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Pure Competition
23C H A P T E R
Market Structure Continuum
FOUR MARKET MODELS
Pure Competition
Market Structure Continuum
PureCompetition
FOUR MARKET MODELS
Imperfect Competition
All Markets that areNot Purely Competitive
Market Structure Continuum
PureCompetition
FOUR MARKET MODELS
Pure Monopoly
Market Structure Continuum
PureCompetition
PureMonopoly
FOUR MARKET MODELS
Monopolistic Competition
Market Structure Continuum
PureCompetition
PureMonopoly
MonopolisticCompetition
FOUR MARKET MODELS
Oligopoly
Market Structure Continuum
PureCompetition
PureMonopoly
MonopolisticCompetition Oligopoly
FOUR MARKET MODELSPure Competition:• Very Large Numbers• Standardized Product• “Price Takers”• Free Entry and Exit
DEMAND AS SEEN BY APURELY COMPETITIVE SELLER
Perfectly Elastic DemandPrice Taker Role
For example...
$131 0 $ 0
Product Price (P)(Average Revenue)
TotalRevenue (TR)
MarginalRevenue (MR)
QuantityDemanded (Q)
DEMAND AS SEEN BY APURELY COMPETITIVE SELLER
$131 131
0 1
$ 0131
$131
Product Price (P)(Average Revenue)
TotalRevenue (TR)
MarginalRevenue (MR)
QuantityDemanded (Q)
DEMAND AS SEEN BY APURELY COMPETITIVE SELLER
]
$131 131131
0 1 2
$ 0131262
$131131
Product Price (P)(Average Revenue)
TotalRevenue (TR)
MarginalRevenue (MR)
QuantityDemanded (Q)
DEMAND AS SEEN BY APURELY COMPETITIVE SELLER
]]
$131 131131131
0 1 23
$ 0131262393
$131131131
Product Price (P)(Average Revenue)
TotalRevenue (TR)
MarginalRevenue (MR)
QuantityDemanded (Q)
DEMAND AS SEEN BY APURELY COMPETITIVE SELLER
]]]
$131 131131131131
0 1 234
$ 0131262393524
$131131131131
Product Price (P)(Average Revenue)
TotalRevenue (TR)
MarginalRevenue (MR)
QuantityDemanded (Q)
DEMAND AS SEEN BY APURELY COMPETITIVE SELLER
]]]]
$131 131131131131131131131131131131
0 1 23456789
10
$ 0131262393524655786917
104811791310
$131131131131131131131131131131
Product Price (P)(Average Revenue)
TotalRevenue (TR)
MarginalRevenue (MR)
QuantityDemanded (Q)
DEMAND AS SEEN BY APURELY COMPETITIVE SELLER
]]]]]]]]]]
$131 131131131131131131131131131131
0 1 23456789
10
$ 0131262393524655786917
104811791310
$131131131131131131131131131131
Product Price (P)(Average Revenue)
TotalRevenue (TR)
MarginalRevenue (MR)
QuantityDemanded (Q)
DEMAND AS SEEN BY APURELY COMPETITIVE SELLER
]]]]]]]]]]
GraphicallyPresented…
DEMAND, MARGINAL REVENUE, AND TOTAL
REVENUE IN PURE COMPETITION
TR
D = MR
1 2 3 4 5 6 7 8 9 10
1179
1048
917
786
655
524
393
262
131
0
Pri
ce
an
d r
ev
enu
e
Quantity Demanded (sold)
SHORT-RUN PROFIT MAXIMIZATIONTwo Approaches...
First:Total-Revenue -Total Cost Approach
The Decision Rule:Produce in the short-run if it can realize
1- A profit (or)2- A loss less than its fixed costs
The Decision Process:•Should the firm produce?•What quantity should be produced?•What profit or loss will be realized?
SHORT-RUN PROFIT MAXIMIZATIONTwo Approaches...
