Perfect competition - Also include Interpretation of the long-run supply curve (perfect competition) How does this relate to supply and demand? - Rachel Kay
October 6 Let's start by defining "perfect competition." There are five conditions that must be met for a market to be perfectly competitive: 1. There is a large number of buyers and sellers in the market. 2. Each firm produces an the identical product. 3. Buyers and sellers have perfect information, that is prices and quality of the product are assumed to be known by all consumers and producers. 4. There are no transaction costs - buyers and sellers are free to move about the market. 5. There is free entry in and exit from the market.
The basic assumption of a perfectly competitive market is that all things are equal - milk is milk, eggs are eggs, beef is beef, carrots are carrots, etc. Other examples of perfectly competitive markets include fish, produce, computer software, cotton and lumber. Can you think of any others?
Another major point of perfect competition is that, because the number buyers and sellers is so large, no single buyer or seller can influence the market. If Firm A tries to charge a higher price for eggs to earn profit, consumers will know the product is not different and go to another firm to buy eggs at market price. Firm A will lose sales and drop their price back to market price to stay competitive.
October 22
In studying the topic of perfect competition and knowing that agriculture is the closest industry we have to this market type, I studied up on the corn industry, specifically. I chose corn because market prices have risen significantly in the last 6 years with technology and focus on ethanol as an althernative fuel. I discovered there has been another more recent move affecting the corn industry - Congress' approval last week of free trade agreements with Columbia, Panama and South Korea. The corn industry is thrilled, to say the least. They have been losing market share in these regions for the last four years. The US is the world's largest producer of corn, but tariffs have kept some markets unattainable for US corn growers. They now believe they can gain significant ground and increase their exporation of corn to these countries with the implementation of these free trade agreements. The National Corn Growers Association estimates the free trade agreements with these three countries will lead to an additional $2.3 billion in farm exports and support almost 20,000 american jobs.
November 29
So, I'm a little behind on posts!
An important aspect of perfect competition is the long-run supply curve. In a perfectly competitive market, market price (P) is where the market supply curve and market demand curve intersect. Individual firms can sell as much as they want at P, so the firm's demand is perfectly elastic (a horizontal line).
Now suppose an innovation in technology allows firms to lower costs, but they do not lower P. Now their average total costs (ATC) are below P and firms earn profits. There are no barriers to entry in a perfectly competitive market, so profits now induce other firms to enter the market. This increases market supply, pushing the supply curve to the right and driving down the market price until it once again hits the ATC. Entry stops when there are no more profits to be had and P = ATC. Firms just break even.
December 1
Again, with agriculture being the closest example of perfectly competitive markets, I found a few examples in agriculture of how supply is adjusting to demand.
For corn, the rise in gas prices has had a positive influence on their industry. Higher gas prices have lead to searches for alternative fuels, including corn-based ethanol. Growing populations have also increased the demand for corn directly and as feed for livestock. All of this is pushing farmers to look for heartier breeds of corn with higher yields and to consider growing corn-on-corn acres. Soil quality has generally lead corn farmers to annually rotate between corn and soybean production, but market prices are leading more to try to produce corn year after year instead of switching back to soybeans. In economic terms, the market demand curve has shifted right. This has caused firms' (farmers) price/demand curve to shift up, leading them to look for ways to supply more.
Another product, lamb, has seen a significant increase in demand since early 2010. The surge is credited to new Hispanic and Muslim immigrants, who prefer lamb, and decreased competition from Australia and New Zealand, who have experienced cuts in government funding. Sheep farmers in Indiana are investing in new barns and equipment so that they can increase their flocks. Hormone treatments are also being considered so that ewes can give birth in October, instead of the normal late winter/early spring, to meet year round demand. Besides lamb meat, the article notes wool prices have also risen to the point where they actually cover the cost of shearing the sheep (variable cost). I would draw conclusion from this article that there are economies of scope to lamb meat and wool, and that the fixed costs of producing wool, but not the variable costs, have been covered by the production of lamb meat. The article did not elaborate as to whether sheep farmers had previously sheered their sheep at a loss, or if this was a new product for existing farmers since their variable costs would now be covered.
December 3 Another industry considered near perfect competition is gasoline. Gasoline is a basic product that is available to the masses and each retailer sells an identical product. On a wholesale level, there may be a limited number of firms who drill for oil and convert oil to gasoline. On a retail level, there is a large number of buyers and sellers in the market. The prices of gasoline are widely known (large, brightly lit signs along the roadway). A 2009 article in Economic Inquiry studied the effects of gasoline tax increases on various markets. Consistent with perfectly competitive markets, the researchers found that gasoline tax hikes are fully shifted to the consumer almost instantly, though gasoline prices have a more asymmetrical response to wholesale price increases. The article also found that highly urbanized (and very competitive) states, retailers with a stored inventory may hold down retail prices to gain market share.
