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Understanding Competitive Industries: A Study on Tipping in the Dishwashing Sector

This chapter explores the impact of tipping on the dishwashing industry, examining why wages are affected and who benefits from tipping. It delves into the dynamics of competitive firms, supply decisions, and the concept of shutdowns and exits in the short and long run. The section further discusses the competitive industry in the short run, focusing on supply, demand, and equilibrium dynamics. Additionally, it analyzes the competitive firm in the long run, profit considerations, and the exit decision-making process.

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Understanding Competitive Industries: A Study on Tipping in the Dishwashing Sector

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  1. Competition

  2. Introduction • BREAD encourages tipping for kitchen staff. • Impact of achieving goal: • In the short-run life will be better for dishwashers. • In the long-run, wages will decrease by full amount of tips so dishwasher take-home pay is not increased. • Chapter investigates: • Why wages are bid down by tips. • Who benefits from tipping? • Key point: dishwashing is a competitive industry.

  3. Section 7.1 The competitive firm

  4. Competitive Firm • A firm is perfectly competitive if it can sell any quantity it wants at the going market price. • A farm is a good example. • Generally firms with small market share and room to grow. • Firms with large market shares normally have to reduce prices to attract more customers. • Horizontal demand curve. • Products are interchangeable and buyers have many options.

  5. Revenue Total Revenue = Price x Quantity For any competitive firm, marginal revenue = price Firm’s marginal revenue curve is flat at the going market price Demand curve for the product is also flat at the going market price

  6. Firm’s Supply Decision • Produce good until MR = MC • Competitive firm produces a quantity where P = MC • Note: P ≡ MR • Supply curve • MC and supply are inverse functions • Supply curve looks like upward sloping portion of MC curve as long as MC curve upward sloping • SR and LR supply curves exist for the firm

  7. Shutdowns and Exits • Does the producer want to produce the good? • Two distinctions • Shutdown: firm stops producing the good but still pays fixed costs • Exit: firm leaves the industry entirely and no longer faces any costs • Firms, in SR, can shutdown but not exit • Remains operational if P > AVC • In LR, can exit

  8. Shutdowns • Shutdown occurs when firm stops producing. • Fixed costs continue for firms in shutdown. • Exit occurs when firm leaves an industry entirely. • No costs are incurred for firms that exit. • In the short run firms can shutdown, not exit. • Should not if Total Revenue > Variable Costs. • Firms continue to operate if, at profit maximizing quantity price of output exceeds average variable cost. • In the long run firms can exit.

  9. Short-Run Supply Curve • When price falls below average variable cost, firm shuts down and produces nothing. • Supply curve is identical to the part of the marginal cost curve that lies above average variable cost curve. • Elasticity of Supply: • Percentage change in quantity supplied resulting from a 1% increase in price. • Positive because a price increase increases supply. • Given two curves through same point, flatter one has the higher elasticity.

  10. Section 7.2 The competitive industry in the short run

  11. Competitive Industry in the SR • All firms in industry competitive • SR is period of time in which no firm can enter or exit the industry • Number of firms cannot change • LR is period of time in which any firm can enter or leave the industry • Industry’s SR supply curve • Sum of SR individual firm supply curves • More elastic than individual supply curves

  12. Supply, Demand, and Equilibrium • Each firm operates where supply meets demand • Industry equilibrium consequence of optimizing behavior on part of individuals and firms • Intersecting industry wide supply and industry wide demand

  13. Competitive Equilibrium • Industry faces a downward-sloping demand curve. • Firms produces where supply (or marginal cost) curve crosses the horizontal line at the “going market price”. • Increase in fixed cost: • Marginal cost is unchanged so supply curve is unchanged. • Both price and quantity stay the same.

  14. Competitive Equilibrium • Increase in variable cost: • Marginal costs rise and shift the supply curve leftward. • Higher market equilibrium price. • Industry output falls but firm’s output could go up or down. • Increase in industry demand: • Increase in firm’s output.

  15. Change in Fixed Cost • Increase in FC • Price and quantity remain unchanged

  16. Change in Variable Cost • Increase in VC • Raises firms MC curve • Causes some firms to shutdown • Higher market equilibrium price • Firm’s output could go up or down

  17. Change in Industry Demand • Increase in industry demand • Higher market equilibrium price • Increase in firm’s output

  18. Industry’s Costs Total cost are minimized when marginal cost is the same at every firm. In competitive equilibrium, every firm chooses to produce a quantity at which price = marginal cost. The equilibrium quantity is automatically produced at the lowest possible total cost.

  19. Section 7.3 The competitive firm in the long run

  20. Competitive Firm in the LR • Some short- run fixed costs become variable costs in the long run. • Firms can enter and exit in the long run. • The long-run supply curve is identical to the long-run marginal cost curve. • More elastic than the short-run supply curve.

  21. Profit and the Exit Decision • Profit = TR – TC • Costs includes all foregone opportunities • SR versus LR supply response • Firm LR supply curve more elastic than SR supply curve • Shuts down if price of output falls below average variable cost • Exits if price of output falls below average cost

  22. LRMC and Supply • Firms operate where P = LRMC • Remain in industry, LR supply curve identical to LRMC curve • Exit decision is made at the point P=AC (note that there is no more fixed cost in the LR)

  23. Section 7.4 The competitive industry in the long run

  24. Competitive Industry in the LR • Firms wishing to enter or exit the market do so in the LR, flatting out the LR supply curve • So unlike the case in the SR, the LR supply curve is a horizontal line. • Important assumption: all firms are identical in costs • Break-even price plays an important role here (1) all firms produce at the break-even price; (2) it determines the level of LR supply curve

  25. Break-even • The price at which a seller earns zero profit. • Occurs where marginal and average cost curves cross. • In a constant-cost industry, the long-run industry supply curve is flat at the level of break-even. • Shifts every time the break-even price changes. • In the long-run, both fixed and variable costs matter. • Market price is determined by the intersection of the industry-wide supply and demand curves. • Firm faces flat demand curve at going market price.

  26. Zero Profit Condition • Economic versus accounting profit • Accounting profit refers to total revenue minus total financial cost • Economic profit refers to accounting profit minus the value of the best foregone opportunity

  27. Industry’s LR Supply Curve • All firms identical • Industry supply curve flat at the break-even price • Break-even price and the LR supply • Break-even price (P = AC) at which a seller earns zero profit • LR supply curve identical with part of firm’s LRMC curve lying above LRAC curve

  28. Flat LR Supply Curve • Flatness based on entry and exit • P < AC, all firms exit • P > AC, unlimited number of firms enter • LR zero profit equilibrium almost never reached • Demand and cost curves shift so often that entry and exit never settles down • Approximation to the truth

  29. Equilibrium • LR same as SR between firm and industry • Market price determined by intersection of industrywide demand and supply • Firms face flat demand curves at market price • Analysis of changes to equilibrium • Changes in FC • Changes in VC • Changes in demand

  30. Application: Government as a Supplier • In the short-run, a government policy to build and operate an apartment complex increases available housing. • Equilibrium price falls. • In the long-run, supply curve does not shift. • Determined by break-even price. • Price of housing returns to break-even price. • Quantity provided returns to break-even quantity: • Number of privately owned apartments withdrawn from the market equals number of apartments built by government.

  31. Relaxing the Assumptions • Assumption 1: All firms are identical, have identical cost curves • True in industries that do not require unusual skills • Assumption 2: Cost curves do not change as industry expands or contracts • True in industries not large enough to affect input prices • Without these assumptions, all firms do not have the same break-even price

  32. Constant Cost • Constant cost industry • Satisfies the 2 assumptions

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