Economics for managers 2nd edition farnham solutions manual

CHAPTER 7: MARKET STRUCTURE: PERFECT COMPETITION

OVERVIEW

This chapter introduces students to perfect competition, a market structure where individual firms have no market control over the product price. In the short run, firms take the market price and maximize their profits. Profits earned can be positive, negative or zero in the short-run. In the long-run, profits signal the entry of new firms and the exit of existing firms through the lack of barriers. Any profits or losses will be competed away until all firms earn equilibrium zero profits. Managers of competitive firms often attempt to gain market power by merging with other firms, differentiating their products or forming associations to increase the industry demand, as illustrated by the examples in the chapter.

OUTLINE OF TEXT MATERIAL

I. Introduction

A. There are four major forms of markets structure: perfect competition, monopolistic competition, oligopoly and monopoly.

B. Perfectly competitive firms cannot influence the price of the product while monopolies have the ability to do so due to market power.

C. Pricing strategies of managers depend on the market structure.

D. The Wall Street Journal article illustrates the deviation from perfect competition in the potato industry as potato farmers collude with one another

II. Case for Analysis: The Spud’s Not for You

A. The article discusses the emergence of the United Potato Farmers of America, a farming cooperative, which helped manage the supply of potatoes so that prices would be kept high to increase profits.

1. Like OPEC in the petroleum industry, the organization acts as a cartel.

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall

B. Traditionally, the high prices caused overproduction of potatoes that drove down prices below costs of production resulting in an unprofitable industry.

C. There is great market volatility in the fresh vegetable market due to weather and other factors.

1. In 1995, potatoes cost $8 per 100 pounds.

2. An overproduction of potatoes resulted in a lower price, between $1.50 and $2 per 100 pounds.

D. Idaho farmers face competition from around the world.

1. The demand for potatoes is heavily influenced by the demand for French fries.

2. U.S. exports of french fries doubled between 1989 and 1996 as the fastfood industry grew.

E. United Potato has successfully united farmers to curb production to take advantage of higher prices.

1. Potato production was cut by $6.8 million.

2. Revenues shot up by 48%.

F. The french fries industry’s demand may be affected by the U.S. Department of Agriculture’s substitute product made from a rice flour mixture and changing consumer preference in the future.

III. The Model of Perfect Competition

A. The assumptions of perfect competition are:

1. a large number of firms in the market;

2. an undifferentiated product;

3. ease of entry into the market or no barriers to entry; and

4. complete information available to all market participants.

Teaching Tip: Make sure the students understand that the model of perfect competition is hypothetical. The potato industry and other agricultural markets come close to perfectly competitive industries.

B. Perfectly competitive firms are price-takers.

1. Price-Taker: A characteristic of a perfectly competitive firm in which a firm cannot influence the price of its product and can therefore sell any amount of output at that price.

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall

C. Model of the Industry or Market and the Firm

1. The market demand and supply determine price of the good and the quantity producers are willing to supply.

[[Insert Figure 7.1a here]]

2. The demand curve facing an individual firm is perfectly elastic or horizontal, as it cannot influence the market price.

[[Insert Figure 7.1b here]]

3. The output produced by a competitive firm depends on the goal of the firm, profit maximization.

(a) Profit Maximization: The assumed goal of firms, which is to develop strategies to earn the largest amount of profits possible. This can be accomplished by focusing on either revenues or costs or both factors.

(b) Equation 7.1: = TR-TC

where = Profit

TR= Total Revenue

TC=Total Cost

(c) Profit Maximization Rule: To maximize profits, a firm should produce the level of output where marginal revenue equals marginal cost.

(d) Equation 7.2: Produce the level of output where MR=MC

where MR= Marginal Revenue= (∆TR/∆Q)

where MC= Marginal Cost= = (∆TC/∆Q)

4. The marginal revenue equals the price and the demand curve is horizontal only for a perfectly competitive firm. The reason is that it is a price-taker and does not need to lower the price to sell more units of the output.