December 6
In researching on the Department of Justice website, I stumbled upon a letter to the DoJ arguing that the real estate industry is a model of competition, written by a Ms. Anne-Marie Schiering in October 2005. Now, looking back, we can realize that this was written at the height of the real estate boom that came crashing down almost three years later. But to her point, it was, and I believe largely still is, a highly competitive industry. A few of her points:
- low barriers to entry. Perhaps the barriers are too low, as she points out. The basic needs to enter the market are passing a real estate licensing exam and studying the local housing market. In 2005, the number of real estate licenses in California climbed 14%. Again, looking back, it seemed that everyone wanted a piece of the golden housing-market pie, and the low barriers to entry allowed many to take part.
- buyers and sellers have near perfect information. The internet has been instrumental in allowing buyers to assess the market before they even step onto a property. They gain knowledge on prices, marketing alternatives and agency options.
- little transaction costs. For someone selling a property, their transaction costs are minimal. It's up to the agent they choose to sink money and time into marketing to get the house sold. A seller can negotiate lower commissions to that agent, or pull out of the relationship altogether in a short time period.
Ms. Schiering's arguments, statistics and personal point of view that the real estate market is a highly competitive industry were convincing. Who was she convincing? She was pleading her case to the Antitrust Division of the Department of Justice. Due to the boom in the industry, politicians were considering legislation to regulate real estate agents and the contracts they sign with house sellers. Legislators wanted to implement minimum-service policies that would require a seller to purchase a minimum number of services from an agent (a price floor). The industry was concerned that legislation would limit consumer choice and lead to higher brokerage fees. To date, the DoJ has not found any evidence of harm to consumers in their traditional relationships with real estate agents that would justify the need for such laws.
Questions:
1. Which of the following is a characteristic of perfect competition?
a. There are barriers to entry.
b. Firms produce differentiated products.
c. There are few firms in the market.
d. Buyers and sellers have perfect information.
2. What would happen if an individual firm in a perfectly competitive market raised its price above market price?
a. It would sell nothing.
b. Other firms would also raise their prices.
c. Consumers would think the firm's product is better.
d. New firms would enter to take up the profit the firm is making.
3. Which of the following is false about marginal revenue?
a. It is the change in revenue attibutable to the last unit of output.
b. It is the vertical distance between the cost function and the revenue line.
c. It is the slope of the revenue curve.
d. For a competitive firm, it is the market price.
4. In the short run, a firm should decide to shut down when:
a. it cannot cover its fixed costs.
b. when price is below the average total cost curve.
c. when price is below the average variable cost curve.
d. marginal cost equals marginal revenue.
5. In the long run, perfectly competitive firms:
a. earn zero accounting profits.
b. produce where price = marginal revenue = marginal cost.
c. produce a socially inefficient level of output.
d. do not cover their opportunity costs.
Answers:
1. d Buyers and sellers have perfect information is a characteristic of perfect competition.
2. a The firm would sell nothing because they can purchase an identical product from another firm for market price.
3. b The vertical distance between the cost function and the revenue line is profit.
4. c Firms should shut down when the variable cost to produce a unit is less than the price it will receive for that unit.
5. b Price is the same as the marginal revenue curve, and firms produce where marginal revenue equals marginal cost.
Company Green case study by James Casteel. Company Green is an auto manufacturer trying to determine if it should increase its mass production to penetrate the hybrid and all-electric vehicle market. The risks involve sunk costs and penetration pricing to induce brand loyal customers away from companies like Toyota. The hybrid and all-electric markets are niche markets and car owners who currently have a hybrid or all-electric will likely stick with their current make when it is time to get a new one. To even be a consideration, Company Green would need to invest heavily in production to compete with suggested retail prices. Their quality is superior to competitors, but that is also reflected in the slightly higher price tag. Increasing their supply and sales would help lower retail prices. In the long run, this superior quality, along with heavy marketing, could keep the company afloat until it is able to penetrate the market for regular sales volume.
