Perfect Competition Market Price and Profit Maximization

O Market

O Individual Firm

Profit Maximization Perfect Competition

110 129 138 144148

Quantity

110 129 138 144148

Quantity

Using Graphs Under perfect competition, the market forces of supply and demand establish the equilibrium price. The perfectly competitive firm treats this price as its demand curve and its marginal revenue (MR) because the firm will receive $15 for each and every unit it sells. Is perfect competition always a theoretical situation? Explain.

CONTENTS

The profit maximizing quantity of output is found where the marginal cost of production is equal to the marginal revenue from sales, or where MC = MR. This occurs at 144 units of output, shown in both Figure 5.6 and Panel B of Figure 7.1. Other levels of output may generate the same amount of profits, but none will generate more.

A Theoretical Situation

Few, if any, perfectly competitive markets exist, although local vegetable farming ("truck" farming) comes close to satisfying all five conditions. In these markets many sellers offer nearly identical products. Individual sellers are unable to control prices, and both buyers and sellers have reasonable knowledge of products and prices. Finally, anyone who wants to enter the business by growing tomatoes, corn, or other products can easily do so.

Careers

Market Researcher

Can you organize and evaluate data? Can you be impartial when you compile your findings?

The Work

Market researchers gather, record, and analyze facts about products and sales. Information may be gathered from company or government records, published materials, statistical files, and other sources. Researchers often print and circulate questionnaires, or survey people over the phone or door-to-door. The information is used to prepare forecasts of future sales trends, offer recommendations on product design, and define the market toward which advertising should be directed.

Qualifications

Strong analytical and writing skills and experience with computerized data are essential. Courses in marketing, statistics, English composition, speech, psychology, and economics are required.

Although perfect competition is rare, it is important because economists use it to evaluate other market structures. Imperfect competition is the name given to a market structure that lacks one or more of the conditions of perfect competition. Most firms and industries in the United States today fall into this classification, which has three categories-monopolistic competition, oligopoly, and monopoly.

Monopolistic Competition

MM Monopolistic competition is the market *JJr structure that has all the conditions of perfect competition except for identical products. By making its product a little different, the monopolistic competitor tries to attract more customers and monopolize a small portion of the market.

Product Differentiation

In contrast to perfect competition, monopolistic competition utilizes product differentiation-real or imagined differences between competing products in the same industry. Most items produced today-from the many brands of athletic footwear to personal computers-are differentiated. The differentiation may even be extended to store location, store design, manner of payment, delivery, packaging, service, and other factors.

Sometimes differences between products are real. For example, some brands of athletic footwear have special shock-absorbing soles. Others have certain construction materials to reduce weight. Some are just designed to look more appealing, or are linked to star athletes.

Nonprice Competition

Monopolistic competitors want to make consumers aware of product differences. Nonprice competition-the use of advertising, giveaways, or other promotional campaigns to convince buyers that the product is somehow better than another brand-often takes the place of price competition. Therefore, monopolistic competitors usually advertise or promote heavily to make their products seem different from everyone else's.

HC GLOBAL ECONOMY

Marketing in China

An important part of any product is its name. It must convey what the producers intend.

Potential exporters must understand cultural characteristics when considering brand management. Because the Chinese continue to favor names that convey goodness, luck, happiness, long life, prosperity or historical significance, it is sometimes difficult to translate a Western brand name into Chinese.

The Coca-Cola Company took 11 years to make a profit, in part due to an ill-advised brand name, after it came back to China in 1979. Today, Coke dominates the vast soft drink market across the Chinese continent after creating an improved name meaning "delicious, enjoyable and makes you happy."

PepsiCo, Inc., came up with "everything makes you happy" to capture market share for Pepsi. . . .

—Alcinda Hatfield, Foreign Agricultural Service, July 1999

Critical Thinking

1. Making Generalizations Why is it sometimes difficult to translate a brand name into a name acceptable to people in another country?

2. Categorizing Information What part does the brand name and labeling of a product play in product differentiation?

This explains why producers of designer jeans spend so much on advertising and promotion. If the seller can differentiate a product in the mind of the buyer, the firm may be able to raise the price above its competitors' prices.

Monopolistic Competition and Profit Maximization

Under monopolistic competition, similar products generally sell within a narrow price range. The monopolistic aspect is the seller's ability to raise the price within this narrow range. The competitive aspect is that if sellers raise or lower the price enough, customers will forget minor differences and change brands.

