[Music]
In recent years, the demand for healthier
food has increased.
Many people have begun buying organically
grown fruits and vegetables at farmers' markets.
Lured by higher profits, increasing numbers
of farmers began participating in these markets.
But the additional supply of produce has forced
down prices and reduced profits.
Many farmers have found that the profits they
earn from selling in farmers' markets are
no longer higher than what they earn by selling
to supermarkets.
A perfectly competitive market meets the conditions
of (1) many buyers and sellers, (2) all firms
selling identical products, and (3) no barriers
to new firms entering the market.
Firms in perfectly competitive market are
unable to affect the prices of the goods they
sell and are unable earn economic profits
in the long run.
[Music]
The way we chose our products.
In the
beginning were just the typical things
that I was going for the family.
Tomatoes,
beans, zucchini and I would watch what
was walking around the market and I
would think that would be a good thing
to ask.
We start everything from seed
generally I would choose four or five
different varieties in the beginning and
if something wasn't selling very much
when I would eliminate that I wanted to
provide fresh produce in salad greens to
the local community.
When I started the
first things I planted were spinach
lettuce and different types of greens.
I wanted to be in that market of providing
basically salad greens.
We do a lot of
beets but we also grow over 40 different
crops in a given year.
We have taken
persimmons, garlic, mushrooms that it was
two weeks ago a couple came and bought
persimmons and they weren't that
familiar with them, and this last week
they brought us back a couple pieces
of person and pie!
I grew chilies myself
of my little health garden in town.
Chilies and tomatoes anything you have
like in a normal house garden but it
really like chillies a lot so that was what I
wanted to have more of than anything
else and then I started to get seeds
from various places friends who travel
during me seeds back and I started to
get more and more unusual varieties and
then they started swap and cheese with
growers in other countries number one I
did not want to be spending my days
picking 100 feet long rows of green
beans just didn't inspire me flowers
inspired me aesthetically but they also
can make the most per square foot on a
farm if they're well grown and then well
marketed so for having a small farm I
wanted to it
to be profitable enough that it also
most of all appealed to me aesthetically
we price our products probably by
several means one will go and look at
what the products are selling for in
local grocery stores and also local food
co-ops we also take walk through the
market to see what other farmers are
selling at we try to get the best price
for the product that we offer I actually
some learnings get up and go ask a
vendor what are you selling this for
today our expenses are higher per item
being a small farm many of the customers
at mark at the farmers market understand
this our food is also higher in
nutrients because we fed our soil
they're getting more nutrients per
dollar even if they're getting less
weight per dollar in the beginning of
the season when there's not very much
say zucchini in the market the price is
a little higher time has a lot to do
with it too like okra takes forever to
pick but you can generally charge a
little bit more for it my prices i would
say are more intuitive than scientific
like this is how much it cost you to
produce this and the labor to produce it
so this is how much I have to charge I'm
not that scientific it's intuitive but I
think it's pretty close it's also very
expensive to run this farm our flower
bouquets are generally the most
expensive at any market I believe
they're worth it I think my customers
believe that too I pay my people well
and it's working if it wasn't working
I'd be forced to price lower and absorb
it that it is working we rarely come
home from the market with anything left.
[Music]
Farmer's Market produce is the ultimate example
of a perfectly competitive marketplace.
By definition these markets support the produce
that grows locally, so the crops could be
grown by the buyers but either they do not
have the land and time to grow it themselves,
they do not plan ahead, or they would rather
exchange their money for the green products
sold grown by others.
As you listened to the sellers commenting
about their strategies in the farmer's markets,
you listened to how they deal with being price
takers.
In perfectly competitive markets, sellers
take the floating price and only get variation
because of service they add on.
Through the next three chapters in class,
we will explore Perfectly competitive markets,
monopolistically competitive markets, and
Monopolies and Oligopolies.
The last two appear as different chapters
in the textbook, but we will combine them
together for discussions here.
These market structures are easily recognizable,
when you come loaded with the ability to recognize
them.
