Economics For Managers Global Edition 3rd Edition Farnham Solutions Manual
Economics For Managers Global Edition 3rd Edition Farnham Solutions Manual
OVERVIEW
This chapter begins the discussion on Market Structure or Industrial Organization in Economics.
The chapter introduces the Perfectly Competitive model. Perfect competition is important as a
stand-alone model and also as a comparison tool for the other market structures. As a stand-alone
model, it allows students to understand what happens in a market when no individual firm has any
market power and therefore takes the market price as given. It also defines the conditions for price-
taking behavior. As a comparison tool, it allows students to see the impact lack of competition and
presence of significant market power can have on the market, the consumer, and the economy as a
whole.
I. Introduction
A. There are four major forms of markets structure: perfect competition, monopolistic
competition, oligopoly and monopoly.
II. Case for Analysis: Competition and Cooperative Behavior in the Potato Industry
C. Idaho farmers managed to differentiate Idaho grown potatoes from others. This
product differentiation is an important step at establishing market power because it
effectively splits the market.
D. In 2004, Idaho farmers formed a cooperative, United Potato (a very cute name),
which has successfully united farmers to curb production
1. Potato production was cut by $6.8 million in 2005.
2. Revenues shot up by 48.5% in 2005.
3. Legal issues (United Potato argued that Capper-Volstead Act exempts
farmers from federal antitrust laws and permit then to share price and
control supply).
Teaching Tip: Make sure the students understand that the model of perfect
competition is hypothetical. The potato industry and other agricultural markets
come close to perfectly competitive industries. Try to make sure that the students
understand the role of each of the assumptions.
C. Table 7.1 contrasts the four market structures and presents an easy teaching tool for
comparing the characteristics of the four market environments.
1. The market demand and supply determine market price of the good (and
the market quantity of output).
3. The output produced by a competitive firm depends on the goal of the firm,
profit maximization.
5. If MR = MC, then the firm produces the optimal output level, Q*. At this
level of output, profits can be positive, negative or zero.
Teaching Tip: it is important to emphasize that profit maximization does not mean
positive profits. In the case of losses, profit maximization is synonymous with loss
minimization.
Teaching Tip: It may also be a good idea to teach the profit area on the graph,
determined by (P – ATC)*Q or TR – TC so that students can see if a firm is making
positive, negative or zero profits.
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Chapter 7: Market Structure: Perfect Competition 73
7. Even if the firm is producing the output where MR = MC, it should stop
producing and shut down if the price is below AVC, i.e. it cannot cover its
variable cost.
(a) Shut-Down Point: The price, which just equals the firm’s average
variable cost, below which it is more profitable for the perfectly
competitive firm to shut down than to continue to produce it.
Teaching Tip: This is a good place to review fixed and variable inputs to the firm.
Make sure that the students understand that the firm incurs the fixed costs of
production such as a rental fee for the plant facility regardless of the output
produced. If the revenues of the firm do not cover the cost of variable inputs (in our
model that is labor), then it makes no sense to employ those inputs. In this case, the
firm shuts down and faces only the fixed costs. If revenue from production exceeds
the variable costs of production (while the firm is still earning negative profits) then
the firm should continue to operate because losing all of the fixed costs is worse
than losing only a percentage of them. This may also serve as a good time to recall
the concept of opportunity cost in economics.
8. The supply curve for the perfectly competitive firm is the portion of the
marginal cost curve that lies above the minimum average variable cost.
1. The firm cannot change the scale of operation in the short run since at least
one input is fixed.
1. Entry and exit by new and existing firms and changes in the scale of
operation by all firms can occur in the long run.
Teaching Tip: It is a common mistake for the students to confuse the terminology,
“shut down” (a short-run decision) and “exit” (a long-run decision). Make sure
you make the distinction between the decisions of a competitive firm in the short run
versus the long run.
2. Equilibrium Point: The point where price equals average total cost since
the firm earns zero economic profit.
3. An increase in the market demand raises the profits earned by all firms
through an increase in the price.
4. As there are no barriers, the positive profits signal new firms to enter the
market. Entry of new firms increases the market supply to the right.
5. Entry continues until all firms are once again earning zero profits and there
is no more incentive for new firms to enter. The market reaches its long-
run equilibrium.
Teaching Tip: This is a good place to review the determinants of market demand
and supply.
2. The high price of $8 per 100-pound sack and profits earned by individual
farmers are shown in point A.
4. The new price was below the average total cost for many farmers, leaving
them with significant debt.
2. Positive profits signal new firms to enter while negative profits signal firms
to exit the industry.
Teaching Tip: At this point it may make sense to show the students why perfect competition
represents the perfect world for the economy (not firms in the industry). Economic efficiency is
reached. The model guarantees minimization of costs of production in the long-run. The model
guarantees that the market generates the most surplus by setting the marginal cost equal to the
price. The last point is optional in a managerial economics course, but could be used to show
why perfect competition is desirable from the economy’s perspective.
B. A perfectly competitive industry is unconcentrated and each firm does not have any
market power.
3. The demand for most farm crops is highly inelastic. This means that a
decrease in price decreases the total revenues for producers, resulting in the
“farm problem” that industrialized countries face.
3. Real and subjective product differentiation exit among the different broiler
processors. One such example is skin color.
4. Competition depends on the market channel used and the extent of value-
added processing involved.
5. Broiler processing has the lowest price-cost margin (PCM) in the food
system.
(a) Price-Cost Margin (PCM): The relationship between price and costs
for an industry, calculated by subtracting total payroll and the cost of
the materials from the value of shipments and then dividing the
results by the value of shipments. The approach ignores taxes,
corporate overhead, advertising, marketing, research, and interest
expenses.
3. This shift has resulted from a declining demand for red-meat consumption
in the United States.
(a) In 2012, two studies demonstrated that red meat increases the
probability of developing health conditions including cancer, and can
even increase the probability of a premature death.
1. The “Got milk?” and milk mustache campaigns were strategies to increase
industry demand for milk.
2. The change in lifestyles and consumer tastes has led to increased strategies
for product differentiation in a highly competitive industry.
1. There are more than 150,000 companies in the truckload segment of the
industry.
3. Higher costs, adverse weather and an overall slowing in the economy in the
last quarter of 2000 led to numerous companies that went out of business.
4. The rising costs of labor, fuel and equipment plus the subprime mortgage
crisis in recent years have decreased demand.
A. Elasticity of Supply
1. The shape of the industry supply curve illustrates the elasticity of supply
within that industry.
2. Supply elasticity is lower for major crops grown in areas where there are
few alternatives for the use of land.
3. The aggregate supply relationship for all farm output in most countries is
very price inelastic in the short run.