First:Total-Revenue -Total Cost Approach
The Decision Rule:Produce in the short-run if it can realize
1- A profit (or)2- A loss less than its fixed costs
The Decision Process:•Should the firm produce?•What quantity should be produced?•What profit or loss will be realized?
AppliedGraphically…
TotalCost
0 1 23456789
10
TotalProduct
TotalFixedCost
TotalVariable
CostTotal
Revenue Profit
$ 100 100 100100100100100100100100100
$ 090
170240300370450540650780930
$ 100190270340400470550640750880
1030
Price: $131
- $100- 59
- 8+ 53
+ 124+ 185+ 236+ 277+ 298+ 299+ 280
TOTAL REVENUE-TOTAL COST APPROACH
$ 0131262393524655786917
104811791310
Can you see the
profit maxim
ization?
TotalCost
0 1 23456789
10
TotalProduct
TotalFixedCost
TotalVariable
CostTotal
Revenue Profit
$ 100 100 100100100100100100100100100
$ 090
170240300370450540650780930
$ 100190270340400470550640750880
1030
Price: $131
- $100- 59
- 8+ 53
+ 124+ 185+ 236+ 277+ 298+ 299+ 280
TOTAL REVENUE-TOTAL COST APPROACH
$ 0131262393524655786917
104811791310
Graphing Total
Cost & Revenue
$1,8001,7001,6001,5001,4001,3001,2001,1001,000 900 800 700 600 500 400 300 200 100 0
Tota
l re
ven
ue
an
d t
ota
l co
st
TotalRevenue
TotalCost
MaximumEconomic
Profits$299
Break-Even Point(Normal Profit)
Break-Even Point(Normal Profit)
1 2 3 4 5 6 7 8 9 10 11 12 13 14
TOTAL REVENUE-TOTAL COST APPROACH
SHORT-RUN PROFIT MAXIMIZATIONTwo Approaches...
First:Total-Revenue -Total Cost Approach
Three Characteristics of MR=MC Rule:• The rule applies only if producing
is preferred to shutting down• Rule applies to all markets• Rule can be restated P=MC
Second:Marginal-Revenue -Marginal Cost
Approach
MR = MC Rule
AverageTotalCost
0 1 23456789
10
TotalProduct
AverageFixedCost
AverageVariable
Cost
Price =MarginalRevenue
TotalEconomicProfit/Loss
$100.00
50.00 33.3325.0020.0016.6714.2912.5011.1110.00
$90.0085.0080.0075.0074.0075.0077.1481.2586.6793.00
$190.00135.00113.33100.00
94.0091.6791.4393.7597.78
103.00
- $100- 59
- 8+ 53
+ 124+ 185+ 236+ 277+ 298+ 299+ 280
MARGINAL REVENUE-MARGINAL COST APPROACH
$ 131131131131131131131131131131
MarginalCost
90807060708090
110130150
Thesame profitmaximizing
result!
AverageTotalCost
0 1 23456789
10
TotalProduct
AverageFixedCost
AverageVariable
Cost
Price =MarginalRevenue
TotalEconomicProfit/Loss
$100.00
50.00 33.3325.0020.0016.6714.2912.5011.1110.00
$90.0085.0080.0075.0074.0075.0077.1481.2586.6793.00
$190.00135.00113.33100.00
94.0091.6791.4393.7597.78
103.00
- $100- 59
- 8+ 53
+ 124+ 185+ 236+ 277+ 298+ 299+ 280
MARGINAL REVENUE-MARGINAL COST APPROACH
$ 131131131131131131131131131131
MarginalCost
90807060708090
110130150
Graphically
$200
150
100
50
0
Co
st a
nd
Rev
enu
e
1 2 3 4 5 6 7 8 9 10
MC
MR
AVCATC
Economic Profit
$131.00
$97.78
MARGINAL REVENUE-MARGINAL COST APPROACH
Profit Maximization Position
$200
150
100
50
0
Co
st a
nd
Rev
enu
e
1 2 3 4 5 6 7 8 9 10
MC
MR
AVCATC
Economic Profit
$131.00
$97.78
MARGINAL REVENUE-MARGINAL COST APPROACH
MR = MCOptimumSolution
Profit Maximization Position
the MR=MC rule still applies
If the price is lowered from $131 to $81…
…but the MR = MC point changes.