Market diversity by James Crews. This case study discusses early forms of “money” which started as bartering in China. The trend eventually shifted to backing “money” with gold and silver to maintain its value, but in modern day, government regulation and law dictates the value of money. The different types of markets (monopoly, oligopoly and perfect competition) are also discussed and how the allocation of resources within markets can also determine prices. The last half of the case study described an article written in 1945 about how World War II POW camps became their own all-encompassing miniature markets, illustrating all of the basic economic concepts. Since there was no currency, prisoners used the supplies they were allocated to barter and trade with one another. New shipments (supply) increased market prices while lengthy waits in between shipments lowered prices and lead prisoners to retain their goods in hopes of higher market prices later.
Increasing profits by changing price by Collin Hornbaker. This case study begins by defining many key economic terms, such as profit, profit maximization, monopolies and perfect competition. The most interesting part of the case was two specific examples towards the end. One example looked at an existing cancer drug used to treat colon cancer that was approved to treat lung and breast cancer. As the drug became available to new patients, those new patient saw a 50% increase in the price. It seems that the drug manufacturer saw a larger market (expanded consumer base) and adjusted their profit-maximizing price and quantity accordingly. The author noted a clear business decision, but grey area in the ethical and human perspective. The other example looked at Netflix and the decision to separate the online and DVD delivery services and increase the prices of each by nearly 50%. Netflix lost significant market share, but their revenue and net income rose anyway with the higher prices.
When to acquire a company by Katherine Ittenbach. The case study begins by analyzing the failed merger between AOL and Time Warner and the proposed viability of a merger between Time Warner and Fox News. Basic terms like Herfindahl-Hirschman Index and the Four-Firm Concentration Ration are reviewed, as well as some simple items to consider when looking to acquire or merge companies. The real world analysis of the proposed merger between AT&T and T-Mobile from March 2011 was a spot-on example of mergers. There are only four major carriers in the wireless communications market, and the merger of two of them has analysts calling it a “textbook case” of anti-trust law. Both the Department of Justice and the Federal Communications Commission have filed lawsuits to stop the merger as a violation of anti-trust laws. One analysis of the HHI put the index nationwide at 3,100 if the merger were to go through, with the Obama administration citing 2,500 as a concentrated industry. AT&T defends the merger, claiming it will lead to faster 4G networks, increased innovation and more jobs. The DoJ and FCC claim it will lead to higher price, less consumer choices and lower quality products.
Different pricing scenarios and maximizing profits by Cody Muhlenkamp. This blog reviews two models the author found on pricing strategy – one involving a pricing pyramid and the other a pricing checklist. One of the more interesting points was to make sure your pricing matches up with the value you are offering, which is a basic concept that could easily get overlooked. You also need to make customers aware of what you have to offer. Customers have more information than ever, so it is difficult and very risky to misguide customers. Price integrity is also very important as fluctuating prices lead to mistrust. Pricing is an easy way to create brand loyalty. The example used for pricing was a study on college tuition. The article cites providing value for your price, perceived affordability and using financial aid money wisely to get as many potential students as possible.
- Rachel Kay
October 6
Let's start by defining "perfect competition." There are five conditions that must be met for a market to be perfectly competitive:
1. There is a large number of buyers and sellers in the market.
2. Each firm produces an the identical product.
3. Buyers and sellers have perfect information, that is prices and quality of the product are assumed to be known by all consumers and producers.
4. There are no transaction costs - buyers and sellers are free to move about the market.
5. There is free entry in and exit from the market.
The basic assumption of a perfectly competitive market is that all things are equal - milk is milk, eggs are eggs, beef is beef, carrots are carrots, etc. Other examples of perfectly competitive markets include fish, produce, computer software, cotton and lumber. Can you think of any others?
Another major point of perfect competition is that, because the number buyers and sellers is so large, no single buyer or seller can influence the market. If Firm A tries to charge a higher price for eggs to earn profit, consumers will know the product is not different and go to another firm to buy eggs at market price. Firm A will lose sales and drop their price back to market price to stay competitive.
References:
Baye, M. R.(2010). Managerial economics and business strategy (pp. 265-266). New York: McGraw-Hill Irwin.
http://en.wikipedia.org/wiki/Perfect_competition
October 15
This is a cool video, yet a very simple and straight forward way of explaining perfect competition. Enjoy!
http://www.youtube.com/watch?v=61GCogalzVc
October 22
In studying the topic of perfect competition and knowing that agriculture is the closest industry we have to this market type, I studied up on the corn industry, specifically. I chose corn because market prices have risen significantly in the last 6 years with technology and focus on ethanol as an althernative fuel. I discovered there has been another more recent move affecting the corn industry - Congress' approval last week of free trade agreements with Columbia, Panama and South Korea. The corn industry is thrilled, to say the least. They have been losing market share in these regions for the last four years. The US is the world's largest producer of corn, but tariffs have kept some markets unattainable for US corn growers. They now believe they can gain significant ground and increase their exporation of corn to these countries with the implementation of these free trade agreements. The National Corn Growers Association estimates the free trade agreements with these three countries will lead to an additional $2.3 billion in farm exports and support almost 20,000 american jobs.