As consumers, we enter retail clothing stores
without looking for monopolistically competitive
retailers, but when you view them with this
moniker you will understand their pricing
and advertising strategies.
You may start to look to your mobile phone
provider with different market control understanding
to discover how and when you will use aggressive
negotiation techniques to get the best deal
possible.
We start with the perfectly competitive markets
to consider how you can make bulk volume purchases
to reduce their cost of sales and capture
savings for the goods you buy.
[Music]
Prices in perfectly competitive markets are
determined by the intersection of market demand
and supply curves.
Consumers and firms must accept the market
price if they want to buy and sell in a competitive
market.
A price taker is a buyer or seller that is
unable to affect the market price.
Each buyer and seller in a perfectly competitive
market is too small to affect the market price.
A firm in a perfectly competitive market is
selling exactly the same product as many other
firms.
This is the gallon of milk, the dozen eggs,
or a bushel of wheat.
Therefore, the seller can sell as much as
it wants at the current market price, but
it cannot sell anything at all if it raises
the price even by 1 cent.
As a result, the demand curve for a perfectly
competitive firm's output is a horizontal
line.
Whether the wheat farmer sells 6,000 bushels
per year or 15,000 bushels this has no effect
on the market price of $7.
The producer is a price taker.
In a perfectly competitive market, price is
determined by the intersection of market demand
and market supply.
In the left side panel, the demand and supply
curves for wheat intersect at a price of $7
per bushel.
An individual wheat farmer like Farmer Parker
cannot affect the market price for wheat.
Therefore, as the right side panel shows,
the demand curve for Farmer Parker's wheat
is a horizontal line.
To understand this figure, it is important
to notice that the scales on the horizontal
axes in the two panels are very different.
In the left side panel, the equilibrium quantity
of wheat is 2.25 billion bushels, and in the
right side panel, Farmer Parker is producing
only 15,000 bushels of wheat.
[Music]
It is reasonable to assume that the objective
of a producer is to maximize profit, which
is equal to total revenue minus total cost.
To maximize profit, a firm must produce that
quantity of output where the difference between
total revenue (TR) and total cost (TC) is
as large as possible.
Since producers have no control over price,
it puts them in position to become the low-cost
producer.
Reduce your costs and you increase your profits.
Right away you gain a perfect understanding
of why farmers are so well known for building
their large family farms with three generations
all participating in the growing and harvest
together to drive trucks, operate harvesters,
record output, and make the family farm operation
efficient.
It is more economically efficient to pay family
members to work the farm then to bring on
others.
A firm's average revenue (AR) is equal to
total revenue divided by the quantity of the
product sold.
Average revenue is also equal to the market price.
Marginal revenue (MR) is the change in total
revenue from selling one more unit of a product.
For a firm in a perfectly competitive market,
price is equal to both average revenue and
marginal revenue.
We start here to really develop the principles
of cost accounting to consider how price is
both your average revenue and your marginal
revenue.
It means that when you sum your total revenue
and divide it by the number of goods you sold,
you get the price per unit.
This is only true in perfect competition.
Price does not change because you as a producer
cannot affect price.
You do not own enough of the total market
to make an impact on it.
Marginal revenue is the value you receive
from selling the last unit, or the next unit
of your produce.
Since it does not change in the perfectly
competitive marketplace, Marginal Revenue
is your price, is your average revenue.
You might be thinking that if price does not
change, then the best way to make more money
is to make more product!
Sure, grow more apples, make your wheat heads
bigger, engineer garlic heads with more cloves!
Right away you realize that anything you do
to increase your genetic production will cost
money.
As that marginal cost column climbs with increasing
production levels, your ultimate profit decreases.
Seek the profit-maximizing level of output.
When combining Total Revenue and Total Cost,
the sweet spot is where these come together
for maximum profit.
When I show you these simplified tables of
only 10 rows the solution appears obvious.
In reality you will be looking at dozens,
or even hundreds of quantities of production
scattered across many fields as you seek financially
optimal production levels.