MARGINAL REVENUE-MARGINAL COST APPROACH
Loss Minimization Position
$200
150
100
50
0
Co
st a
nd
Rev
enu
e
1 2 3 4 5 6 7 8 9 10
MC
MRAVCATC
Economic Loss
$81.00$91.67
MARGINAL REVENUE-MARGINAL COST APPROACH
Loss Minimization Position
$200
150
100
50
0
Co
st a
nd
Rev
enu
e
1 2 3 4 5 6 7 8 9 10
MC
MR
AVCATC
$71.00
MARGINAL REVENUE-MARGINAL COST APPROACH
Short-Run Shut Down Point
Minimum AVCis the Shut-Down
Point
MARGINAL REVENUE-MARGINAL COST APPROACH
Marginal Cost & Short-Run Supply
Price
QuantitySupplied
Maximum Profit (+)Or Minimum Loss (-)
Observe the impact upon profitability as price is changed
$151 131 111 91 81 71 61
10987600
$+480+299
+138 -3
-64 -100 -100
Co
st a
nd
Rev
enu
e, (
do
llar
s)MC
MR1
AVC
ATC
MARGINAL REVENUE-MARGINAL COST APPROACH
Quantity Supplied
MR2
MR3
MR4
MR5
P1
P2
P3
P4
P5
Q2 Q3 Q4 Q5
Marginal Cost & Short-Run Supply
Do notProduce –Below AVC
Break-even(Normal Profit)Point
Co
st a
nd
Rev
enu
e, (
do
llar
s)MC
MR1
MARGINAL REVENUE-MARGINAL COST APPROACH
Quantity Supplied
MR2
MR3
MR4
MR5
P1
P2
P3
P4
P5
Q2 Q3 Q4 Q5
Marginal Cost & Short-Run SupplyYields theShort-Run
Supply Curve
Supply
NoProductionBelow AVC
MARGINAL REVENUE-MARGINAL COST APPROACH
Marginal Cost & Short-Run Supply
AVC2
MC2
Higher Costs Move theSupply Curve to the Left
Co
st a
nd
Rev
enu
e, (
do
llar
s)
MC1
AVC1
Quantity Supplied
S1
S2
MARGINAL REVENUE-MARGINAL COST APPROACH
Marginal Cost & Short-Run Supply
AVC2
MC2
Lower Costs Movethe Supply Curve
to the Right
Co
st a
nd
Rev
enu
e, (
do
llar
s)
MC1
AVC1
Quantity Supplied
S1
S2
P
Q
S=MC
AVC
ATC
8
D
P
Q8000
D
S= MCs
IndustryFirm(price taker)
EconomicProfit
$111$111
SHORT-RUN COMPETITIVE EQUILIBRIUM
The Competitive Firm “Takes” itsPrice from the Industry Equilibrium
P
Q
S=MC
AVC
ATC
8
D
P
Q8000
D
S= MCs
IndustryFirm(price taker)
EconomicProfit
$111$111
SHORT-RUN COMPETITIVE EQUILIBRIUM
The Competitive Firm “Takes” itsPrice from the Industry Equilibrium
How about thelong-run?
PROFIT MAXIMIZATION IN THE LONG RUN
Assumptions...• Entry and Exit Only• Identical Costs• Constant-Cost Industry
Goal of the AnalysisPrice = Minimum ATCLong-Run Equilibrium - TheZero Economic Profit Model
Temporary profits and the reestablishmentof long-run equilibrium
S1
MCATC
P
Q100
P
Q100,000
IndustryFirm(price taker)
$60
50
40
$60
50
40
PROFIT MAXIMIZATION IN THE LONG RUN
MR
D1
An increase in demand increases profits…
MR
D1
MCATC
P
Q100
P
Q100,000
IndustryFirm(price taker)
$60
50
40
$60
50
40
PROFIT MAXIMIZATION IN THE LONG RUN
D2
EconomicProfits
S1
New competitors increase supply, and lowerprices decrease economic profits.