CBS News article on the free trade agreements:
http://www.cbsnews.com/stories/2011/10/12/national/main20119615.shtml
National Corn Growers Association:
http://www.ncga.com/
Nebraska Corn Board:
http://www.nebraskacorn.org/news-releases/trade-agreements-offer-opportunities-for-nebraska-u-s-agriculture/
South Dakota Corn Council:
http://www.sdcorn.org/page/News/sub/News_Releases/shownews/story/id/340
November 29
So, I'm a little behind on posts!
An important aspect of perfect competition is the long-run supply curve. In a perfectly competitive market, market price (P) is where the market supply curve and market demand curve intersect. Individual firms can sell as much as they want at P, so the firm's demand is perfectly elastic (a horizontal line).
Now suppose an innovation in technology allows firms to lower costs, but they do not lower P. Now their average total costs (ATC) are below P and firms earn profits. There are no barriers to entry in a perfectly competitive market, so profits now induce other firms to enter the market. This increases market supply, pushing the supply curve to the right and driving down the market price until it once again hits the ATC. Entry stops when there are no more profits to be had and P = ATC. Firms just break even.
December 1
Again, with agriculture being the closest example of perfectly competitive markets, I found a few examples in agriculture of how supply is adjusting to demand.
For corn, the rise in gas prices has had a positive influence on their industry. Higher gas prices have lead to searches for alternative fuels, including corn-based ethanol. Growing populations have also increased the demand for corn directly and as feed for livestock. All of this is pushing farmers to look for heartier breeds of corn with higher yields and to consider growing corn-on-corn acres. Soil quality has generally lead corn farmers to annually rotate between corn and soybean production, but market prices are leading more to try to produce corn year after year instead of switching back to soybeans. In economic terms, the market demand curve has shifted right. This has caused firms' (farmers) price/demand curve to shift up, leading them to look for ways to supply more.
Another product, lamb, has seen a significant increase in demand since early 2010. The surge is credited to new Hispanic and Muslim immigrants, who prefer lamb, and decreased competition from Australia and New Zealand, who have experienced cuts in government funding. Sheep farmers in Indiana are investing in new barns and equipment so that they can increase their flocks. Hormone treatments are also being considered so that ewes can give birth in October, instead of the normal late winter/early spring, to meet year round demand. Besides lamb meat, the article notes wool prices have also risen to the point where they actually cover the cost of shearing the sheep (variable cost). I would draw conclusion from this article that there are economies of scope to lamb meat and wool, and that the fixed costs of producing wool, but not the variable costs, have been covered by the production of lamb meat. The article did not elaborate as to whether sheep farmers had previously sheered their sheep at a loss, or if this was a new product for existing farmers since their variable costs would now be covered.
Lamb article on Indystar.com:
topnews|text|IndyStar.com
December 3
Another industry considered near perfect competition is gasoline. Gasoline is a basic product that is available to the masses and each retailer sells an identical product. On a wholesale level, there may be a limited number of firms who drill for oil and convert oil to gasoline. On a retail level, there is a large number of buyers and sellers in the market. The prices of gasoline are widely known (large, brightly lit signs along the roadway). A 2009 article in Economic Inquiry studied the effects of gasoline tax increases on various markets. Consistent with perfectly competitive markets, the researchers found that gasoline tax hikes are fully shifted to the consumer almost instantly, though gasoline prices have a more asymmetrical response to wholesale price increases. The article also found that highly urbanized (and very competitive) states, retailers with a stored inventory may hold down retail prices to gain market share.
http://ejscontent.ebsco.com/ContentServer.aspx?target=http%3A%2F%2Fonlinelibrary%2Ewiley%2Ecom%2Fresolve%2Fdoi%2Fpdf%3FDOI%3D10%2E1111%2Fj%2E1465%2D7295%2E2008%2E00164%2Ex
December 6
In researching on the Department of Justice website, I stumbled upon a letter to the DoJ arguing that the real estate industry is a model of competition, written by a Ms. Anne-Marie Schiering in October 2005. Now, looking back, we can realize that this was written at the height of the real estate boom that came crashing down almost three years later. But to her point, it was, and I believe largely still is, a highly competitive industry. A few of her points:
- low barriers to entry. Perhaps the barriers are too low, as she points out. The basic needs to enter the market are passing a real estate licensing exam and studying the local housing market. In 2005, the number of real estate licenses in California climbed 14%. Again, looking back, it seemed that everyone wanted a piece of the golden housing-market pie, and the low barriers to entry allowed many to take part.