The mathematical clincher is to find where
Marginal Revenue is as close as possible to
Marginal Cost.
I say, as close as possible, because sometimes
you cannot produce parts of a good, like half
a beef steer, or half an egg - you need to
be all in, or all out.
Right here we sit on a critical part of this
discussion to look closely at marginal cost.
I want you to give close attention to how
that column of numbers is calculated.
It is the change in cost when producing the
next unit of output.
It is moving from producing 3 units to 4 units.
Three cost $18.50 and 4 cost $21.00, the difference
is $2.50 and THAT is your marginal cost of
producing that one additional unit of the
good.
Repeat it for the entire column, a super-fast
calculation in Excel, and you have a powerful
decision making tool at your disposal.
We will use that one again on a graph just
two screen ahead.
These cost curves of total revenue and total
cost are really fairly realistic as we see
low production at 1 bushel shows costs higher
than revenue.
And after 10 bushels, marginal costs are greater
than marginal benefits so again the producer
is out of profitability range.
It is the area between these two lines showing
a constant climb in marginal revenue with
a variable cost curve indicating that sought
after zone where profitability is maximized.
Farmer Arnzen maximizes his profit where the
vertical distance between total revenue and
total cost is the largest, which occurs at
an output of 7 bushels.
I said we would come back to Marginal Revenue
from Table 12.2 and here we are.
I took that schedule and graphed it.
Remember how marginal cost went from $4 at
1 unit and dropped to $2.50, then to $2.00
between 3 and 4 units.
Marginal cost started a climb after that.
Minimizing marginal cost is not really where
optimality is found, this is the case where
you need to spend more to make more.
Farmer Arnzen?s marginal revenue (MR) is equal
to a constant $7 per bushel.
Farmer Arnzen maximizes profit by producing
wheat up to the point where the marginal revenue
of the last bushel produced is equal to its
marginal cost, or MR = MC.
In this case, at no level of output does marginal
revenue exactly equal to its marginal cost.
The closest Farmer Arnzen can come is to produce
7 bushels of wheat.
He will not want to continue to produce once
marginal cost is greater than marginal revenue
because that would reduce his profits.
Both the previous graph and this graph show
alternative ways of thinking about how Farmer
Arnzen can determine the profit-maximizing
quantity of wheat to produce.
They give the same answer, and always will.
The marginal revenue curve for a perfectly
competitive firm is the same as its demand
curve.
As long as marginal revenue is greater than
marginal cost, the firm's profits are increasing,
and it will expand production.
When marginal revenue is equal to marginal
cost, the firm will make no additional profit
by increasing production, so it will have
maximized its profits.
The profit-maximizing level of output is also
where the difference between total revenue
and total cost is greatest.
Because price is equal to marginal revenue
for a perfectly competitive firm, price equals
marginal cost at the profit-maximizing level of output.
[Music]
Profit is expressed in terms of average total
cost (ATC).
Doing this will allow us to show profit on
a cost curve graph.
Because profit equals TR minus TC, and TR
is price multiplied by quantity:
Profit = (P x Q) - TC.
If we divide both sides of this equation by
Q, we have:
Profit divided by quantity, equals price time
quantity divided by quantity minus total cost
divided by quantity.
Or profit divided by quantity equals price
minus average total cost.
This equation tells us that profit per unit
equals price minus average total cost.
We obtain the expression for the relationship
between total profit and average total cost
by multiplying through by Q:
Profit = (P - ATC) x Q.
This confirms that a firm's total profit is
equal to the quantity produced multiplied
by the difference between price and average
total cost.
Graphically we bring them together right here.
This is a figure you will revisit often in
microeconomics as it shows basic concepts
into the meaning of operational efficiency,
and profits.
Start with our perfectly elastic horizontal
demand curve equal to our marginal revenue
curve.
Put up the marginal cost curve we just looked
into.
Next our average total cost curve arcs in.
A firm maximizes profit at the level of output
at which marginal revenue equals marginal
cost.
The difference between price and average total
cost equals profit per unit of output.
Total profit equals profit per unit multiplied
by the number of units produced.
