Price-Searcher

Markets With
Low Entry Barriers
Full Length Text — Part: 5 Chapter: 22
Micro Only Text — Part: 3 Chapter: 10

Slides to Accompany “Economics: Public and Private Choice 9th ed.”

James Gwartney, Richard Stroup, and Russell Sobel

Slides authored and animated by:

James Gwartney, David Macpherson, and Charles Skipton
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1. Competitive Price-
Searcher Markets

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Competitive Price-
Searcher Markets
■ Firms in price-searcher markets with low
entry barriers face a downward sloping
demand curve
◆ Firms are free to set price, but face
strong competitive pressure.
✦ Competition exists from existing firms
and potential rivals
■ An alternative term for such markets is
monopolistic competition

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Product Differentiation
■ Price-searchers produce differentiated
products: Products that differ in
design, dependability, location, ease of
purchase, or etc.
◆ Rival firms produce similar products
(good substitutes) and therefore each
firm confronts a highly elastic demand
curve

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2. Price and Output in
Competitive Price-
Searcher Markets

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Price and Output
■ A profit-maximizing price searcher will
expand output as long as marginal
revenue exceeds marginal cost.
◆ Price will be lowered and output
expanded until MR=MC
■ The price charged by a price searcher
will be greater than its marginal cost

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 Marginal Revenue of a Price Searcher
• Consider a market for a product
where the initial price is P1 and Price Reduction in
output q1. Total revenue = P1 * q1. Total Revenue
• When a firm faces a downward
sloping demand curve, a price
reduction that increases sales will
exert two conflicting influences on
total revenue. Increase in
• As we decrease price from P1 to P2, Total Revenue
output increases from q1 to q2. P1
What effects does this have on total
revenue? P2
• First, total revenue will rise because
of an increase in the number of units
sold (q2 - q1) * P2. d
• However, total revenue will decline
by [(P1 - P2) * q1] because q1 units
that were previously sold at the
higher price (P1) are now sold at the
lower price (P ). MR
• Depending on 2the size of the
respective shaded regions, total Quantity /
revenue may increase or decrease. q1 q2 Time
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 Price-Searcher’s Price and Output
Price MC
• A price searcher maximizes profits Economic
by producing where MR = MC, at Profits
output level q . . . and charges a
price (P) along the demand curve
for that output level. ATC
• At q the average total cost is C . . .
• Because P > C the firm is making P
economic profits equal to the shaded
C
• area,
What( impact
[ P - C will
] * qeconomic
) profits
have if this is a typical firm? d

MR
q Quantity /
Time
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Profits and the Long Run
■ If existing firms are making economic
profits, then rival firms will be
attracted to the market.
◆ The entry of new firms will expand
supply and lower price.
◆ The demand curve faced by each will
shift inward until the economic profits
are eliminated.

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Losses and Long Run
■ Economic losses will cause price
searchers to exit from the market
◆ The demand for the output of the
remaining firms will rise until the
losses have been eliminated, ending
the incentive to exit.
■ Price searchers can make either profits
or losses in the short run, but only zero
economic profit in the long run

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 Price-Searcher’s Price and Output
Price MC
• Because entry and exit are free,
competition will eventually drive
prices down to the level of ATC.
When profits (losses) are present,
the demand curve will shift inward ATC
(outward) until the zero profit
equilibrium is restored.
• Again, the price searcher establishes P
its output level where MC = MR.
• At q the average total cost is equal to
the market price. Zero economic
profit is present. There is no
tendency for firms to either enter or
exit the market.
d
MR
q Quantity /
Time
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Questions for Thought:
1. What are the distinguishing characteristics of
competitive price searcher markets? Indicate a
market that approximates these conditions.

2. Price searchers can set the price of their product.

Does this mean that price searchers will charge the
highest possible price for their product? What price
will maximize the profits of a price searcher?

3. In price‑searcher markets with low barriers to entry,

will the firms be able to make economic profit in
the long run? Why or why not? What do
competitive price searchers have to do in order to
make economic profit?
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3. Contestable Markets
and the Competitive
Process

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Contestable Markets
■ A contestable market is one in which
entry and exit costs are low and there
are no legal barriers to entry.
◆ Example: Airline industry
■ Actual and potential competition
leads to:
◆ Zero economic profits
◆ Efficient production

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4. The Left-Out Variable:
Entrepreneurship

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Entrepreneurs
■ There is uncertainty about which projects are
profitable, this information must be discovered.
This is the function of the Entrepreneur.

