CHAPTER 7

MARKET STRUCTURES

Pretending you were the owner of the company on your sheet of paper…1) How much competition do you have (how many

other companies/people sell the same or at least a similar product)?

2) Can you advertise to try to attract customers to your product? (in other words, is it possible to differentiate your product from the competition?)

3) How difficult would it be to start a business such as this? (Are there substantial start-up costs or relatively few start-up costs?)

4) Do you have the ability to charge a higher price than your competitors or do you need to charge exactly the same price as the competition?

5) Do you think you are able to make large profits or would they be modest?

Hampton Shaler Water Authority and the NFL

Competition?Advertise?Difficulty to start?Price…Large profits possible?

Coca-Cola Competition?Advertise?Difficulty to start?Price…Large profits possible?

Burger KingCompetition?Advertise?Difficulty to start?Price…Large profits possible?

Cover Girl makeupCompetition?Advertise?Difficulty to start?Price…Large profits possible?

A farmer who sells his oranges to juice companiesCompetition?Advertise?Difficulty to start?Price…Large profits possible?

Let’s get some things straight…Price does NOT equal cost!

Price is what is charged for a good (what a producer RECEIVES by selling it).

Cost is what is takes him to produce the good.

Revenue = money IN Total revenue = price of product x quantity sold

Cost = money OUT Total cost = cost of product x quantity sold

Therefore, profit = revenue – cost (i.e., what is leftover!)

PRODUCTION COSTS

Variable costs - costs that rise or fall depending on quantity produced Raw materials, wages of workers, utilities

Fixed cost – cost that does not change, no matter how much of a good is produced Rent, property taxes, salaries of workers

Total cost – fixed costs + variable costs Marginal cost – additional cost of

producing one more unit

LABOR AND OUTPUT

Basic question of any business: How many workers should we hire???

Consider: relationship between # workers and how much they produce

LABOR AND OUTPUT

Marginal product of labor – change in output from hiring one more worker

Increasing marginal returns – adding another worker increases total output at an increasing rate Benefits from specialization for the first few workers Ex: did adding your 2nd worker more than double your

output? Diminishing marginal returns – when adding more

workers increases total output, but at a decreasing rate Workers must work with a limited amount of capital You only had one stapler, one ruler, and one pair of scissors

Negative marginal returns (diminishing returns) – when adding more workers actually decreases total output

SETTING OUTPUT

Always set output at marginal revenue = marginal cost !!!

Marginal revenue – additional income from selling one more unit of a good (Same as PRICE)

If marginal revenue (what they take IN) is still greater than marginal cost (what they pay OUT), then that additional unit sold will add more to their profit!

THE SHUTDOWN DECISION

Sometimes price is so low that factory’s revenue is lower than its cost Should they continue to produce??

Firms should operate at a loss if the revenue from the goods it produces is greater than the cost of keeping it open (variable costs)They can at least cover some of their fixed costs If they shut down, they still have to pay all fixed

costs!

Perfect Competition

7.1: The first type of competitor we are going to talk about! (Probably the hardest one for you to understand, so it’s all down hill from here!!!)

Four conditions for Perfect CompetitionMany buyers and sellers participate in the

marketSellers offer identical productsBuyers and sellers are well informed about

productsSellers are able to enter and exit the

market freely

1. Many buyers and sellersNo individual buyer or seller can influence the

total market quantity or the market priceSupply and demand determines price without

any influence from individual suppliers or consumers

Sellers MUST charge this price or they will sell NONE of their product

What if ONE orange farmer (out of thousands in our country) decided to charge a slightly more expensive price for his oranges?

2. Identical Products All suppliers offer the same product or

serviceThere are no differences – consumers can’t

tell the differenceThere is no way to differentiate Commodity – a product that is considered

the same regardless of who makes or sells itlow-grade gasoline, notebook paper, milka buyer will not pay extra for one particular

company’s goods but will always choose the supplier with the lowest price

3. Informed buyers and sellersBuyers and sellers know enough about the

market to find the best deal they can getYou have full information about the

product and its price

4. Free market entry and exitWhat are barriers to entry?

How expensive or difficult it is to get into a certain business or to get out of it

Start-up costs – the expenses that a new business must pay before the 1st product reaches the customerHigh start-up costs or technological know-how keep many

entrepreneurs from entering a marketEx: less expensive to start up a sandwich shop than a giant

supermarket

In perfect competition…Firms can very easily enter a market when they can

make moneyFirms can very easily exit a market when they can’t

earn enough to stay in business

Price and OutputSo why do we care and why are we starting

with perfect competition?Because of all of the competing sellers:

Perfectly competitive markets are the most efficientCompetition keeps prices and production costs lowFirms have no choice but to use land, labor,

organizational skills, machinery, and equipment to their best advantage

Prices that consumers pay are very close to what it cost to produce the good prices are the lowest possibleprices just cover the most efficient sellers’ costs of doing

business

To summarize, in a perfectly competitive market…How many sellers?____________________ (a

lot / a few / one) Can sellers differentiate their product? Entry and exit is _________________ (easy /

difficult). Therefore, barriers to entry are ___________ (low / high).

Prices are kept _________________ (low / high). Therefore, they are said to be _________________ (efficient / inefficient).