I love croissants (or “gipfeli” as they are known here in Switzerland). I also love using bakeries as examples of businesses operating in competitive industries when teaching the concepts of perfect competition in my Theory of the Firm unit. So I was thrilled to see this article from the Economist this week called Croissantonomics.

The nature of competition in the market for baked goods in New York City is clearly intense, as the baker featured in the article implies.

In all, it costs Mr Rubin $2.60 to make a $3.50 croissant. If he makes 100 and sells 70, he earns $245 but his costs are $260. Since he refuses to sell leftovers—all goods are sold within a day—he loses money. “Welcome to the bakery business,” Mr Rubin says

The article outlines the secret to success in this competitive market.

First, product differentiation: “his best creations are distinctly American: pretzel croissants (surprisingly tasty), and recipes for making money.”

Second, know the determinants of demand for your product:

There are no brownies or carrot cake on Mondays or Tuesdays—people don’t buy rich desserts after decadent weekends. He watches the weather closely, as demand melts in the rain. He keeps an eye on school calendars, to bake less when children are away. He bakes more after the fasting of Yom Kippur, when demand from Jewish customers picks up.

The article provides an excellent example of how important it is for a producer of a good in a competitive market must be intimately familiar with his consumers in order to succeed. Markets are most efficient when perfect information and knowledge of the desires of consumers is communicated to producers, but in many markets there is information asymmetry, meaning that the sellers do not know what consumers truly want and are therefore unable to bring to market those goods and services that are most in demand.

Mr. Rubin’s bakery has discovered the secret to success in a competitive market: Know thine determinants of demand and make sure you only produce precisely what it is consumers want, and do so at the least possible cost in order to eliminate waste. In this way, Economic Darwinism assures the survival of the most efficient. 

Such strategies have helped the City Bakery survive since 1990. It now has seven smaller shops in New York and seven outposts in Japan, with plans to open in Dubai.

Planet Money – The Raisin Outlaw

When a competitive industry acts like a monopoly, the consumers are the losers, the producers are the winners, and a market that may have been efficient is made less so. But how can this type of collusion be possible, and what happens when collusive agreements fall apart?

NPR’s Planet Money tells the story of a collusive agreement, and what happened when one producer betrayed the agreement.

Gas pushes up cost for Triangle delivery restaurants – Economy – NewsObserver.com

Read the article below and answer the discussion questions that follow:

Do you love the convenience of having your pepperoni pizza or egg foo young delivered right to your door?

If gas prices continue to rise in the next few months, it might cost you more for the privilege depending on where you order.

Triangle-area delivery restaurants worry about the impact higher gas prices could have on their businesses. It’s a concern that is felt among these restaurants nationwide.

On Sunday, the average price for regular unleaded gas in North Carolina was about $3.71, according to AAA. The website raleighgasprices.com listed prices as low at $3.54 in Fuquay-Varina and as high as $3.89 in Cary.

HotBox Pizza on Hillsborough Street charges $2 for a delivery to help offset the costs of gas for its drivers. While owner James McCaskill said there are no imminent plans to raise that fee, he does worry that it could cost more to get food shipments in.

“For us to deliver the pizza, there’s a cost,” McCaskill said. “We have to pay for our drivers and the wear and tear on their car and essentially to help pay for the gas they use to deliver the pizzas.”

Bruno Rodriguez, owner of Amante Gourmet Pizza in Durham, said back in 2008 when gas hovered around $4 a gallon, the effects weren’t so bad because the hike was short lived. But he’s more worried about it in 2012 during a time when roughly 60 percent of his orders are for delivery.

“I think we’re coming slowly out of a recession, but I think with gas prices around $4, I think it’s going to be longer lived so that definitely will have an impact,” he said. “People will tend to not order many deliveries.”

Rodriguez said Amante charges $1.40 for deliveries in the Bull City, and he probably spends about $40 or $50 a week on gas for deliveries. Fortunately for him, he has a small Toyota, but he isn’t ruling out raising his delivery charge 20 or 30 cents if things get worse.

Shanghai Express, across from N.C. State University on Hillsborough Street, serves primarily college students.

“The economy is no good, so business definitely goes down,” said manager Jinlong Wang, who estimates about half of his orders are deliveries. “Their parents pay their tuition. But when economy no good, parents have no money and (students) have no money too.”

Many experts are debating whether gas could reach $5 a gallon by this summer. That could potentially cripple many businesses.

“If it stays there for too long, it will be a problem,” Rodriguez said. “I think sales are going to go down.”