■ Entrepreneurs who discover and

introduce lower-cost production
methods and new products promote
economic progress.
■ Economic models can not fully capture
the role of entrepreneurial judgement.

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5. An Evaluation of
Competitive Price-
Searcher Markets

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Comparing Price-Taker and Price-Searcher Markets
• Below we illustrate the long-run equilibrium conditions in price taker and
price searcher markets when entry barriers are low.
• In both cases P = ATC, and economic profits are equal to zero.
• Because the price-searcher confronts a downward-sloping demand curve for its
product, its profit-maximizing price exceeds marginal cost. In contrast with
the price-taker’s market, the price-searcher’s output is not large enough to
minimize ATC when the market is in long-run equilibrium.
• Even though the two markets have the same cost structure, the price in the
price-searcher’s market is higher than that for the price-taker ( P2 > P1 ).
• Some consider this price discrepancy a sign of inefficiency; others perceive it
as a premium society pays for variety and convenience (product differentiation).
Price MC Price MC

ATC ATC

P2
P1 d

d
MR
Price q1 Quantity / Price q2 Quantity /
Taker Time Searcher Time
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Allocative Efficiency
■ Allocative efficiency is achieved when
the most desired goods are produced at
the lowest possible cost.
■ Criticism of traditional theory of
competitive price-searcher markets:
◆ price > marginal cost at profit
maximizing output
◆ Per-unit cost is not minimized
◆ excessive advertising is encouraged

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Allocative Efficiency
■ Recently economists have been more positive about
competitive price-searcher markets.

◆ Consumers may value a wider variety

of styles and quality (product
differentiation).
◆ Advertising often reduces search time
and provides valuable information.
◆ Price searchers have an incentive to
innovate and operate efficiently.

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6. A Special Case:
Price Discrimination

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Price Discrimination
■ Price discrimination is when a seller
charges different consumers different
prices for the same good or service.
■ Price discrimination can occur when a
price searcher is able to:
◆ identify groups of customers with
different price elasticities of demand
◆ prevent customers from re-trading the
product.

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Price Discrimination
■ Sellers may gain from price
discrimination by charging:
◆ higher prices to groups with more
inelastic demand
◆ lower prices to groups with more
elastic demand
■ Price discrimination generally leads to
more output and additional gains from
trade

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 The Economics of Price Driscrimination
• Consider the market for airline travel where the MC per traveler is $100.
• If the airline charges all customers the same price, profits will be maximized
where MC = MR (P = $400 and q = 100). Net Operating Revenue is equal to
TR ($40,000) - operating costs ($10,000).
• If the airline charges different prices (price discrimination), it will be able to
increase net revenues. If the firm charges a higher price ($600) to business
travelers (who have a highly inelastic demand) and a lower price ($300) to
other travelers (who have a more elastic demand), it is able to increase Net
Operating Revenue to $42,000.
• If sellers can segment their market, they can gain by charging higher prices to
consumers with a less elastic demand and offering discounts to those with a
more elastic demand.
Price Price Net Operating Revenue
from Business Travelers
Net Operating Revenue ($500*60) = $30,000
$700 ($300*100) = $30,000 $700 Net Operating
$600 $600 Revenue from Others
($200*60) = $12,000
$500 $500
$400 $400
$300 $300
$200 $200
MC MC
$100 $100
MR D D
Single 100 Quantity / Price 60 120 Quantity /
Price Time Discrimination Time
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7. Competition Among
Firms: How it
Increases Prosperity

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How Competition
Increases Prosperity
■ Competition encourages price-searcher
firms to:
◆ operate efficiently and cater to the
preferences of consumers
◆ improve products and discover lower-
cost methods of production
◆ discover the types and sizes of
businesses that keep per-unit costs low
■ Competition uses personal self-interest
to elevate our standard of living.

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Questions for Thought:
1. Is price discrimination harmful to the economy?
How does price discrimination affect the total
amount of gains from exchange? Explain. Why do
colleges often charge students different prices,
based on their family income?
2. What is the primary requirement for a market to be
competitive? Is competition necessary for markets to
work well? Why or why not? How does competition
influence the following:
(a) the cost efficiency of producers,
(b) the quality of products, and,
(c) the discovery and development
of new products?

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 End
Chapter 22

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