Unit 4, Lesson 10

Competition

AOFBusiness Economics

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Economics looks at characteristics and outcomes when considering competitive markets

Characteristics• Large number of buyers and sellers• Products are alike • Low or no barriers to entry

Outcomes• Firms and consumers are “price

takers” (the market sets prices)• Zero profits, after allowing for the

opportunity cost of capital• Consumers get low prices • Economically efficient (low price,

better suppliers gain market share)

What economic forces are at work here?

Similar products and lots of choices

Many firms competing

There’s no economic profit in a perfectly competitive market

If a firm begins to make profit (total revenue > total cost) providing a product or service, competitors soon enter to take a piece of the pie

Competition lowers the price until it just covers the costs (opportunity cost of capital included)

With “no profit,” how can firms continue to exist?

More competitors means lower profits for each firm

There are advantages to a highly competitive market

• It’s efficient: Society’s resources are used well to produce the products customers want

• Firms have to operate at the lowest possible per-unit cost

• Consumers get the lowest possible price

Who benefits more from a competitive market: consumers or producers?

There are disadvantages to a highly competitive market

• No profit means no money for research and development

• Doesn’t consider social costs and benefits (only “private” costs are considered)• Smoke from packing

facility pollutes the air• Pretty avocado trees

benefit neighbors

Research goes down while pollution goes up

Is this a good tradeoff for lower prices?

Monopolies share certain attributes

Characteristics• Single seller (high barriers to entry) • A unique product with no close

substitutes• Price maker

Outcomes• Monopoly maximizes profits by

limiting production and setting prices well above the cost of production

• New firms cannot enter to increase supply and decrease costs

• Inefficient use of resources

What are possible barriers to entry?

Monopolies have some advantages to the consumer

• Monopoly profits provide discretionary funds, above the cost of production and the opportunity cost of capital. These can be used to pay for research and development

• Under some circumstances, monopolies are more economically efficient than alternatives:

High fixed costs + low marginal costs =

Extreme economies of scale

Who benefits more from a monopoly: producers or consumers?

• Price generally higher, and quantity lower, than with competition:• Less produced than in a

competitive market• Price can be substantially higher

than the per-unit cost of production

• Often economically inefficient:• Consumers willing and able to

pay more than the full cost of production can’t do so

• Firms willing to produce at a lower price can’t do so

Monopolies also have disadvantages

Why does a monopoly have limited incentives to produce more?

Prices are often higher in a monopolistic market than they

would be in a competitive market

• Patents grant firms an exclusive right to a new product, technology or process, for a period of time

• Monopoly profits provide an incentive to invest in research and development (R&D)

Patents create monopolies

How is illegal downloading of songs like a patent infringement?

The longer the patent right, the greater the incentive for research and development

Are monopolies good or bad?

Good

• Incentivizes companies to engage in R&D and helps them pay for it

• Patents reward the entrepreneurial innovation in new products and technology

Are the economic costs of creating a monopoly worth the benefits of R&D?

Bad• Monopolies often mean

higher prices, and fewer goods produced, than with competition

• The supplier gains, but consumers pay high prices

• Barriers to entry lead to inefficiencies

Markets are constantly shifting

• New products are invented, which make old ones obsolete

• Government regulations change the playing field

• Consumer needs and tastes change

• The cost of resources rises or falls

The business economist must understand local and global economic

shifts

Markets change for many reasons, including: