207
Chapter 22 (9 Micro)
Price Takers and the Competitive Process
OUTLINE
I. Price Takers and Price Searchers
A. Price Takers
1. Price Takers produce identical products and each seller is small relative to the
market.
B. Price Searchers
1. Price Searchers face a downward-sloping demand curve for their product.
C. Why Study Price Takers?
2. Model helps us understand the relationship between individual firms and market
supply.
3. Increases our knowledge of competition as a dynamic process
II. What are the Characteristics of Price-Taker Markets?
A. Conditions for a Market of Price Takers
2. A large number of firms are in the market.
4. No barriers to entry or exit exist.
B.
1. A price-taker firm will face a perfectly elastic demand for its product.
III. How Does the Price Taker Maximize Profit?
A. Marginal Revenue
1. Marginal Revenue is the change in total revenue divided the change in output.
B. Profit Maximization
1. In the short run, the price taker will expand output until marginal revenue (price) is
just equal to marginal cost.
a.
b. If price > marginal cost increase output.
c. If price < marginal cost decrease output.
C. Losses and Going Out of Business
1. A firm experiencing losses, but covering its average variable costs, will operate in
the short run.
3. A firm will shut down in the long run whenever price falls below average total
cost.
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IV. -Run Supply Curve
A. A firm maximizes profits when it produces at P = MC and variable costs are covered.
B. short-run supply curve is its marginal cost curve above average variable cost.
V. The Short-Run Market Supply Curve
A. The short- -run supply
curves.
VI. Price and Output Adjustments in Price Taker Markets
A. Economic Profits and Entry
1. If price exceeds average total cost, firms will earn an economic profit.
3. As market supply increases, price will fall to average total cost.
4. Thus, in long-run equilibrium, firms earn zero economic profit.
B. Economic Losses and Exit
1. If average total cost exceeds price, firms will suffer an economic loss.
3. As market supply decreases, price will rise to average total cost.
4. Thus, in long-run equilibrium, firms earn zero economic profit.
C. Long-Run Equilibrium
D. Long-Run Supply
1. Constant-Cost Industry: Industry where factor prices remain unchanged as market
output is expanded.
2. Increasing-Cost Industry: Industry where factor prices rise as market output is
expanded.
a. The long-run market supply curve is upward sloping.
3. Decreasing-Cost Industry: Industry where factor prices decline as market output is
expanded.
a. The long-run market supply curve is downward sloping.
b. Rare type of industry.
E. Supply Elasticity and Role of Time
2. In the long run, firms can alter the size of their plants and other fixed resources.
3. In the long run, the market supply curve will be more elastic than in the short run.
VII. Role of Profits and Losses
A. Profits and Losses
1. Firms earn an economic profit by producing goods that can be sold for more than
3. Losses are a penalty imposed on firms that reduce the value of resources.
VIII. Competition Promotes Prosperity
A. Competitive Process
1. The competitive process provides a strong incentive for producers to operate
efficiently and heed the views of consumers.
2. Competition and the market process harness self-interest and use it to direct
producers to wealth-creating activities.
OBJECTIVES
The next three chapters analyze the decision making of the firm under alternative industrial
structures. In this chapter the price-taker model is developed and utilized to explain how competitive
market forces respond to changing conditions. The following chapter analyzes decision making for
price searchers with low barriers to entry. Chapter 24 focuses on price takers with high barriers to
entry.
Even though conditions necessary for sellers to be literally price takers are seldom realized in
the real world, the price-taker model is highly significant. By understanding the workings of a world
of price takers, students can understand more fully the role of prices and economic incentives under
varying market conditions. This chapter should help the student better understand market forces
even in cases when some of the price-taker conditions are absent.
This chapter also analyzes the mechanics of profit maximization. While this material is not
very exciting, it is, nonetheless, important. Unless students understand the mechanics of profit
maximization, they will never fully appreciate the interaction between market forces and firm
decision making.
IMPORTANT POINTS AND TEACHING SUGGESTIONS
1. Be sure to point out that the word competition is not without ambiguity. Both laymen and
economists may use the term to describe any situation involving rivalry among producers. In
2. Use the price taker model to explain how the pricing mechanism adjusts to changing market
conditions. Explain what happens when a long-run market equilibrium is disrupted by such
3. Remember that two conditions are necessary for long-run competitive (price searcher)
equilibrium. First current supply and demand must be in balance. Second, producers must be
4. Fixed factors have alternative uses. The opportunity cost of utilizing a factor that is fixed in the
5. Since it includes both long-run and short-run supply curves, Exhibit 8 may be slightly
S1. At market price P2, the firms are earning economic profit. This attractive opportunity will
induce established firms to expand their plant capacity and new firms to enter the industry.
