Chapter 9 PPT[1]

8/8/2019 Chapter 9 PPT[1]

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ECONOMICS: EXPLORE & APPLYECONOMICS: EXPLORE & APPLY

Enhanced EditionEnhanced Edition

Chapter Chapter 99

Pure CompetitionPure Competition



Learning ObjectivesLearning Objectives

1.1. Name four market types and describe theName four market types and describe the

characteristics of pure competition.characteristics of pure competition.

2.2. Illustrate how market demand and supplyIllustrate how market demand and supply

determine the competitive firm¶s demanddetermine the competitive firm¶s demand

curve.curve.

3.3. Identify the competitive firm¶s shortIdentify the competitive firm¶s short--run supplyrun supply

curve.curve.

4.4. Describe the longDescribe the long--run equilibrium in purerun equilibrium in pure

competition. competition.



Learning ObjectivesLearning Objectives

5.5. Explain how efficiency is achieved in aExplain how efficiency is achieved in a

purely competitive market.purely competitive market.

6.6. Specify the difference between aSpecify the difference between aconstantconstant--cost, increasing cost, andcost, increasing cost, and

decreasing cost industry.decreasing cost industry.

7.7. Show how competition can reduceShow how competition can reduce

discrimination in society.discrimination in society.



9.1 Types of Markets

oo There are clearly different types of markets whichThere are clearly different types of markets which

are commonly calledare commonly called industriesindustries (by number of (by number of

suppliers).suppliers).

oo Markets also differ according to whether theMarkets also differ according to whether theproduct is homogenous or differentiated.product is homogenous or differentiated.

oo H omogeneous productsH omogeneous products are identical no matter whichare identical no matter which

firms produces them, and are often called commodities.firms produces them, and are often called commodities.

oo Differentiated productsDifferentiated products will vary from one producer towill vary from one producer tothe next.the next.

oo These differences lead to four differentThese differences lead to four different market market

structures,structures, which are models of the way marketswhich are models of the way markets

work. work.



What do you think? Coca-cola and Pepsi are homogonous

products?

What about your cloths? Ipod and different MP3 players? So you see a product doesn¶t have to

be different we, as consumers, justneed to think it is.





Types of MarketsTypes of Markets

Homogeneous product Differentiated product

One firmMonopoly

(example: city drinking water) Not applicable

Few firms

Oligopoly

(example: gasoline refineries)

Oligopoly

(example: automakers)

Many firms

Pure competition

(example: farmers)

Monopolistic competition

(example: restaurants)



What do you think? In the last lesson we talked about

price taking firms.

In which kind of a market can a firmdictate the price? If you open a new firm, to which type

of market do you think it would beharder for you to enter?



The Spectrum of Market

Models

00PurePure

CompetitionCompetition

MonopolisticMonopolistic

CompetitionCompetitionOligopolyOligopoly MonopolyMonopoly

Less Market Power Less Market Power More Market Power More Market Power

The termThe term market power market power

refers to the degree of refers to the degree of

influence over price byinfluence over price by

the individual firm.the individual firm.



Characteristics of Characteristics of


Numerous buyers and sellersNumerous buyers and sellers

H omogeneous product H omogeneous product

Firms do not advertise in pureFirms do not advertise in purecompetitioncompetition

Costless entry and exit of all firms.Costless entry and exit of all firms.

Firms are price takers with a perfectly Firms are price takers with a perfectly elastic demand! A price taker always sellselastic demand! A price taker always sells

at the market price.at the market price.



Pure competition is characterizedPure competition is characterized

by:by:

A) Few buyers and

sellers

B) A homogeneous

product

C) High costs of entry

and exit of firms

C) High costs of entry

and exit of firms



9.2 THE FIRM¶S DEMAND AND

SUPPLY CURVES

Market Market

Supply Supply

Market Market

Demand Demand

Market

Price

Market

Quantity

Fi rm¶sFi rm¶s

Supply Supply

Fi rm¶sFi rm¶s

Demand Demand

Firm¶s

Output

MarketMarket FirmFirm



Because firms in pure competitionBecause firms in pure competition

are price takers, the firmare price takers, the firm¶¶ss

demand curve is:demand curve is:

