Ch06-AK

1) I prefer the way the WIKI describes commoditization.

“In the business world, commodification (commoditization) is the process that transforms the market for a unique, branded product into a market based on undifferentiated price competition. In economic terms, the market changes from one of monopolistic competition to one of perfect competition… Consumers usually benefit from commodification, since perfect competition usually leads to lower prices. Branded producers often suffer under commodification, since the value of the brand (and ability to command price premiums) can be weakened.  For example, a June 2006 Fortune article by Marc Gunther discussed how commodification has been a challenge to Sony: ‘Almost as soon as Sony unveils a new device, cheap knockoffs are built in China.’ That is to say that Sony products are undifferentiable from the competing products, diminishing the value of the Sony brand.”

 

I would add to this that the market for commodities (e.g., natural resources) is among the few realistic examples of perfect competition (hence the name “commoditization” when manufactured goods become indistinguishable from one and other). Also, long run (economic) profits in such a market are zero, and CEOs naturally hope to do better.

 

2)  The green rectangle represents the firm’s negative profits,

Q*(Avg Rev – ATC).

Since the firm’s average revenue is large enough to cover SR average variable cost, it stays in business in the short run.

 

 

 

 

 

 

 

3)  The green rectangle represents the firm’s negative profits,

Q*(Avg Rev – ATC).

Since the firm’s average revenue is so low that it fails to cover SR average variable cost, it will find it more cost effective to shut down (go out of business).

 

 

 

 

 

 

 

4)  All perfectly competitive firms earn zero economic profits in the long run. Whether they are in a constant cost or increasing cost industry is irrelevant.

 

 

 

 

 

5)  This is exactly as described in class

0.     Begin at a long run equilibrium (with zero profit) at qLR0 in the Firm’s cost graph and QLR0 in the market supply and demand graph. Prices will be P0­.

1.     Some exogenous shock causes demand to rise (permanently). Existing firms can respond by increasing production. This is a movement along the SMC0 curve for individual firms, and a movement along SSR0 for the market. Note, however, that capital and the number of firms remain fixed. Thus, you see a temporary (or short run) equilibrium in which existing firms earn profits > 0.

2.     Profits attract competition. In the long run, the increase in the number of firms will shift short-run supply to the right until profits return to zero. The increased number of firms has two effects: First, it reduces the price. Second, it raises the costs of production for existing firms. This second effect will shift the SMC and SATC curves. The new long run equilibrium is qLR2 in the Firm’s cost graph and QLR2 in the market supply and demand graph.

3.     Connect the long run equilibria in the market supply and demand graph to identify the long run supply curve for this increasing cost industry.