6. In the long run, in a price-taker industry, the market price of a product will be dependent upon
per unit costs. Therefore, the long-run supply curve will slope upward to the right only if
7.
8. Students often have difficulty understanding the mechanics of profit maximization. Exhibits 3
9. The ability of competition to align the self-interest of individuals with economic efficiency
should be discussed. Many instructors will want to recall the views of Adam Smith on this
topic. For example, Smith wrote in The Wealth of Nations:
a.
universally established but in consequence of that free and universal competition which
Chapter 22 (9 Micro)/Price Takers and the Competitive Process 211
10. Critical Analysis question 1 tests student understanding of an important concept. Note that for
price takers, a reduction in factor prices will not increase the long-run profitability of the firms
in an industry. Would government subsidies increase the long-run profitability in an industry,
for example, farming? Interestingly, the answer is no.
11. Problem solving will help the student understand the mechanics of profit maximization. The
12. It is crucial to communicate to students that the price taker model works well at the industry
level (supply and demand implications) because there are large numbers of people searching
to make all the mutually beneficial trades possible. It is this search that drives real world results
toward the implications of the competitive model. This is true even though at the firm level the
model is descriptively and analytically inaccurate in some ways (e.g., how many nonfarmers
can sell all they want at a given price without incurring added selling costs but have no power
over price or other terms of trade?).
14. It is worthwhile to note to students how important market institutions are for understanding
real world market behavior. Organizes exchanges, which are designed to standardize all aspects
15. It is worth emphasizing that predicting the actual adjustment path in a particular market in
response to a particular change is far more difficult than the stylized results of our standard
16. It is important to emphasize that firms are in fact profit seekers, not profit maximizers, in a
world of uncertainty. In a world of certainty (i.e., the standard models), these reduce to the
17. Games 1 to 2 will help reinforce the material in Chapter 22.
212 Chapter 22 (9 Micro)/Price Takers and the Competitive Process
GAMES
1. Think of a Firm
Type: In-Class assignment
Topics: market structure
Textbook: Chapter 21 Price Takers and the Competitive Process
Chapter 22 Price-Searcher Markets with Low Entry Barriers
Chapter 23 Price-Searcher Markets with High Entry Barriers
Materials Needed: none
Time: 15 minutes
Class limitations: works in any size class
Purpose
This assignment helps students relate the concept of market structure to the real world.
Instructions
Ask the class to answer the following questions. After they have answered all of them ask the
students to share their answers with a neighbor. Ask the neighboring student to evaluate the
answer to the last question. List the four market structures on the board and ask for examples that
fit each category
1. Write the name of a specific firm. It should be a real company, not hypothetical.
2. What product or service does this firm sell? If the firm sells a wide variety of goods, choose a
3. What other firms compete with this company? Are there many competitors, only a few, or
none?
4. Do the competing firms sell exactly the same product or does each company produce goods
with special characteristics?
5. Categorize the industry as one of the following market structures
a. Price Takers
– many firms
– identical products
b. Monopoly
2. A Profitable Opportunity?
Type : In-Class assignment
Topics: profit maximization
Textbook: Chapter 21 Price Takers and the Competitive Process
Materials Needed: none
Time: 15 minutes
Class limitations: works in any size class
Purpose
This exercise reinforces the importance of marginal cost in decision-making. It shows average
costs can be misleading.
Instructions
t graduate of this college you have landed a job in production
Quantity Average Total Cost
500 200
501 201
Your current level of production is 500 units. All 500 units have been ordered by your regular
customers.
would have to increase production to 501 units. Your new customer offers you $450 to produce
a. Should you accept this offer?
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Common answers and points for discussion
cost of production
is $201 seems like good business. They are wrong.
The relevant comparison is marginal cost to marginal revenue. Marginal cost can be easily
HINTS FOR ANSWERING CRITICAL ANALYSIS
1. In a highly competitive industry such as agriculture, lower resource prices might improve the
3. False. They must not only produce efficiently, they must also identify those areas where current
4. -run market