Rodriguez said the key to keeping gas prices reasonable is not action by lawmakers in Washington, but in how all Americans act.

“It’s up to us to control how much we drive, how hard we drive, what kind of cars do we drive. I’m not sure Washington can do much except drill more in more dangerousplaces,” he said.

Discussion Questions:

1. How do rising gas prices affect the short-run costs of running a delivery service for local restaurants in North Carolina?
2. Why were the high gas prices in 2008 less of a concern that the rising gas prices in 2012 for these restaurants?
3. Assume the restaurant delivery industry is perfectly competitive and at the beginning of 2012 was in a long-run equilibrium. Using two diagrams, one for the restaurant delivery industry and one for a single restaurant in the industry, illustrate the effect of rising gas prices on the individual firms in the short-run.
4. Assume gas prices remain high throughout 2012 and into 2013. How will the industry adjust to higher gas prices in the long-run? Illustrate the long-run adjustment in your graphs.
5. “The economy is no good, so business definitely goes down.” Which determinant of demand for restaurant meals is described here? How does the bad economy affect the restaurant industry and firms in the industry? In new diagrams, show the effect of the poor economy on the market and a single restaurant in the market. 

I have recently been showing my AP and IB Econ classes the following New Yorker interview with Columbia Professor Tim Wu, the man who coined the phrase “net neutrality”. Wu shares his views on the “cycles” of competition in the communications industry, from radio, telephone and television in the 20th century to the internet and the “mobile web” today.

I find it a useful video for starting discussions about the pros and cons of perfectly competitive markets (represented by the “chaotic” period of any new communications technology) and imperfectly, more monopolistic industries (represented by the period later in the cycle of any communications technology when market power becomes concentrated among a few large firms).

Watch the video and pause it along the way to discuss some of the questions below.

Currents: Tim Wu on Communication, Chaos, and Control : The New Yorker

Discussion Questions:

1. Why are new communications industries often characterized by “chaos” in their early years? How did the internet industry reflect the perfectly competitive characteristics in its early days, or even 10 years ago?
2. How are consumers affected as communications industries go from “chaos” to control under big companies like Apple and Google?
3. How does the behavior of firms like Google and Apple demonstrate the concept of non-price competition?
4. Would the technology industry be more efficient if it were more competitive?
5. Can you envision a world in which all of our online activities are done through one company, i.e. the “Googlenet” or the “Facebooknet” instead of the “Internet”? Would that world be better or worse than what we have now? Why?
6. How is the communications industry today similar to the telephone industry 30 years ago? How is it different?
7. Tim Wu suggest that in the future there will be no internet. Discuss as a class what you envision as a possible successor to the internet.
8. If you had a time machine and could travel back to 1970, how would you try to explain to someone on the stree how we communicate with one another in 2011. How would you have tried to explain the internet and smart phones? Do you think someone from 1970 would believe your descriptions of products like Skype, like Google, like a phone you could watch movies on, like video chat, like “Google goggles”, etc…?
9. If someone from 40 years in the future arrived in 2011 and tried to explain to you how humans are communicating in 2050, do you think you would believe them?
10. Economist Joseph Schumpeter referred to capitalism as a system driven by a system of “creative destruction”. How does the history of the communications industry demonstrate the concept of “creative destruction”?

Imperfect competition in the News: After watching the video and discussion the questions with your class, go to Welker’s Wikinomics Universe and follow the link to the “Econ News” tab.  Browse the headlines from the various news feeds and look for articles that you think may be about non-price competition between firms in a monopolistically competitive or an oligopolistic market.

When you’ve found one good article, open your Diigo toolbar and add highlights to the lines in the article that you think demonstrate non-price competition between the firms described. Add one or two sticky notes using the Diigo toolbar, and when you’ve added your own thoughts, bookmark the article. Be sure to share it to your class’s group before bookmarking it so your classmates can view your highlights and sticky notes online.

If there is time left in class, log into your Diigo account and visit our class group. Read some of the highlights from your classmates’ articles and discuss with the people around you the various types of non-price competition described.

Efficiency means more than just producing in the least cost manner. To be efficient a market must also allocate the right amount of resources towards the production of the good or service it provides. Allocative efficiency occurs when land, labor and capital are allocated towards the production of goods and services in combinations that are socially optimal. In other words, the right amount of output of various products is being produced given the demands of consumers in the economy and the costs faced by firms.

Because of firms’ profit maximizing behavior, perfectly competitive markets allocate resources efficiently, neither over nor under-producing the goods consumers demand.