MR
D1
MCATC
P
Q100
P
Q100,000
IndustryFirm(price taker)
$60
50
40
$60
50
40
PROFIT MAXIMIZATION IN THE LONG RUN
D2
Zero EconomicProfits
S1
S2
Decreases in demand, losses, and the reestablishment of long-run equilibrium
S1
MCATC
P
Q100
P
Q100,000
IndustryFirm(price taker)
$60
50
40
$60
50
40
PROFIT MAXIMIZATION IN THE LONG RUN
D1
MR
A decrease in demand creates losses…
MR
D1
MCATC
P
Q100
P
Q100,000
IndustryFirm(price taker)
$60
50
40
$60
50
40
PROFIT MAXIMIZATION IN THE LONG RUN
D2
EconomicLosses
S1
MR
D1
MCATC
P
Q100
P
Q100,000
IndustryFirm(price taker)
$60
50
40
$60
50
40
PROFIT MAXIMIZATION IN THE LONG RUN
D2
Return to ZeroEconomic Profits
S1
S3
Competitors with losses decrease supply, andprices return to zero economic profits.
LONG-RUN SUPPLY IN ACONSTANT COST INDUSTRY
Constant Cost Industry
Perfectly Elastic Long-Run Supply
Graphically...
P
Q
=$50 S
D1
Z1
Q1
D2
Z2
Q2Q3
D3
Z3
100,000 110,00090,000
LONG-RUN SUPPLY IN ACONSTANT COST INDUSTRY
P1
P2
P3
P
Q
=$50 S
D1
Z1
Q1
D2
Z2
Q2Q3
D3
Z3
100,000 110,00090,000
LONG-RUN SUPPLY IN ACONSTANT COST INDUSTRY
P1
P2
P3
How does an increasingcost industry differ?
P
Q
$555045
S
D1
Y1
Q1
D2
Y2
Q2Q3
D3
Y3
100,000 110,00090,000
LONG-RUN SUPPLY IN ANINCREASING COST INDUSTRY
P1
P2
P3
P
Q
$555045
S
D1
Y1
Q1
D2
Y2
Q2Q3
D3
Y3
100,000 110,00090,000
P1
P2
P3
How does adecreasing costindustry differ?
LONG-RUN SUPPLY IN ANINCREASING COST INDUSTRY
P
Q
$555045
S
D1
Y1
Q1
D2
Y2
Q2Q3
D3
Y3
100,000 110,00090,000
P1
P2
P3
What is the long-run competitive
equilibrium?
LONG-RUN SUPPLY IN ANINCREASING COST INDUSTRY
P MR
Q
MCATC
Quantity
Pri
ce
Price = MC = Minimum ATC(normal profit)
LONG-RUN EQUILIBRIUM FOR A COMPETITIVE FIRM
PURE COMPETITION AND EFFICIENCY
Productive EfficiencyPrice = Minimum ATC
Allocative EfficiencyPrice = MC
UnderallocationPrice > MC
OverallocationPrice < MC
PURE COMPETITION AND EFFICIENCY
Productive EfficiencyPrice = Minimum ATC
Allocative EfficiencyPrice = MC
UnderallocationPrice > MC
OverallocationPrice < MC
Resources are
efficiently allocated
under competition
PURE COMPETITION AND EFFICIENCY
Productive EfficiencyPrice = Minimum ATC
Allocative EfficiencyPrice = MC
UnderallocationPrice > MC
OverallocationPrice < MC
ConsumerSurplus
PURE COMPETITION AND EFFICIENCY
Productive EfficiencyPrice = Minimum ATC
Allocative EfficiencyPrice = MC
UnderallocationPrice > MC
OverallocationPrice < MC
Coming Next...
Pure Monopoly
Chapter 24