Total profit is represented by the area of
the green-shaded rectangle, which has a height
equal to (P - ATC) and a width equal to Q.
Boom!
You have just found where profit is maximized,
it was where marginal cost equaled marginal
revenue and when you did that you found the
quantity to produce, and even the profitability
made by producing right here!
Some folks who should know better will trip
up by assuming production should happen where
marginal cost equals average total cost.
Your marginal cost is less than your marginal
revenue at this level of production so you
are leaving money on the table by not producing
up to the profit maximizing level.
It is not always possible to operate in a
profitable level of production.
It might be caused by short term market problems,
unanticipated supply price shocks, or new
competition with super-low production costs.
You want to stay in business, maybe to sustain
market share, so you seek the level of output
where your loss is as small as possible.
I faced this situation in 1997 when I was
selling timber products in the Asian market,
mainly to Japan and South Korea.
The 1997 Asian financial crisis threatened
all regional economies with economic meltdown.
Timber log buyers lowered their prices as
few were able to remain in business.
We felt the crisis would recover within the
year and we were prepared to stay in operation
because shutdown and restart options carried
high costs we did not want to bear.
I sought the loss-minimizing level of output
where marginal cost equaled marginal revenue.
We were able to capture and maintain market
share in the West Cost Japan delivered log
market.
Now, we can take a look at how this is seen.
Here we can see where marginal revenue equals
marginal cost, the point I am looking for!
But, price also equals average total cost,
and the firm breaks even because its total
revenue will be equal to its total cost.
In this situation, the firm makes zero economic
profit.
But, it is not loosing money either.
Now see how price is below average total cost,
and the firm experiences a loss.
The loss is represented by the area of the
red-shaded rectangle, which has a height equal
to (ATC - P) and a width equal to Q.
Do you see how the decision to produce where
marginal revenue equals marginal cost is satisfied?
It is the place to find your quantity of optimal
production.
It happened even though your average total
cost is higher than marginal revenue.
Profits are negative, but they are as small
a negative number as could be achieved.
This is where my logging operation was in
late 1997 and early 1998.
We reduced production by setting aside certain
areas, building transportation infrastructure,
and streamlining log sorting and handling
operations.
We also negotiated long-term price agreements
with buyers so our market share would substantiate
the losses we experienced.
When the markets began recoverery in 1998
we were able to float the competitive market
prices upwards into profitable operations.
Whether a firm makes a profit depends on the
relationship of price to average total cost.
There are three possibilities: (1) P > ATC,
which means the firm makes a profit;
(2) P = ATC, which means the firm breaks even; and
(3) P < ATC, which means the firm experiences losses.
[Music]
In the short run, a firm suffering losses
has only two choices: (1) Continue to produce
or (2) stop production by shutting down temporarily.
During a temporary shutdown, a firm must still
pay its fixed costs.
If by producing the firm would lose an amount
greater than its fixed costs, it should shut
down.
In analyzing the firm's decision to shut down,
we assume that its fixed costs are sunk costs.
A sunk cost is a cost that has already been
paid and cannot be recovered.
The firm should treat its sunk costs as irrelevant
to its decision making.
One option the firm does not have is to raise
its price.
If a perfectly competitive firm raises its
price, it would lose all its customers and
sales would drop to zero.
If the price the firm can charge drops below
average variable cost, the firm will still
have a smaller loss if it shuts down and produces
no output.
So, the firm's marginal cost curve is its
supply curve for prices at or above average
variable cost.
Because the marginal cost curve intersects
the average variable cost curve where the
average cost curve is at its minimum point,
the firm's supply curve is its marginal cost
curve above the minimum point of the average
variable cost curve.
The shutdown point is the minimum point on
a firm's average variable cost curve; if the
price falls below this point, the firm shuts
down production in the short run.
Because price equals marginal revenue for
a firm in a perfectly competitive market,
the firm will produce where P = MC.
For any given price, we can determine the
quantity of output the firm will supply from
the marginal cost curve, so the marginal cost
curve is the firm's supply curve.
