Kinh tế học - Chapter 5: Competition and market power

Chapter 5Competition and Market PowerMcGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.Learning ObjectivesDefine perfect competition, and identify its key characteristics.Describe how businesses maximize profits in perfectly competitive markets.Discuss the long-term outcome of perfect competition.Compare and contrast the four types of market structure.Explain how market power affects price and quantity supplied.5-2The Role of CompetitionCompetition plays a key role in a market economy.Companies are forced to deliver to the product that consumers want at the lowest cost.Competition in the market leads to more production, more innovation, lower costs, and higher living standards.5-3Perfect CompetitionThe highest degree of competition is found in a perfectly competitive market.This is an extreme type of market structure rarely found in the real world.In perfect competition, all buyers and sellers are price takers.In this case, buyers and sellers do not set the price of their product, but take the price as given.Prices are determined by the market.5-4Conditions Necessary for Perfect CompetitionFor a market to be perfectly competitive, the following conditions must hold:First, products have to be standardized or homogenous so there is little difference between them.Second, sellers and buyers must be well-informed about what all the other sellers are charging. 5-5Conditions Necessary for Perfect CompetitionThird, a market with perfect competition will have many sellers and many buyers.No buyer or seller is large enough to have an impact on the price. In national or global markets, buyers and sellers are in different parts of the country or the world.5-6Examples of Perfect CompetitionMost markets do not meet all three of the conditions necessary for perfect competition.But today’s economy is moving more toward perfect competition as more markets become global.Agricultural markets are the best examples of perfect competition.There are many buyers and sellers, products are standardized, and no buyer or seller can set the price. 5-7Profit Maximization in Perfect CompetitionRemember, profit maximization occurs at the output level, where marginal revenue (MR) equals marginal cost (MC).In perfect competition, the marginal revenue received from selling one more unit of output is simply equal to the price (P).So in perfect competition the firm will produce at the point where price equals marginal cost.Profit maximization occurs at P = MC.5-8Profit Maximization for a Computer MakerAssuming a firm can sell its computer for $500, the firm will maximize profits by producing 4,000 computers. At this output level, P=MC. Output (Number of Computers)Marginal Cost (Dollars)Marginal Revenue (Dollars)1,000$200$5002,000$300$5003,000$400$5004,000$500$5005,000$600$5005-9Profit Maximization by a Single Business in a Competitive Market 010020030040050060070001,0002,0003,0004,0005,0006,000Output (number of computers)Price (dollars)Marginal cost curve(also individual supplycurve)Market priceProfit-maximizingoutput A5-10Market Supply with Ten Identical Businesses0100200300400500600700010,00020,00030,00040,00050,00060,000Output (number of computers)Price (dollars)Market supply curve(with ten identical businesses)Market priceProfit-maximizingoutput A5-11Market Equilibrium in Perfect CompetitionIn perfect competition, the price is set in the market.This table shows market demand and supply for computers. At a price of $500, quantity demanded equals quantity supplied.Price (Dollars)Quantity Demanded by All Buyers(Number of Computers)Quantity Supplied by All Sellers(Number of Computers)20070,00010,00030060,00020,00040050,00030,00050040,00040,00060030,00050,0005-12Graphing Market Equilibrium0100200300400500600700020,00040,00060,00080,000Output (number of computers)Price (dollars)Market supply curve(with ten identical businesses)Market priceA5-13Perfect Competition in the Long RunIn perfect competition, the existence of profits attracts competition as new firms enter the market.In some industries, barriers to entry make it difficult for firms to enter a market.Barriers to entry include government regulation, availability of land, capital investment required, etc. 5-14Perfect Competition in theLong RunBarriers to entry are insignificant in perfectly competitive markets.Thus, in a market with perfect competition and no barriers to entry, profits will trend toward zero in the long run.This is because new firms enter the industry, causing the supply curve to shift to the right and the market price to fall.5-15New Entrants Drive Down the Market Price5-16Consequence of No Barriers to EntryIf there are no barriers to entry, only the low cost producers survive in the long run.The low cost providers will drive down the price to the point at which