A) Upward sloping

B) Downward sloping

C) Horizontal

D) Vertical



ShortShort--Run SupplyRun Supply

oo At any price above the shutdown price, theAt any price above the shutdown price, theprofitprofit--maximizing firm equates marginal revenuemaximizing firm equates marginal revenueand marginal cost.and marginal cost.

oo Because the price taking firm¶s marginalBecause the price taking firm¶s marginalrevenue equals the market price, the firmrevenue equals the market price, the firmproduces the quantity associated with itsproduces the quantity associated with itsmarginal cost curve at that price.marginal cost curve at that price.

oo T he price taking firm¶s short T he price taking firm¶s short- -run supply curve isrun supply curve isthat part of its marginal cost curve that liesthat part of its marginal cost curve that liesabove average variable cost.above average variable cost.



Supply in Pure

Competition

MarketMarketFirmFirm

Marginal CostMarginal Cost

AverageAveragevariablevariable

costcost

Shutdown

price

$160

6

$250

7 6000 7000

Firm¶sFirm¶ssupplysupply

MarketMarketsupplysupply



Supply in Pure

Competition

MarketMarketFirmFirm

Marginal CostMarginal Cost

AverageAveragevariablevariable

costcost

Shutdown

price

$160

6

$250

7 6000 7000

Firm¶sFirm¶ssupplysupply

MarketMarketsupplysupply

Firms supply is itsFirms supply is its

marginal costmarginal costcurve above itscurve above its

shutdown price.shutdown price.

For each price,For each price,

the market supplythe market supply

adds up theadds up the

Quantities suppliedQuantities supplied

by each firm.by each firm.





99..3 3 THE LONGTHE LONG--RUNRUN-- Entry, Exit, and EfficiencyEntry, Exit, and Efficiency

In the shortIn the short--run, the market price could berun, the market price could besufficiently high that the firm earns profits, or itsufficiently high that the firm earns profits, or itcould be so low that the firm loses money.could be so low that the firm loses money.

ShortShort--run profits attract new firms to enter the market.run profits attract new firms to enter the market.

ShortShort--run losses cause existing firms to leave therun losses cause existing firms to leave theindustry.industry.

TheThe long long- -run equilibriumrun equilibrium market price results inmarket price results inthe expectation of the expectation of zero profit zero profit for a firm that isfor a firm that is

considering entry into the industry.considering entry into the industry.Zero profit means the firm is breaking even, that is,Zero profit means the firm is breaking even, that is,earning a normal profit. (remember you are economistsearning a normal profit. (remember you are economistsnot accountants)not accountants)

In the long run, only advantages will mean aboveIn the long run, only advantages will mean above

normal profitnormal profit



Profit Attracts New Entrants

Losses Cause Firms to Leave

Quantity

I ni t i al Supply I ni t i al Supply

Demand Demand

Initial Price

Supply after Ex i t Supply after Ex i t

Supply after Supply after

Entry Entry

Higher Price

after Exit

Lower Priceafter Entry



LongLong--Run Equilibrium inRun Equilibrium in


Market Market

Supply Supply

Market Market

Demand Demand

Market Price

Market

Quantity

Marg i nal Marg i nal

cost cost

Fi rm¶sFi rm¶s

Demand Demand

Firm¶s

Output

MarketMarket FirmFirm

Average Average

cost cost

Adjusts until price

leaves firms withonly a normal profit.

= price

= marginalrevenue

The longThe long--run equilibrium in pure competition occurs when the last firm to enter run equilibrium in pure competition occurs when the last firm to enter

the market earns zero profits, as shown by the firm¶s average cost curve justthe market earns zero profits, as shown by the firm¶s average cost curve justtangent to its demand. There would be no reason for a new firm to enter and notangent to its demand. There would be no reason for a new firm to enter and no



The Efficiency of Pure CompetitionThe Efficiency of Pure Competition

The competitive market equilibrium produces anThe competitive market equilibrium produces an

allocatively efficient amount of output.allocatively efficient amount of output.

Competition also forces firms to keep cost inCompetition also forces firms to keep cost in

check, thus inducing technological efficiency ascheck, thus inducing technological efficiency aswell.well.