Allocative Efficiency: P=MC

Under the conditions of perfect competition, a market will be allocatively efficient as long as the firms in that market produce at the P=MC level of output. Price is a signal from buyers to sellers, and the price seen by firms signals the marginal benefit of consumers in the market. If the price consumers pay for a product is greater than the marginal cost to firms of producing it, then the message being sent to producers is that more output is demanded. In the pursuit of profits, more resources will be allocated towards the production of the product until the marginal cost and the price are equal. At the P=MC point firms maximize their profits and resources are said to be efficiently allocated.

Graph: Profit maximizing behavior leads to allocative efficiency

Assume that the firm on the right represents the typical firm in a perfectly competitive market. When firms produce at Q1 level of output, resources are under-allocated towards this good, since the price consumers are willing to pay (Pe, determined by market supply and demand) is greater than firms’ marginal cost of production. Notice that when individual firms produce Q1 units, the market supply of Qs is less than the market demand of Qd; there is a shortage in the industry as long as firms produce only Q1 units.

However, firms are unlikely to produce at this socially undesirable level for long because in their pursuit of profits they will increase their output to the quantity at which marginal cost equals the price. When they increase their output to Qf, firms maximize their profits and as a result the shortage in the market that existed when firms produced at Q1 is eliminated, improving social welfare and maximizing the total amount of consumer and producer surplus (the combined areas of the pink and green triangles in the industry graph).

Because of the profit maximizing behavior of self-interested business managers in the competitive market above, resources are more efficiently allocated than they would be otherwise. The price determined by supply and demand in the market signals the benefit society derives from this good, and as long as the price is greater than the marginal cost, the message sent from buyers to seller is “WE WANT MORE!” On the other hand, if at a given level of output marginal cost exceeds the price, resources are over-allocated towards the good. The message sent in such a market is that consumers value the product less than it costs firms to produce, so firms will reduce their output to maximize profits, correcting the over-allocation of resources and restoring a socially optimal level of output.

Allocative efficiency is achieved in a perfectly competitive market precisely because firms will always wish to maximize their profits by producing the quantity of goods at which their marginal cost equals the price.

The article Farmers May Switch Crops Due to Labor Shortage discusses some the effects of rising costs on a perfectly competitive market. Read the extract below and answer the questions that follow.

Farmers may change their crops due to the shortage of immigrant labor. Of all crops, fresh fruits and vegetables are the most labor intensive. Lettuce, strawberries and broccoli all have to be picked by hand. In Arizona, farmers are passing on chili peppers to plant corn, which is harvested by machine.

After 37 years, Ed Curry is not planting green chili anymore because corn can be harvested by machines; green chili can’t.

Curry explains, “It would take about 250 people to pick this year’s chili crop. With immigration tightened up the way it is, well, number one, we just can’t get the labor.”

About seven years ago, Ed Curry was busted for using illegal labor. Today his workers are legal. They go back and forth from Mexico each day, making seven to $8 an hour. Most are in their 50s and 60s. One man is 72 years old. Younger workers can’t get visas or don’t want the jobs. So as his workers age and his workforce dwindles, Ed Curry says he’s thinking about moving some of his operation to Mexico.

“We’re down to survival. Am I going to stay in this or not? And if I’m going to stay in it, I’ve got to do it where there’s plenty of labor and we can be competitive.”

That’s one farmer’s plight. The Western Growers Association based in California represents 3,000 farmers across the region. Its president, Tom Nassif, says farmers need Congress to pass legislation that will allow more workers in, something he says it should have done already.

Nassif says his association polled a dozen members and found more than 40,000 acres had moved to Mexico in the last year or so.

Exercise:

1. Assuming the market for chili peppers is perfectly competitive, illustrate the effects of the shortage of immigrant workers on the short-run production costs and profits of chili farmers in the American Southwest.
2. Based on your answer to #1, explain how the chili market will evolve in the long-run in response to the shortage of immigrant workers. How will the market for corn and other capital-intensive agricultural commodities be affected?
3. Assume the US chili pepper market reaches a new long-run equilibrium following the shortage of immigrant labor. Now demand for chili peppers increases. Use a diagram to illustrate how the profit maximizing behavior of chili pepper farmers assures that there will not be a shortage of chili peppers following the increase in consumers’ demand.

Discussion Questions: In their pursuit of economic profits, firms in a competitive market will, through their collective pursuit of self-interest, inadvertently achieve an allocation of society’s scarce resources that is socially optimal.

1. Discuss the view that allocative efficiency as defined in this chapter is a socially desirable outcome.
2. Is it accurate to say that goodness can be achieved through greediness in a market economic system?