed factors of production such as plant size limit the ability of firms to expand output quickly. In the long run, firms can alter plant size and other fixed factors of production. Therefore, the market supply curve will be more elastic in the long run than in the short run.

Profit Maximization when the Firm is a Price Taker

In the short run, the firm will expand output until marginal revenue (MR) is just equal to marginal cost (MC). This will maximize the firm's profits Slide 10

........... are a penalty for the production of a good that consumers value less highly than the value of the resources required for its production.

Losses

In order for the firm to maximize its profit it will expand output until ....

MC = P.

.... is the change in total revenue divided by the change in output.

Marginal Revenue

economic profits = 0

No exit or entry

constant cost industry ???

an industry that can expand or contract without affecting the long run per-unit cost of production; the long-run industry supply curve is horizontal

.....produce identical products (for example, wheat, corn, soybeans) and because the firms are small relative to the market each must take the price established in the market.

Price takers

.....firms produce products that differ and therefore they can alter price. The amount that the price-searcher firm is able to sell is inversely related to the price it charges. Most real world firms are price searchers.

Price-searcher

....... is a reward for production of a product that has greater value than the value of the resources required for its production.

Profit

Keys to Prosperity: Competition

The competitive process provides a strong incentive for producers to operate efficiently and heed the views of consumers. Competition and the market process harness self-interest and use it to direct producers into wealth-creating activities.

Operating with Short-Run Losses slide 13

The firm operates at an output level where MR = MC, but here ATC > P resulting in a loss. The magnitude of the firm's short-run loss is equal to the size of the rectangle C - A - B - P1. A firm experiencing losses but covering average variable costs will operate in the short-run. A firm will sSHUTDORN in the short-run whenever price falls below average variable cost (P2). A firm will GO OUT OD BUISNESexit the market in the long-run when price is less than average total cost (ATC).

What are two ways the price taker maximized profit?

Use TR and TC to find Q* Use MR and MC to find Q*

natural monopoly

a market that runs most efficiently when one large firm supplies all of the output

what are examples of large firms in the market?

agricultural products financial markets airlines in US

If ATC exceeds price, firms will suffer... As market supply decreases, price will rise to average total cost. Thus, profits and losses move price toward the zero-profit in ....

an economic loss. long-run equilibrium.

If price exceeds ATC, firms will earn .......

an economic profit.

Characteristics of the Competitive Price-Taker Markets Factors that promote cost efficiency and customer service but limit shirking by corporate managers include:

competition among firms for investment funds and customers compensation and management incentives the threat of corporate takeover

Firms earn an ..................... by producing goods that can be sold for more than the cost of the resources required for their production.

economic profit

Price = ATC

economic profits=0 called LR equilibrium because there is no entry or exit

economic profits > 0

entry easy

economic profits < 0

exit easy

constant-cost industry

factor prices (inputs) remain unchanged as market output is expanded

increasing-cost industry

factor prices (inputs) rise as market output is expanded most common

oligopoly

few firms ex: cars, manufacturing, appliances-fridges

If P < ATC and P < AVC

firm would shut down because you couldnt pay ATV or VC

price searchers

firms that face a downward sloping demand curve for their product. the amount a firm can sell is inversely related to price changes. price makers

4 assumptions Price takers market 1 all firms produce identical goods 2 large # of firms (less chance of monopolies ) 3 each firm supplies a small % of total amount supplied to the market 4 no boundaries to enter/exit markets ex. regulations, license

ideal situation we hope markets drive toward strawberry

If P < ATC but P > AVC

if the firm chooses to stay open it experiences losses.

Decreasing-Cost Industry:

industry were per-unit costs decline as market output expands. implies either economies of scale exist in the industry or that an increase in demand for inputs leads to lower input prices The long-run market supply curve in a decreasing-cost industry is downward-sloping. Decreasing-cost industries are rare.

Increasing-Cost Industry:

industry where per-unit cost rises as market output is expanded. results because an increase in industry output generally leads to stronger demand and higher prices for the inputs The long-run market supply curve in an increasing-cost industry is upward-sloping. This is the most common type of industry.

Constant-Cost Industry:

industry where per-unit costs remain unchanged as market output is expanded resource prices remain unchanged occurs when the industry's demand for resource inputs is small relative to the total demand for the resources The long-run market supply curve in a constant-cost industry is horizontal in these markets.

What are the characteristics of price taker market?

large number of firms produce identical products each firm supplies small portion no barriers to entry or exit

Therefore, the market supply curve will be more elastic in the ..... than in the .....

long run short run. .....

monopolistic competition

many firms different products ex: restaurants

The ... The short-run market supply curve is the horizontal summation of the all the firms' short-run supply curves (segment of firms' MC curves above AVC).

market's short-run supply curve:

Market S curve will be more or less elastic in the LR?

more

do we always want many firms

most of the time yes but not always

monopoly

one firm unique product (almost no close subsitutes)

competition gives incentives for producers to...

operate efficiently heed the views of consumers engage in wealth-creating activities

legal barriers

patents government permission

role of losses

penalty imposed on firms

price takers market= pure competition market

perfect competition take same price as other markets. perfectly competitive- many firms/ identical products.

the price-taker firm's demand curve is .... - it is horizontal at the price determined in the market

perfectly elastic

role of profits

produce goods and sell for a price that is greater than the cost of resources. reward for actions motivator/incentive

Price < ATC

profits < 0 losses existing firms reduce output and some exit market S curve shifts left Price equilibrium will rise until P=ATC

Price > ATC

profits > 0 existing firms expand output new firms will enter market S curve shifts right Price equilibrium will fall until P=ATC

decreasing-cost industry

rare/no examples

price taker

sellers who must take market price in order to sell their product. Because each price takers output is small relative to total market, price takers can sell all its output at the equilibrium price (market price) but can sell none of its output at any price higher than market price.

Because this is an increasing-cost industry, expansion in market output leads to a higher equilibrium market price. Thus, the market's long-run supply curve Slr is upward sloping.

slide 32

monoply

slope of MR= 2x Slope of demand

LR S curve for the firm

starts at minimum point on ATC curve then coincides with MC curve

Economic losses induce:

the exit of firms from the market, and, a reduction in the scale of operation of the remaining firms.

SR S curve for the market

the horizontal summation for all the firms in the market. slopes upward to the right because of law of S

LR S curve for the market

the horizontal summation of the individual S curves for the firms

Price takers have no control over .....n the market. If such a firm was to charge a price above that established by the market, consumers would simply buy elsewhere.

the price that they may charge i

In the SR, if P < ATC...

there isnt enough time to exit, may instead shut down business but keep building. This would stop operations to eliminate VC. the firm could stay open and pay fixed and variable costs or shut down and only pay fixed costs.

In the LR, if P<ATC...

there will be exit

The long-run market supply curve in an increasing-cost industry is .... This is the most common type of industry.

upward-sloping.

SR S curve for the firm

vertical axis up until P=AVC then S curve coincides with MC curve above AVC

Why do we study price takers?

we want to understand the importance of the market structure. it is competition in its purest form want to understand economic efficiency

If P < ATC but P = AVC

wouldnt make any money because in order to pay fixed costs, you would have to take money out of savings. SR is indifferent between staying open and shutting down