Question

In certain industries, firms buy their most important inputs in markets that are close to perfectly competitive and sell their output in imperfectly competitive markets. Cite as many examples as you can of these types of businesses. Explain why the profits of such firms tend to increase when there is an excess supply of the inputs they use in their production process.

Short answer

Businesses such as agricultural processors, apparel manufacturers, and tech companies buy inputs in perfectly competitive markets and sell in imperfectly competitive markets. Their profits tend to increase when input costs fall due to excess supply, while they still sell their outputs at high prices due to less price-sensitive demand.

Step-by-step solution

Understanding the Concept of Market Structures

There are different types of market structures where goods and services are bought and sold. A perfectly competitive market is one with many buyers and sellers, all having negligible impact on the market price. An imperfectly competitive market is one where companies have some control over the price of their products due to differentiation or limited competition. The exercise involves identifying firms that operate between these two types of markets.

Identifying Examples of Such Businesses

Examples of industries where firms buy their inputs in perfectly competitive markets but sell in imperfectly competitive markets include: agricultural processors (buy raw crops and sell processed foods), apparel manufacturers (buy textiles and sell branded clothes), and tech companies (buy standard components and sell differentiated gadgets).

Explaining the Profit Increase with Excess Supply of Inputs

When there is an excess supply of inputs in a perfectly competitive market, the input prices tend to decrease due to competition among suppliers to sell their goods. Firms purchasing these inputs can now produce their goods at a lower cost. However, since these firms sell in an imperfectly competitive market, the price of their output is not as strongly influenced by the market, allowing them to maintain higher prices and therefore increase their profits.

Key concepts

Perfectly Competitive Market

In a textbook definition, a perfectly competitive market is an idealized form of market structure that contains numerous buyers and sellers, where no single entity has the power to influence the market prices. All the products offered in this market are homogeneous, meaning that there is no distinction between goods provided by different suppliers. Additionally, there is free entry and exit for firms in this market, which means new businesses can start selling and existing businesses can leave without substantial barriers.
An excellent example to understand this concept is the agricultural industry, where many farmers sell identical crops such as wheat or corn. These farmers are price takers because they have no power to set prices for their crops. They must accept the market price which is determined by the overall supply and demand for the crops.
The significance of perfectly competitive markets in managerial economics lies in their efficiency and the role they play in setting a benchmark for other market structures. They aid in understanding the dynamics of supply and demand and the allocation of resources in an economy without any manipulation by individual firms.

Imperfectly Competitive Market

An imperfectly competitive market is a more common scenario, where the idyllic conditions of perfect competition do not hold. Under this type of market structure, businesses have some degree of market power, which allows them to influence prices to a certain extent. This power originates from various factors such as brand identity, product differentiation, control over supply, or barriers to entry for new competitors.
Examples include large apparel brands that can set higher prices due to their brand value and technological firms that produce unique gadgets with features not available in competitor products. The critical aspect of imperfect competition is that firms actively engage in strategic decision-making to maximize profits, considering how their actions will affect the market and how the market will react in return. An understanding of imperfect competition equips managers with the insight to navigate through market barriers and strategize accordingly to achieve sustained profitability.

Input Supply and Firm Profits

In managerial economics, the connection between input supply and firm profits is pivotal. If a firm sources inputs from a market that is close to perfectly competitive, the firm is a price taker for those inputs. When there is an excess supply of these inputs, competition among suppliers intensifies, leading to a decrease in input prices. For the firm, this represents a cost-saving opportunity, enabling them to purchase the required inputs at a lower price and subsequently reduce their production costs.
The other side of the equation is the market where the firm sells its products. If this market is imperfectly competitive, the firm enjoys the ability to maintain or even increase output prices despite the decrease in their input costs. This creates a wider margin between costs and revenues, leading to higher profits. It is essential for managers to monitor shifts in input supply closely to capitalize on these situations, thereby enhancing profitability through strategic purchasing and pricing decisions.

Examples of Market Structures

There are several market structures that can be observed in economics, each with its own set of characteristics and implications for how businesses operate and compete. Apart from the perfectly competitive and imperfectly competitive markets mentioned previously, other common types include:

• Monopoly: One seller dominates the market with no close substitutes for the product, allowing for significant control over prices.
• Oligopoly: A few large sellers control the market, often resulting in strategic pricing and production decisions that consider the actions of rivals.
• Monopolistic Competition: Many sellers offer differentiated products, which leads to competition based on product features, branding, and quality alongside price.

Each of these structures affects a firm's pricing strategies, cost structures, and competitive tactics differently. For instance, a monopoly might focus on profit maximization without the threat of competitors, while firms in an oligopoly must consider potential reactions from their few competitors when making strategic choices.