The profit maximization behavior of the monopolistic competitor is no different from that of other firms. The firm produces the quantity of output where its marginal cost is equal to its marginal revenue. If the firm convinces consumers that its product is better, it can charge a higher price. If it cannot convince them, the firm cannot charge as much.

The monopolistic competitor can enter the market easily. The possibility of profits draws new firms, each of which produces a product only a little different from the ones already on the market.

In time, both the number of firms in an industry and the supply of the product becomes fairly stable with no great profits or losses.

Oligopoly

Oligopoly is a market structure in which a few very large sellers dominate the industry. The product of an oligopolist may be differenti-ated-as in the auto industry, or standardized-as in the steel industry. The exact number of firms in the industry is less important than the ability of any single firm to cause a change in output, sales, and

you know?

N*

Competing in the Market On an average shopping trip, a consumer's eye lingers on a product for only

about 2.5 seconds. In order to stay competitive, companies experiment with new formulas, along with the color and size of the product's packaging. These research and development costs can range from $100,000 for adding a new color to an existing product line to millions of dollars for the creation of a new product.

prices in the industry as a whole. Because of these characteristics, oligopoly is further from perfect competition than is monopolistic competition.

In the United States, many markets are already oligopolistic, and many more are becoming so. Pepsi and Coke dominate the soft drink market. McDonald's, Burger King, and Wendy's dominate the fast-food industry. A few large corporations dominate other industries, such as the domestic airline, automobile, and long-distance telephone service industries. Oligopolists are even popping up on the Internet. The Internet bookstores discussed in the cover story-Amazon.com, Barnesandnoble.com, and Borders.com-are oligopolists in their industry.

Interdependent Behavior

Because oligopolists are so large, whenever one firm acts the other firms usually follow. For example, if one airline announces discount fares, the

Competition

Example Perfect Competition Market

Advertising Advertisers often use celebrities, such as star athletes, to increase the popularity of their products. What is the purpose of product differentiation?

other airlines generally match the lower prices in a matter of days, if not hours. Each oligopolist knows that the other firms in the industry have considerable power and influence. Therefore, firms tend to act together.

Sometimes the interdependent behavior takes the form of collusion, a formal agreement to set prices or to otherwise behave in a cooperative manner. One form of collusion is price-fixing-agreeing to charge the same or similar prices for a product. In almost every case these prices are higher than those determined under competition. The firms also might agree to divide the market so that each is guaranteed to sell a certain amount. Because collusion usually restrains trade, it is against the law.

Pricing Behavior

While an oligopolist can lower the price of its product at any time, that firm knows that other oligopolists are likely to follow suit. When one firm lowers prices it can lead to a price war, or a series of price cuts that result in unusually low prices.

The cover story describes a typical oligopolistic price war. Amazon's two competitors matched its lower prices immediately, and prices were so low that none of the firms made a profit at the sale prices. Oligopolistic price wars are usually short but intense-and almost always provide welcome price breaks for consumers.

Raising prices is also risky, unless the firm knows for certain that its rivals will follow suit. Otherwise, the firm with higher prices will lose sales to its competitors. Because of the potential threat to profits when prices go up or down, oligopolists generally prefer to compete on a nonprice basis.

Nonprice competition has the advantage of making it more difficult for rivals to respond quickly. If an oligopolist finds a new advertising gimmick or a way to enhance a product, the other firms are at a disadvantage for a period of time. After all, it takes longer to develop a better advertising campaign or a new physical attribute for a product than it does to match a price cut.

Oligopoly and Profit Maximization

The oligopolist, like any other firm, maximizes its profits when it finds the quantity of output

CONTENTS

ECO I

N OMICS

Figure 7.2

AT A

GLANCE

The Difference Market Structure Table

Using Tables The term market structure refers to the nature and degree of competition among firms operating in the same industry. Individual market structures—perfect competition, monopolistic competition, oligopoly, and monopoly—are determined by the five characteristics listed in the columns above. In which market structure does nonprice competition play a major role?

where its marginal cost is equal to its marginal revenue. Having found this level of production, the oligopolist will charge the price consistent with this level of sales.

The product's final price is likely to be higher than it would be under monopolistic competition, and much higher than it would be under perfect competition. Even when oligopolists do not collude formally, they still tend to act conservatively and seldom protest price hikes by their rivals.

Monopoly

At the opposite end of the spectrum from perfect competition is the monopoly. A monopoly is a market structure with only one seller of a particular product. This situation-like that of perfect competition-is an extreme case. In fact, the American economy has very few, if any, cases of pure monopoly-although the local telephone company or cable TV operator may come close.