But the firm will shut down if the price falls
below average variable cost.
This is the critical decision point to face.
The marginal cost curve crosses the average
variable cost at the firm's shutdown point
at the output level QSD.
For prices below PMIN, the supply curve is
a vertical line, perfectly inelastic, along
the price axis, which shows that the firm
will supply zero output at those prices.
The red line is the firm's short-run supply curve.
I bring your attention back to the idea of
the marginal cost curve for one producer.
Of course, every producer has a marginal cost
curve and when we make the market supply curve,
we will combine these individual marginal
cost curves by adding the quantity supplied
by each producer at the market price level.
The market supply curve in a perfectly competitive
industry is determined by adding up the quantity
supplied by each firm in the market at each
price.
We can derive the market supply curve by adding
up the quantity that each firm in the market
is willing to supply at each price.
On the left side panel, one wheat farmer is
willing to supply 15,000 bushels of wheat
at a price of $7 per bushel.
If every wheat farmer supplies the same amount
of wheat at this price and if there are 150,000
wheat farmers, the total amount of wheat supplied
at a price of $7 will equal 15,000 bushels
per farmer * 150,000 farmers = 2.25 billion
bushels of wheat.
This amount is one point on the market supply
curve for wheat shown on the right side panel.
We can find the other points on the market
supply curve by determining how much wheat
each farmer is willing to supply at each price.
[Music]
Economic profit is equal to a firm's revenues
minus all its costs, implicit and explicit.
A firm is unlikely to earn an economic profit
for very long.
Other firms that are just breaking even have
an incentive to enter the market so they can
earn economic profits.
The more firms there are in an industry, the
further to the right is the market supply
curve.
Entry into the market will continue until
all firms are just breaking even.
Firms can suffer economic losses in the short
run.
An economic loss is the situation in which
a firm's total revenue is less than its total
cost, including all implicit costs.
As long as price is above average variable
cost, a firm suffering a loss will continue
to produce in the short run.
But in the long run, firms will exit an industry
if they are unable to cover all their costs.
Initially, Farmer Gillette and other farmers
selling carrots in farmers' markets are able
to charge $15 per box and earn an economic
profit.
Farmer Gillette's economic profit is represented
by the area of the green box in panel (b).
Panel (a) shows that as other firms begin
to sell carrots in farmers' markets, the market
supply curve shifts to the right, from S1
to S2, and the market price drops to $10 per box.
Panel (b) shows that the falling price causes
Farmer Gillette's demand curve to shift down
from D1 to D2, and she reduces her output
from 10,000 boxes to 8,000.
At the new market price of $10 per box, carrot
growers are just breaking even: Their total
revenue is equal to their total cost, and
their economic profit is zero.
When the price of carrots is $10 per box,
Farmer Gillette and other farmers are breaking
even.
A total quantity of 310,000 boxes is sold
in the market.
Farmer Gillette sells 8,000 boxes.
Panel (a) shows a decline in the demand for
carrots sold in farmers' markets from D1 to
D2 that reduces the market price to $7 per box.
Panel (b) shows that the falling price causes
Farmer Gillette's demand curve to shift down
from D1 to D2 and her output to fall from
8,000 to 5,000 boxes.
At a market price of $7 per box, farmers have
economic losses, represented by the area of
the red box.
As a result, some farmers will exit the market,
which shifts the market supply curve to the left.
Panel (c) shows that exit continues until
the supply curve has shifted from S1 to S2
and the market price has risen from $7 back
to $10.
Panel (d) shows that with the price back at
$10, Farmer Gillette will break even.
In the new market equilibrium in panel (c),
total sales of carrots in farmers' markets
have fallen from 310,000 to 270,000 boxes.
Economic profits attract firms to enter an
industry.
The entry of firms forces down the market
price until the typical firm is breaking even.
Economic losses cause firms to exit an industry.
The exit of firms raises the market price
until the typical firm is breaking even.
This process results in a long-run competitive
equilibrium.
