43. Markets and the Competitive Environment

The competitive environment, also known as the market structure, is the dynamic system in which your business competes. The state of the system as a whole limits the flexibility of your business. World economic conditions, for example, might increase the prices of raw materials, forcing companies that supply your industry to charge more, raising your overhead costs. At the other end of the scale, local events, such as regional labor shortages or natural disasters, also affect the competitive environment. Direct Competitors Your direct competitors provide products or services similar to yours. For example, a small computer repair business competes with other local computer repair businesses, as well as large retail stores that offer computer repair services. Small retail shops compete with warehouse clubs and big-box retail stores that use their huge buying power to lower overhead costs, enabling them to offer steep discounts that small stores can’t afford.

Indirect Competitors In addition to direct competitors, some businesses also face competition from providers of dissimilar products or services. For example, a fine dining restaurant competes with other local restaurants, but it also competes with nearby supermarkets that offer ready-to-eat meals. And a pottery studio that relies heavily on children’s birthday parties must compete with other family-friendly establishments that offer children’s activities, such as roller rinks, theme restaurants and children’s museums.

A competitive environment is where there are several similar firms that are competing for the same market segment. These firms normally produce products of the same nature and form and whose uses are more or less the same. However, because of the competition that exists for the market, these firms are likely to differentiate their products to endear them to a larger number of consumers compared to their rivals.

44. Markets and Firms

The theory of the firm consists of a number of economic theories that describe, explain, and predict the nature of the firm, company, or corporation, including its existence, behavior, structure, and relationship to the market

In simplified terms, the theory of the firm aims to answer these questions:

1. Existence. Why do firms emerge, why are not all transactions in the economy mediated over the market?

2. Boundaries. Why is the boundary between firms and the market located exactly there as to size and output variety? Which transactions are performed internally and which are negotiated on the market?

3. Organization. Why are firms structured in such a specific way, for example as to hierarchy or decentralization? What is the interplay of formal and informal relationships?

4. Heterogeneity of firm actions/performances. What drives different actions and performances of firms?

5. Evidence. What tests are there for respective theories of the firm?

Firms exist as an alternative system to the market-price mechanism when it is more efficient to produce in a non-market environment. For example, in a labor market, it might be very difficult or costly for firms or organizations to engage in production when they have to hire and fire their workers depending on demand/supply conditions. It might also be costly for employees to shift companies every day looking for better alternatives. Similarly, it may be costly for companies to find new suppliers daily. Thus, firms engage in a long-term contract with their employees or a long-term contract with suppliers to minimize the cost or maximize the value of property rights

45. Short-Run Technology Constraint

The Short Run is a time frame in which the quantity of one or more

resources used in production is fixed.For most firms the capital is fixed in the short run. Other resources used by the firm (such as labor, raw materials, and

energy) can be changed in the short run. Short-run decisions are easily reversed.

The marginal product of labor is the change in total product that results from a one-unit increase in the quantity of labor employed, with all other inputs remaining the same.Almost all production processes are like the one shown here and have:

Initially increasing marginal returns When the marginal product of a worker exceeds the marginal product of the previous worker, the marginal product of labor increases and the firm experiences increasing marginal returns. Eventually diminishing marginal Returns When the marginal product of a worker is less than the marginal

product of the previous worker, the marginal product of labor decreases and the firm experiences diminishing marginal returns.

46. Product Schedules, Product Curves, The law of diminishing returns

Total product is the maximum output that a given quantity of labor can produce. The marginal product of labor is the increase in total product that results from a one-unit increase in the quantity of labor employed with all other inputs remaining the same. The average product of labor is equal to the total product of labor divided by the quantity of labor. The table to the right has examples of these product schedules.