Even the telephone company, however, faces competition from other communication companies, from the United States Postal Service, and from Internet providers that supply E-mail and voice-mail services. Local cable providers face competition from video rental stores, satellite cable systems, and the Internet. Consequently, when people talk about monopolies, they usually mean near monopolies.

One reason we have so few monopolies is that Americans traditionally have disliked and tried to outlaw them. Another reason is that new technologies often introduce products that compete with existing monopolies. The development of the fax machine allowed businesses to send electronic letters that compete with the United States Postal Service. Later, E-mail became even more popular than the fax.

CHAPTER 7: MARKET STRUCTURES 169

CONTENTS

Types of Monopolies

Sometimes the nature of a good or service dictates that society would be served best by a monopoly. One such case is a natural monopoly-a market situation where the costs of production are minimized by having a single firm produce the product.

Natural monopolies can provide services more cheaply as monopolies than could several competing firms. For example, two or more competing telephone companies serving the same area would be inefficient if they each needed their own telephone poles and lines. Public utility companies fall into this category because it would be wasteful to duplicate the networks of pipes and wires that distribute water, gas, and electricity throughout a city. To avoid these problems, the government often gives a public utility company a franchise, the exclusive right to do business in a certain area without competition. By accepting such franchises, the companies also accept a certain amount of government regulation.

The justification for the natural monopoly is that a larger firm can often use its personnel, equipment, and plant more efficiently. This results in economies of scale, a situation in which the average cost of production falls as the firm gets larger. When this happens, it makes sense for the firm to be as large as is necessary to lower its production costs.

Sometimes a business has a monopoly because of its location. A drugstore operating in a town that is too small to support two or more such businesses becomes a geographic monopoly, a monopoly based on the absence of other sellers in a certain geographic area. Similarly, the owner of the only gas station on a lonely interstate highway exit also has a type of geographic monopoly.

A technological monopoly is a monopoly that is based on ownership or control of a manufacturing method, process, or other scientific advance. The government may grant a patent—an exclusive right to manufacture, use, or sell any new and useful invention for a specific period. Inventions are covered for 20 years; however, the product's designs can be patented for shorter periods, after which they become public property available for the benefit of all. Art and literary works are protected through a copyright, the exclusive right of authors or artists to publish, sell, or reproduce their work for their lifetime plus 50 years.

Still another kind of monopoly is the government monopoly—a monopoly the government owns and operates. Government monopolies are found at the national, state, and local levels. In most cases they involve products or services that private industry cannot adequately provide.

Competition

Calvin And Hobbes Short Cartoon

I1' -jWv. r?> ^VL tJCHÎLO, ■ w '.rvLHViiï rj, w? 'Jp M. I El'-.h' Ï': I.V'i

ÇKiirtiV^

VL jwtt.ovfc WÉ..-I TO ï VITlr'-fî .--mii-Jir:L V.I I V

Profit Maximization

Nonprice Competition If advertisers can make you believe their product is better than others, you might pay more for it. How has nonprice competition affected your buying habits?

CONTENTS

Many towns and cities have monopolies that oversee water use. Some states control alcoholic beverages by requiring that they be sold only through state stores. The federal government controls the processing of weapons-grade uranium for military and natural security purposes.

Monopoly and Profit Maximization

Monopolies maximize profits the same way other firms do: they equate marginal cost with marginal revenue to find the profit-maximizing quantity of output. Even so, there are differences between the monopolist and other profit-maximizing firms—especially the perfect competitor.

First, the monopolist is very much larger than the perfect competitor. This is because there is only one firm—the monopolist— supplying the product, rather than thousands of smaller ones. Second, this large size, along with the lack of meaningful competition, allows the monopolist to behave as a price maker—as opposed to the perfect competitor who is a price taker.

Because there are no competing firms in the industry, there is no equilibrium price facing the

Monopoly

Images Geographic Monopolies

Geographic Monopoly

A lone general store in an isolated area enjoys a geographic monopoly. How does a geographic monopoly differ from a natural monopoly?

monopolist. Instead, the monopolist determines the price that will equate its marginal revenue with its marginal cost, and then produces the quantity of output consistent with that price. In every case, the monopolist will charge more for its product—hence the term price maker—and then limit the quantity for sale in the market.

Section 1 Assessment

Checking for Understanding

1. Main Idea Describe the four basic market structures. Explain how they differ from one another.

2. Key Terms Define laissez-faire, market structure, perfect competition, imperfect competition, monopolistic competition, product differentiation, nonprice competition, oligopoly, collusion, price-fixing, monopoly, natural monopoly, economies of scale, geographic monopoly, technological monopoly, government monopoly.

