4. The Struggling Masses

Two places, in isolation from the rest of the world, each meet the requirements of a perfectly competitive market. In Model 4A, the unit shipping cost is prohibitive. Each place is in autarky. Price locally reflects only local demand and local supply. However, if the unit shipping cost is low, arbitrageurs purchase where price is low for resale at the other place. In Model 4B, unit shipping cost is zero everywhere, and there is a common equilibrium price at the two places. A change in any parameter of local demand or local supply at either place can affect this price. In Model 4C, shipping cost is neither prohibitive nor zero. Here, shipping occurs up the price gradient. Because of the actions of arbitrageurs, the price difference between the two places shrinks to the unit shipping cost. Corner solutions—in which either demand or supply drops to zero in one or the other of the two places—are solved and interpreted. The models in this chapter are the competitive market equivalent of the models of a monopolist in Chapter 2. However, as in Chapter 3, congestion in production means that unit cost rises the more output the industry produces. Usually, we imagine that competition causes excess profit to disappear. However, the notion of congestion (an upward sloped supply curve) here in Chapter 4 means that some producers are less efficient than others. More efficient suppliers earn a monopoly profit even in competitive markets. In this chapter, localization of production, prices (one for each place), and excess profit (for all but the marginal producer) are joint outcomes of a competitive market.