Question

Many people – including retailers, hawkers and consumers buy their fresh produce at one of the National Fresh Produce Markets (NFPMs) in South Africa. Most of the fresh fruit and vegetable producers supply their products to these NFPMs. The price of potatoes varies daily because the price is determined by supply and demand, as one would expect in this type of market structure. Prices are displayed to the buyers and sellers of potatoes at the fresh produce markets and this is the way in which potatoes are marketed. Due to the daily fluctuations in the supply and demand of potatoes, the producers, like the consumers, are never sure about the price they will receive for their products. For this type of market structure to function efficiently, all role players in the market need perfect information on the supply and demand. The Fresh Produce Markets display the supply levels for all fresh produce traded on the market so that prices can quickly be changed if the supply changes. The Fresh Produce Markets therefore provide daily market information which gives market signals to all stakeholders (producers, retailers, hawkers and consumers). This information enables all role players to make strategic business decisions daily.

3.1 Discuss the type of market structure the scenario illustrates in terms of the three specific market characteristics being discussed. (15)

3.2 If the economic profit of firms operating in this market structure act as an incentive for new firms to enter the industry, explain and illustrate with the aid of a diagram, the long-run profit maximizing situation of firms in this industry.

Answer 1

3.1 PERFECT COMPETITION

This market is featured by large number of buyers and sellers, homogenous products,with free entry and exit, perfect information about the price of a good and absence of transaction costs, .Marginal revenue is calculated by dividing the change in TR by change in Q. Average revenue is calculated by dividing total revenue by quantity and A firm in a competitive market tries to maximize profits.The total revenue for a firm in this competitive market is the product of price and quantity ie TR = price* Quantity .

In the short-run, it is favourable condition for a firm’s economic profits to be positive, negative, or zero. Economic profits will be zero in the long-run. In the short-run, if a firm has a negative economic profit, it should be continued to operate if its price ov its average variable cost. It should shut down if its price is below its average variable cost.

features

• homogeneous products
• many buyers and sellers in the market.
• Have access to perfect information about price.
• There are no barriers to entry into or exit from the market.
• Lack of transaction costs.

3.2  

A firm in a competitive market wants to maximize profits just like any other firm. The profit is the difference between a firm’s total revenue and its total cost. For a firm operating in a perfectly competitive market, the revenue is calculated as follows:

• Total Revenue = Price * Quantity
• MR (Marginal Revenue) = Change in Total Revenue / Change in Quantity
• AR (Average Revenue) = Total Revenue / Quantity

The average revenue (AR) is the amount of revenue a firm receives for each unit of output. The marginal revenue (MR) is the change in total revenue from an additional unit of output sold. For all firms in a competitive market, both AR and MR will be equal to the price.

Profit Maximization

Over the long-run, if firms in a perfectly competitive market are earning positive economic profits, more firms will enter the market, which will shift the supply curve to the right. As the supply curve shifts to the right, the equilibrium price will go down. As the price goes down, economic profits will decrease until they become zero.

When price is less than average total cost, firms are making a loss. Over the long-run, if firms in a perfectly competitive market are earning negative economic profits, more firms will leave the market, which will shift the supply curve left. As the supply curve shifts left, the price will go up. As the price goes up, economic profits will increase until they become zero.

In the long-run, economic profit cannot be sustained. The entry of new firms in the market causes the demand curve of each individual firm to shift downward and  bringing down the price, the average revenue and marginal revenue curve. In this condition firms that are engaged in a perfectly competitive market earn zero economic profits. The long-run equilibrium point for a perfectly competitive market occurs where the demand curve (price) cuts the marginal cost (MC) curve at the minimum point of the average cost (AC) curve. In the long-run, the firm will make zero economic profit. Therefore its horizontal demand curve will touch its average total cost curve at its lowest point.