CHAPTER 12 STUDY GUIDE
12.1 MARKET STRUCTURE
1. Many people have an inherent dislike and distrust for large entities: big government, big
corporations, big stores. This is often due to a perceived connection between size and power:
bi entities can be powerful. And, power can be used, misused, and abused. So, Bill Gates,
Donald Trump, and other successful individuals are often criticized, and big firms such as
Microsoft, Cargill, and ADM are also attacked. In economics, we try to remain unbiased, and
look at both the benefits and costs of all things. The bigness of firms often results in desirable
characteristics such as lower costs (Walmart), uniformity (McDonalds), or network
economies (Microsoft, Facebook). We will attempt to purge our discussion of all value
judgments (normative economics) and stick to factual statements (positive economics).
12.3 THE PERFECTLY COMPETITIVE FIRM
1. One of the most surprising aspects of learning economic principles is that competitive firms
are not rivals; competitive firms can be nice to each other, since no single firm affects the
price. Firm behavior and decision making is unrelated to what other individual firms do.
However, all firms taken together can have a large influence on market outcomes: if many
firms experience a drought, the price impact affects every single firm.
12.3.1 The Demand Curve Facing a Competitive Firm
1. Recall the notation introduced earlier in the book: “q” represents the output of a single firm
in an industry, and “Q” represents the market output for all firms in the industry. This is a
crucial distinction due to both the magnitude of the quantity, and due to the impact of the
output quantity on price. Any individual firm will produce a relatively small amount of
output, and the quantity is too small to affect the price. On the other hand, when the market
quantity changes, the price will change, since the market quantity of output is large.
2. Marginal revenues are equal to the output price (MR = PY). Each individual firm can produce
as much or as little as it chooses without influencing the price. Given these two statements,
does it follow that each firm should produce as large a quantity as it possibly can? The
answer is not necessarily. The reason is that so far, only revenues have been considered. A
firm must also take into account how much it costs to produce more output. The profitmaximizing firm should continue to increase output as long as the marginal benefits (MR)
are larger than the marginal costs (MC). At some point, diminishing returns will set in, and
costs will rise. There will be a point where MR = MC, and this point will occur before an
infinite quantity is produced. In many cases, the limiting factor to a firm is burnout, or an
individual’s physical constraints: we cannot work all day and all night indefinitely.
12.4 THE EFFICIENCY OF COMPETITIVE INDUSRIES
1. Efficiency is an important goal for society, as it can bring about greater levels of
consumption from the same level of resources. However, efficiency, just like all other
societal goals, can be pushed to the point where it has a detrimental impact on society.
Examples include slave labor, child labor, poor working conditions, and poor workplace
safety. As nations increase the standard of living, they will reduce these practices that are
efficient, but not desirable, and replace them with practices that are considered more ethical.
© Taylor & Francis 2016
This makes good sense. After all, the nation that only produces, and does not consume, is
missing the point. Production is only to meet consumer desires, not the other way around.
2. Cut flowers are a good example of a luxury good. Since 2008, the Great Depression has
caused job displacement and slow growth in incomes. When this occurs, many consumers
experience a decrease in purchasing power, and cut flowers may be viewed as a nonnecessary item. The cut flower industry has experience a decrease in demand, as our theory
in Chapter 8 predicts.
12.5 STRATEGIES FOR PERFECTLY COMPETITIVE FIRMS
1. The firms that adopt new technology early are the ones who will be most profitable in a
competitive industry. This is an interesting and important result of economic principles, and
one of urgency in a market economy that is rapidly changing. In industries with a great deal
of research and development, the best way to make money is to adopt the new, cost-saving,
technologies as they become available. This is not always easy, especially if the pace of
change is fast.
2. Another important result for competitive firms is that marketing and advertising are costly
activities that will not work. Many firms have made the mistake of trying to differentiate
their product, when it is the same, homogeneous product that other firms sell. For example,
wheat producers may desire to market their wheat as “higher quality” when millers and
bakers do not see it that way. In this case, advertising and marketing efforts result in higher
costs, but the marginal revenues are determined in the global market, rather than by demand
enhancements. Competitive firms should focus on cost savings, rather than demand
enhancements.
3. Agricultural research is changing dramatically. In the US in previous decades, a great deal of
agricultural research was conducted in Land Grant Universities and by the United State
Department of Agriculture. The trend has been away from publically funded research
towards research and development in the private sector. This has occurred due to stronger
ownership rights for intellectual property. In other words, if a business firm can retain the
right to a new invention such as seeds, it will invest more in the development of new seeds.
4. Biotechnology is a good example of a technology where early adopters gain the largest
benefits. The US and China have adopted biotechnology in agriculture, whereas most nations
in Europe and Africa have not. The early adopters of biotechnology reap several economic
advantages, including crop yield increases, pest control cost savings, and ease of
management. Individual producers and nations that are slow to adopt biotechnology will be
at a competitive disadvantage.
© Taylor & Francis 2016