Chapter 9 Price Takers and the Competitive Process

Chapter 9 Price Takers and the Competitive Process 1

Overview n n n The difference between a price taker and a price searcher The characteristics of price takers Marginal revenue The profit maximizing rule Profits and losses Long-Run equilibrium 2

Price Takers: The sellers who must take the market price in order to sell their product Ex. Wheat farmers, cattle ranchers 3

Price Searchers: firms that choose the price they charge for their product, but the quantity they are able to sell is inversely related to price Ex. Nike, Sony, Nintendo 4

Characteristics of Price Taker Markets 1. There a large number of firms in the market 5

Characteristics of Price Taker Markets 2. Each firm produces identical products 6

Characteristics of Price Taker Markets 3. Their output is small relative to the total market 7

Characteristics of Price Taker Markets 4. They are able to sell all of their output at the market price 8

Characteristics of Price Taker Markets 5. There are no barriers to entry or exit of firms in the market Barriers to Entry: Obstacles that limit the freedom of potential rivals to enter and compete in an industry or market Ex. Excessive licensing and regulations 9

Graphing Price Taker Markets The market forces of supply and demand determine price. Price takers have no control over this price, so the demand for the product of the firm is perfectly elastic 10

Graphing Price Taker Markets Price takers will be unable to sell any goods at a higher price Price takers have no incentive to lower price 11

Marginal Revenue (MR): The change in total revenue derived from the sale of one additional unit of a product For a price taker: Marginal Revenue (MR) = Price (P) 12

Maximizing Profits To maximize profits, a firm should increase output until marginal revenue is equal to marginal cost. Profit maximizing rule: MR = MC *Note: n A firm should produce when MR > MC n A firm should never produce when MC > MR 13

Maximizing Profits Graphically, firms should produce where the marginal cost curve intersects the marginal revenue curve. MR = MC 14

Profits and Losses 1. If MR = MC occurs above the ATC curve then the firm is making an economic profit 2. If MR = MC occurs below the ATC curve then the firm is making an economic loss 15

Remaining Open in the Short-Run A firm making losses will remain open in the short run if: 1. 2. It can cover its variable costs now Expects price to be high enough in the future to cover all of its costs Otherwise, it will shut down. 16

Entry and Exit in the Long-Run 1. 2. If firms are making an economic profit: New firms will enter and drive price down If firms are making an economic loss: Firms will leave the market and drive price up 17

Long-run Equilibrium Long-run equilibrium will occur when all firms in the industry are making zero economic profit 18

The Role of Profits and Losses Why economists love competition: 1. 2. 3. Keeps costs and prices low Firms have the incentive to be efficient and innovative Good firms stay, bad firms leave! 19

Why economists love Walmart! 20

Review 1. Know the difference between a price taker and a price searcher. 2. Know the characteristics of a price taker 3. Know what marginal revenue is and how to maximize profits 4. Be able to graphically analyze what quantity a firm should produce, whether they are making profits and losses, and whether or not they should remain open in the short run 21

Review 5. Know when firms will enter and exit the market and how long-run equilibrium is maintained. 22