3. List the five characteristics of perfect competition.

4. Describe monopolistic competition.

5. Explain why the actions of one oligopolist affect others in the same industry.

6. Identify the types of monopolies.

Applying Economic Concepts

7. Product Differentiation Make a list of as many clothing stores in your community as possible. Describe how each store tries to differentiate itself from the others.

Criikat Thinking

8. Synthesizing Information Provide at least two examples of oligopolies in the United States today.

Practice and assess key social studies skills with the Glencoe Skillbuilder Interactive Workbook, Level 2.

CHAPTER 7: MARKET STRUCTURES 171

CONTENTS

Economics

"I Love the Challenge":

Charles Wang

"There are CEOs who brag about never having touched a PC," says Charles Wang, head of Computer Associates International. "I say to them, 'Get your head out of the sand, kid.'" Wang's aggressive approach has helped him grow his company from a four-person operation to one that earns more than $5 billion in computer software sales a year. Today, Computer Associates is the largest independent supplier of software for business computing.

A DIFFICULT START

Born in Shanghai, China, in 1944, Charles Wang and his family fled the communist regime in 1952 to settle in the United States. Wang attended Queens College in New York and then opened an American subsidiary of Swiss-owned Computer Associates in New York City in 1976. Wang began his operations with just one product.

STRATEGY FOR GROWTH

Wang believed that the best growth strategy for the fledgling company was to purchase existing software firms and market their

Economics

Profit Maximization

products. This would spare his company the risk of developing its own products and enable it to get products to market sooner. The strategy paid off. Computer Associates purchased a number of firms throughout the 1980s, and increased its sales more than tenfold, from $85 million in 1984 to $1 billion in 1989.

The recession of 1990-1991 put a damper on business, but Wang remained optimistic about the future of his company and launched a campaign to purchase even more companies. His efforts were amply rewarded, and Computer Associates soon found itself back on the fast track.

PROGRESSIVE MANAGEMENT

Despite its enormous growth, the company still remains focused on its people. Wang supplies on-site fitness facilities and child development centers for employees. He brought together 2,000 members of Computer Associates' development staff for "Nerd Weekend"-a celebration for the people who fueled Computer Associates' growth. Wang also sponsors "Technology Boot Camps" to help chief executives get over their fear and ignorance of computers. In 1994, he wrote a book urging business people to start thinking like technology people, and vice versa.

How has Wang accomplished so much? "I love it when people say it can't be done," he says. "I love the challenge."

Examining the Profile

1. Identifying Cause and Effect What business strategy helped Wang's fledgling company become successful?

2. Evaluating Information How important do you think Wang's "Nerd Weekend" and similar activities are to his company's success?

SECTION 2.

Was this article helpful?

0 0
Guide To Internet Entrepreneurship

Guide To Internet Entrepreneurship

Discover What It Really Takes To Succeed And Profit From Your Online Business And Find Out The Little Discussed Facts That People Ignore - Or Choose To Ignore - That Makes You Either An Internet Entrepreneur Or Simply, Plain Broke! The Ultimate Factors That Decide Your Internet Business Journey And Success Has LITTLER To Do With The Techniques You Use Or The Programs You Join Than You Expected!

Get My Free Ebook


Responses

  • jeanie
    How to find equilibrium price and quantity in perfect competition?
    7 years ago
  • karolin eisenberg
    How advertisers use celebrities?
    7 years ago
  • melissa goold
    How do firms in different market structures determine a profit maximizing?
    7 years ago
  • elvin
    Why charge a price higher than profit maximization?
    7 years ago
  • sini
    Why is the marginal revenue for a firm in perfect competition equal to the market price?
    7 years ago
  • trahand
    How does a perfect market maximize profits?
    7 years ago
  • paola
    Is oligopoly competition profit maximising?
    7 years ago
  • brian
    How has nonprice competition affected your buying habits?
    5 years ago
  • jouni
    Which market structure does nonprice competition play a major role?
    5 years ago
  • nuguse
    How important do you think wang's nerd weekend and similar activities are to his company's success?
    4 years ago
  • lucie
    What business strategy helped wangs fledgling company become successful?
    4 years ago
  • Ayesha
    How important do you think wangs nerd weekend and similar activities are to his company success?
    4 years ago
  • valentin
    What are the qualifications of Perfect Competition?
    2 years ago

Post a comment