Teaching Tip: Students find it more intuitive to learn the profit maximization rule not just with numbers but with a graph as well. In order to do so, it may be a good idea to review how to calculate the marginal revenue and marginal cost and what they represent to the firm.

5. If MR=MC, then the firm produces the optimal output level, Q*. At this level of output, profits can be positive, negative or zero.

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall

6. An alternative method of calculating profit is the per-unit profit, (P-ATC), multiplied by the quantity, Q.

Teaching Tip: It may also be a good idea to teach the profit area on the graph, determined by (P-ATC)*Q or TR-TC so that students can see if a firm is making positive, negative or zero profits.

7. Even if the firm is producing the output where MR=MC, it should stop producing and shut down if the price is below AVC, or it cannot cover its variable cost.

(a) Shut-Down Point: The price, which just equals the firm’s average variable cost, below which it is more profitable for the perfectly competitive firm to shut down than to continue to produce it.

Teaching Tip: This is a good place to review fixed and variable inputs to the firm. Make sure that the students understand that the firm incurs the fixed costs of production such as a rental fee for the plant facility regardless of the output produced. If the firm cannot pay out the variable costs such as wages from its revenue, then it is not profitable and decides to shut down.

8. The supply curve for the perfectly competitive firm is the portion of the marginal cost curve that lies above the minimum average variable cost.

[[Insert Figure 7.2 here]]

9. The supply curve for the perfectly competitive industry or market is upward sloping.

D. The Short Run in Perfect Competition

1. The firm cannot change the scale of operation in the short run since at least one input is fixed.

2. Firms cannot enter or exit the industry in the short run.

3. Where P=MR=MC, the firm can be earning positive, negative or zero profits. If the price is below the average variable cost, the firm shuts down.

E. Long-Run Adjustment in Perfect Competition: Entry and Exit

1. Entry and exit by new and existing firms and changes in the scale of operation by all firms can occur in the long run.

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall

Teaching Tip: It is a common mistake for the students to confuse the terminology, “shut down” and “exit.” Make sure you make the distinction between the decisions of a competitive firm in the short run versus the long run.

2. Equilibrium Point: The point where price equals average total cost since the firm earns zero economic profit.

3. An increase in the market demand raises the profits earned by all firms through an increase in the price.

4. As there are no barriers, the positive profits signal new firms to enter the market. Entry of new firms increases the market supply to the right.

5. Entry continues until all firms are once again earning zero profits and the market is in long-run equilibrium.

[[Insert Figure 7.3a and 7.3b here]]

Teaching Tip: This is a good place to review the determinants of market demand and supply.

F. Adjustment in the Potato Industry

1. The long-run adjustment process applies to the potato industry.

[[Insert Figure 7.4a and 7.4b here]]

2. The high price of $8 per 100-pound sack and profits earned by individual farmers are shown in point A.

3. In response to the prices and profits, farmers planted more potatoes in 1996. The favorable weather and insect conditions helped increase the supply and driving down the price to $2 per 100-pound sack.

4. The new price was below the average total cost for many farmers, leaving them with significant debt.

G. Long-Run Adjustment in Perfect Competition: The Optimal Scale of Production

1. Entry and exit in a perfectly competitive industry result in the zero-profit equilibrium (P=ATC).

2. Positive profits signal new firms to enter while negative profits signal firms to exit the industry.

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall

3. The long-run average cost curve (LRAC) incorporates both economies of scale and diseconomies of scale for the firm.

[[Insert Figure 7.5 here]]

(a) Economies of Scale: Achieving lower unit costs of production by adopting a larger scale of production, represented by the downward sloping portion of a LRAC.

(b) Diseconomies of Scale: Achieving higher unit costs of production by adopting a larger scale of production, represented by the upward sloping portion of a LRAC.

4. The two types of adjustments that are made to reach equilibrium (P=LRAC) in the long run are:

(a) the choice of the scale of operation, and

(b) entry by firms that lowers product price and competes away any positive economic profits.

