FIRM IN COMPETITION
Firms can operate in one or more markets and not always on the same side of the market. General Motors is a buyer in the resource market and a seller in the automotive market.
In the next four chapters we will be looking at the output market for four market structures. You will look at the way a firm is structured and their ability to make revenues (sales). Then we will combine the revenues with the cost curves studied in the last chapter to determine profitability.
The four market structures are:
1. Perfect Competition
2. Monopoly
3. Monopolistic Competition
4. Oligopoly
Why the different market structures? They are divided by power – the power to generate revenues – leading to higher profits. The first two market structures are very rare, but are used to help us understand the two extreme market conditions and then it will help us understand the two most prevalent structures; Monopolistic Competition and Oligopoly
It is also necessary to understand that when profits are discussed they are economic profits.
Economic profits take into consideration opportunity cost. It is the opportunity cost of capital.
For example if the normal cost of capital (return on equity [ROE]) is 10% then we would determine profit as follows:
Economic Profit = Accounting profit – Opportunity Cost
or you can state as: Accounting profit – Normal Rate of Return (NROR)
Accounting profit = 10%
Example one
Economic profit = 10% – 10% = 0
Therefore, zero economic profit states the firm is making a positive profit which is the average for the industry. This is good – the firm is operating very efficiently.
Example two
Economic profit = 12% -10 = +2% Very positive. The firm is making above the average for the industry or is operating very efficiently.
Example Three
Economic profit = 10% – 12% = -2%his firm is still making an accounting profit , but it is below the average for the industry. We can state this firm is not as efficient…