- buyers and sellers have near perfect information. The internet has been instrumental in allowing buyers to assess the market before they even step onto a property. They gain knowledge on prices, marketing alternatives and agency options.
- little transaction costs. For someone selling a property, their transaction costs are minimal. It's up to the agent they choose to sink money and time into marketing to get the house sold. A seller can negotiate lower commissions to that agent, or pull out of the relationship altogether in a short time period.
Ms. Schiering's arguments, statistics and personal point of view that the real estate market is a highly competitive industry were convincing. Who was she convincing? She was pleading her case to the Antitrust Division of the Department of Justice. Due to the boom in the industry, politicians were considering legislation to regulate real estate agents and the contracts they sign with house sellers. Legislators wanted to implement minimum-service policies that would require a seller to purchase a minimum number of services from an agent (a price floor). The industry was concerned that legislation would limit consumer choice and lead to higher brokerage fees. To date, the DoJ has not found any evidence of harm to consumers in their traditional relationships with real estate agents that would justify the need for such laws.
Real Estate Workshop Public Comment by Ms. Anne-Marie Schiering:
http://www.justice.gov/atr/public/workshops/rewcom/213144.htm
Competition in the Real Estate Marketplace website:
http://www.ftc.gov/bc/realestate/index.htm
Questions:
1. Which of the following is a characteristic of perfect competition?
a. There are barriers to entry.
b. Firms produce differentiated products.
c. There are few firms in the market.
d. Buyers and sellers have perfect information.
2. What would happen if an individual firm in a perfectly competitive market raised its price above market price?
a. It would sell nothing.
b. Other firms would also raise their prices.
c. Consumers would think the firm's product is better.
d. New firms would enter to take up the profit the firm is making.
3. Which of the following is false about marginal revenue?
a. It is the change in revenue attibutable to the last unit of output.
b. It is the vertical distance between the cost function and the revenue line.
c. It is the slope of the revenue curve.
d. For a competitive firm, it is the market price.
4. In the short run, a firm should decide to shut down when:
a. it cannot cover its fixed costs.
b. when price is below the average total cost curve.
c. when price is below the average variable cost curve.
d. marginal cost equals marginal revenue.
5. In the long run, perfectly competitive firms:
a. earn zero accounting profits.
b. produce where price = marginal revenue = marginal cost.
c. produce a socially inefficient level of output.
d. do not cover their opportunity costs.
Answers:
1. d Buyers and sellers have perfect information is a characteristic of perfect competition.
2. a The firm would sell nothing because they can purchase an identical product from another firm for market price.
3. b The vertical distance between the cost function and the revenue line is profit.
4. c Firms should shut down when the variable cost to produce a unit is less than the price it will receive for that unit.
5. b Price is the same as the marginal revenue curve, and firms produce where marginal revenue equals marginal cost.
Bibliography
Alm, J., Sennoga, E., Skidmore, M. “Perfect Competition, Urbanization, and Tax Incidence in the Retail Gasoline Market.” Economic Inquiry, August 21, 2008, Volume 47, Issue 1.
Associated Press. cbsnews.com, October 2011. Online: http://www.cbsnews.com/stories/2011/10/12/national/main20119615.shtml
Baye, M. R. Managerial Economics and Business Strategy (pp. 265-266). New York: McGraw-Hill Irwin, 2010.http://en.wikipedia.org/wiki/Perfect_competition
Federal Trade Commission. Competition in the Real Estate Marketplace. Online: http://www.ftc.gov/bc/realestate/index.htm
mjmfoodie. You Tube, August 2009. Online: http://www.youtube.com/watch?v=61GCogalzVc
National Corn Growers Association: http://www.ncga.com/Nebraska Corn Board: http://www.nebraskacorn.org/news-releases/trade-agreements-offer-opportunities-for-nebraska-u-s-agriculture/
Schiering, A. Real Estate Workshop Public Comments, October 24, 2005. Online: http://www.justice.gov/atr/public/workshops/rewcom/213144.htm
South Dakota Corn Council: http://www.sdcorn.org/page/News/sub/News_Releases/shownews/story/id/340
Swiatek, J. “Favorable market for lamb has farmers flocking to sheep.” Indianapolis Star, November 2011. Online: http://www.indystar.com/article/20111113/BUSINESS/311130001/Favorable-market-lamb-has-farmers-flocking-sheep?odyssey=tab
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