Long-run competitive equilibrium is the situation
in which the entry and exit of firms has resulted
in the typical firm breaking even.
The long-run equilibrium price is at a level
equal to the minimum point on the typical
firm's average total cost curve.
The long-run supply curve is a curve that
shows the relationship in the long run between
market price and the quantity supplied.
In the long run, a perfectly competitive market
will supply whatever amount of a good consumers
demand at a price determined by the
minimum point on the typical firm's average total cost curve.
Panel (a) shows that an increase in demand
for carrots sold in farmers' markets will
lead to a temporary increase in price from
$10 to $15 per box, as the market demand curve
shifts to the right, from D1 to D2.
The entry of new firms shifts the market supply
curve to the right, from S1 to S2, which will
cause the price to fall back to its long-run
level of $10.
Panel (b) shows that a decrease in demand
will lead to a temporary decrease in price
from $10 to $7 per box, as the market demand
curve shifts to the left, from D1 to D2.
The exit of firms shifts the market supply
curve to the left, from S1 to S2, which causes
the price to rise back to its long-run level
of $10.
The long-run supply curve shows the relationship
between market price and the quantity supplied
in the long run.
In this case, the long-run supply curve is
a horizontal line; perfectly elastic.
Think about market conditions to a perfectly
competitive market place: many buyers and
sellers, all firms sell identical products,
and there are no barriers to entry.
Does this apply to iPhone apps?
Anyone with some programming skills, creativity,
and a computer can write the apps.
A few programmers entered the market on day
one of iPhone's introduction and made a profit quickly.
That attracted attention and many people entered
the market.
Get rich quick faded quickly and the perfectly
competitive market became established.
Any industry in which the typical firm's average
costs do not change as the industry expands
production will have a horizontal long-run
cost curve.
Industries where this result holds true are
called constant-cost industries.
If an input used in producing a good is available
in only limited quantities, the cost of the
input will rise as the industry expands.
In this case, the long-run supply curve will
slope upward.
Industries with upward-sloping long-run supply
curves are called increasing-cost industries.
This situation can be seen in the wine making
industry as more bottles of a particular variety
of wine are produced, the price of the grapes
used to make the wine will increase.
As a result, the average total cost curve
for the typical firm shifts up and the firm's
breakeven price increases.
In some cases, the typical firm's average
costs fall as the industry expands, and the
long-run supply curve will slope downward.
Industries with downward-sloping long-run
supply curves are called decreasing-cost industries.
[Music]
In a market system, consumers get as many
carrots as they want, produced at the lowest
average cost possible.
The forces of competition will drive the market
price to the minimum average cost of the typical
firm.
Productive efficiency is the situation in
which a good or service is produced at the
lowest possible cost.
Managers of firms strive to earn an economic
profit by reducing costs.
But in a perfectly competitive market, other
firms quickly copy ways of reducing costs,
so that in the long run, only consumers benefit
from cost reductions.
Allocative efficiency aims to target consumer
preferences and creates products that get
you to spend your scarce money resources on
that good.
It might be that new wine variety with the
climbing cost curve that catches your allocative
efficiency interest, or the brand of smart
phone you most wanna have.
Competitive firms not only produce goods and
services at the lowest possible cost, they
also produce the goods and services that consumers
value most.
Perfect competition achieves allocative efficiency,
a state of the economy in which production
represents consumer preferences; in particular,
every good or service is produced up to the
point where the last unit provides a marginal
benefit to consumers equal to the marginal
cost of producing it.
Productive efficiency and allocative efficiency
are useful benchmarks against which to compare
the actual performance of the economy.
Perfectly competitive markets come in scales
of perfection.
Wheat farming is considered one of the closest
markets to this scenario because of the lack
of differentiation around North America and
around the world.
Apples are close to perfect competition, but
really there are a lot of apple varieties
and certain areas are better at growing certain
varieties than others.
This is differentiation of the product.
We will see in Monopolistically Competitive
industries how differentiation divides perfectly
competitive marketplaces.
Stay tuned.
[Music]