the high cost producers will not be able to make a profit.These firms will then simply leave the industry (the shutdown decision), since costs exceed revenues.This trend to low cost producers is evident in such industries as retail, apparel, and furniture.5-17Escaping Perfect CompetitionBusinesses try to avoid the extreme competition evident in perfectly competitive markets.To do this, businesses try to differentiate their product from rivals.This gives firms some power over price.Firms differentiate through product design and advertising.Advertising enables a firm to establish a brand name.5-18Market StructureEconomists classify markets into different types, or market structures.Classification depends on:the intensity of competition in the markets.the number of buyers and sellers.whether the product is similar or differentiated.5-19Market StructureThere are four market structures in the economy:Perfect competitionMonopolistic competitionOligopolyMonopoly5-20Monopolistic CompetitionMonopolistic competition is characterized by a large number of sellers with similar but not standardized products. Monopolistic competition is the most common market structure in today’s economy.Restaurants and gasoline stations are good examples.Monopolistic competitive firms are not price-takers and the firms face a downward-sloping demand curve.5-21Profit Maximization with Monopolistic CompetitionIn the case of perfect competition, the profit maximization rule is that price equals marginal cost (MC).In this case, price is equal to marginal revenue (MR) since the business can sell as much as it likes at the market price.In monopolistic competition, MR is below price.The reason MR is below price is that the business must cut the price to everyone to sell another unit. 5-22Profit Maximization with Monopolistic CompetitionThe business gains more revenue from new sales, but loses on products it is already selling.A monopolistic competitive firm maximizes product at the output level where marginal revenue equals marginal cost (MR = MC).In the long run, monopolistic competition starts looking more and more like perfect competition as more businesses enter the market. 5-23MR, MC, and Profit Maximization for Car DealerCars Sold per DayPrice per Car (Dollars)Total Revenue (Dollars)Marginal Revenue (Dollars)Marginal Cost (Dollars)130,00030,00030,00024,000229,00058,00028,00025,000328,00084,00026,00026,000427,000108,00024,00027,000526,000130,00022,00028,0005-24OligopolyAn oligopoly occurs when there are a small number of sellers (usually 4 or less) in a market producing similar products.This is a common market structure in manufacturing and amongst airlines.Oligopolists can compete very intensely.In this case, the market looks very much like perfect competition, with prices under downward pressure and profits very low. 5-25OligopolyBut oligopolistic firms may engage in illegal collusion, working together to keep the price of their product high.Oligopolistic firms often engage in implicit collusion, where they do not communicate directly about price. In this case, one company (the market leader) sets the price.There is a tendency for parties in a collusive arrangement to cheat on the deal.5-26MonopolyA monopoly is a market where there is only one seller, and buyers have no good alternatives.Monopoly is the extreme opposite of perfect competition.A monopolist can push up price due to its control over a market.But to do so, it must restrict output.Why? Because of the law of demand:Higher prices result in lower quantity demanded. 5-27MonopolyThe extent to which a monopolist can raise price depends on the elasticity of demand.If demand is very inelastic, the monopolist has the ability to substantially raise price above the competitive level.But if demand is elastic, the pricing power of the monopolist is limited as consumers will cut purchases in response to higher prices.A natural monopoly is an industry in which it makes economic sense to have only one supplier.Monopolies in recent years have been undermined by globalization and technology.5-28Benefits of Perfect CompetitionPerfect competition is viewed to be the most beneficial market structure because:Businesses produce products consumers want to purchase.Businesses produce products at their lowest cost.Since businesses are price takers, they will automatically increase their output when price exceeds marginal cost.5-29Downside of Market PowerMonopoly, monopolistic competition, and oligopoly are all sellers with some degree of market power. Market power is the ability to raise prices above the level that perfect competition would produce.Thus, firms with market power will produce less and charge a higher price than a perfectly competitive firm.This leads to higher profits for the firm with market power.5-30Market Power and Perfect Competition5-31