IV. Other Illustrations of Competitive Markets

A. Farming is one of the best examples of a perfectly competitive industry.

B. A perfectly competitive industry is unconcentrated and each firm does not have any market power.

1. Industry Concentration: A measure of how firms produce the total output of an industry. The more concentrated the industry, the fewer the firms operating in that industry.

C. Competition and The Agricultural Industry

1. There are still 2 million farms in the United States today.

2. Large scale farms dominate the market due to economies of scale.

3. The demand for most farm crops is highly inelastic. This means that a decrease in price decreases the total revenues for producers, resulting in the “farm problem” that industrialized countries face.

4. Governments have implemented farm price support programs to control production. However, these have caused imbalances in demand and supply.

D. Competition and the Broiler Chicken Industry

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall

1. The broiler chicken industry was traditionally unconcentrated and produced a relatively undifferentiated product. This has been changing.

2. Most of the increase in industry concentration resulted from mergers.

3. Real and subjective product differentiation exit among the different broiler processors. One such example is skin color.

4. Competition depends on the market channel used and the extent of valueadded processing involved.

5. Broiler processing has the lowest price-cost margin (PCM) in the industry.

(a) Price-Cost Margin (PCM): The relationship between price and costs for an industry, calculated by subtracting total payroll and the cost of the materials from the value of shipments and then dividing the results by the value of shipments. The approach ignores taxes, corporate overhead, advertising, marketing, research, and interest expenses.

E. Competition and the Red-Meat Industry

1. Managers in the red-meat packing industry have also turned to changing an undifferentiated product into a brand name.

2. Branding represents a major shift in an industry that traditionally labeled its low-end products such as Spam.

3. This shift has resulted from a declining demand for red-meat consumption in the United States.

F. Competition and the Milk Industry

1. The “Got milk?” and milk mustache campaigns were strategies to increase industry demand for milk.

2. The change in lifestyles and consumer tastes has led to increased strategies for product differentiation in a highly competitive industry.

3. To appeal to the large Asian market, a New Zealand producer has experienced with new flavors.

4. New Developments include the industry’s “3-A-day” campaign for increased daily consumption of milk.

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall

G. Competition and the Trucking Industry

1. There are more than 150,000 companies in the truckload segment of the industry.

2. The changing forces of demand and supply alter the profitability of trucking companies.

3. Higher costs, adverse weather and an overall slowing in the economy in the last quarter of 2000 led to numerous companies that went out of business.

4. The rising costs of labor, fuel and equipment plus the subprime mortgage crisis in recent years have decreased demand.

V. Appendix 7A: Industry Supply

A. Elasticity of Supply

1. The shape of the industry supply curve illustrates the elasticity of supply within that industry.

(a) A supply elasticity greater than 1 indicates an elastic supply while a supply elasticity less than 1 indicates an inelastic supply.

(b) A perfectly inelastic supply curve is vertical supply curve while a perfectly elastic supply curve is a horizontal supply curve.

B. Agricultural Supply Elasticity

1. The supply curves of various agricultural products are illustrated by an Sshaped curve.

[[Insert Figure 7.A.1 here]]

2. Supply elasticity is lower for major crops grown in areas where there are few alternatives for the use of land.

3. The aggregate supply relationship for all farm output in most countries is very price inelastic in the short run.

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall

Another random document with no related content on Scribd:

The Project Gutenberg eBook of Regényirók

This ebook is for the use of anyone anywhere in the United States and most other parts of the world at no cost and with almost no restrictions whatsoever. You may copy it, give it away or re-use it under the terms of the Project Gutenberg License included with this ebook or online at www.gutenberg.org. If you are not located in the United States, you will have to check the laws of the country where you are located before using this eBook.

Title: Regényirók Tanulmányok

Author: Géza Voinovich

Release date: December 14, 2023 [eBook #72409]

Language: Hungarian

Original publication: Budapest: Franklin-Társulat, 1921

Credits: Albert László from page images generously made available by the Hungarian Electronic Library