For these reasons the model of pure competitionFor these reasons the model of pure competition

is often used as the standard of efficiency byis often used as the standard of efficiency by

which other market structures are judged.which other market structures are judged.



The Efficiency of Pure CompetitionThe Efficiency of Pure Competition

Supply Supply

Demand Demand

Competitive

OutputToo Much

Output

Supply Supply

Competitive

OutputToo Little

Output

Demand Demand

Maximum

social surplus

Surplus lost

from producing

too much

Surplus foregone

from producingtoo little



In the longIn the long--run equilibrium, allrun equilibrium, allthe firms will:the firms will:

A) Earn an economic

profit

B) Break even

C) Have losses

D) None of the above;

some will have

profits, some will

break even, and some

will have losses



99..4 4 LONG RUN SUPPLYLONG RUN SUPPLY

The expansion or contraction of The expansion or contraction of industries over time sometimes affectsindustries over time sometimes affectsthe cost of production in that industry.the cost of production in that industry.

In response to entry, input prices mightIn response to entry, input prices mightremain unchanged, rise, or fall, whichremain unchanged, rise, or fall, whichgives rise to three industry types«.gives rise to three industry types«.

ConstantConstant--cost industrycost industry

IncreasingIncreasing--cost industrycost industry

DecreasingDecreasing--cost industrycost industry



LongLong--Run CharacteristicsRun Characteristics

of Industriesof Industries

Constant Constant- -cost industry;cost industry; an increase in thean increase in theindustry¶s output does not affect the costindustry¶s output does not affect the costof production (resource prices are fixed). of production (resource prices are fixed).

I ncreasing I ncreasing- -cost industry;cost industry; an increase inan increase inthe industry¶s output causes input pricesthe industry¶s output causes input pricesto rise (resource prices will go upto rise (resource prices will go upaccording to demand).according to demand).

Decreasing Decreasing- -cost industry;cost industry; an increase inan increase inthe industry¶s output causes input pricesthe industry¶s output causes input pricesto fall (resource prices will go down withto fall (resource prices will go down withhigher demand).higher demand).



Perfect Competition andPerfect Competition and

LongLong--Run SupplyRun Supply

Perfect competitionPerfect competition is a variant of pureis a variant of purecompetition.competition.

Perfect competition adds to the model of purePerfect competition adds to the model of purecompetition a further assumption that all firmscompetition a further assumption that all firmsare identical, with access to resources andare identical, with access to resources andtechnology, with all information fully and freelytechnology, with all information fully and freelyavailable.available.

In a constantIn a constant--cost industry, the entry of newcost industry, the entry of newfirms would have no effect on the productionfirms would have no effect on the productioncost of other firm¶s, and with perfectcost of other firm¶s, and with perfectcompetition, expansion of the industry wouldcompetition, expansion of the industry wouldlead to the same equilibrium output price. lead to the same equilibrium output price.





In an increasingIn an increasing --cost industry, the entry of newcost industry, the entry of newfirms would not only increase industry output,firms would not only increase industry output,but would shift up the cost curves of each firmbut would shift up the cost curves of each firm

in the industry.

in the industry.

Thus, an expansion of the industry would lead toThus, an expansion of the industry would lead toa higher equilibrium price of the industry¶sa higher equilibrium price of the industry¶soutput.output.

Conversely, in a decreasingConversely, in a decreasing--cost industry, thecost industry, theentry of new firms would lower production costentry of new firms would lower production costfor all firms and thus lead to a lower equilibriumfor all firms and thus lead to a lower equilibriumprice of output.price of output.





Supply

Demand

Price

Average

cost

Industry¶s

quantity

Firm¶s

quantity

$

Long-run supply

Constant average cost

curve as industry size

grows

Constant-cost industry





Supply

Demand

Price

Industry¶s

quantity

Firm¶s

quantity

$

Long-run

supply

Higher average cost


grows

Average cost

Increasing-cost industry





Supply

Demand

Price

Average cost

Industry¶s

quantity

Firm¶s

quantity

$

Long-run

supply

Lower average cost


grows

Decreasing-cost industry



Pure competition results in:Pure competition results in:

A) Allocative efficiency

B) Technological

efficiency

C) Both A and B



In response to the entry of newIn response to the entry of newfirms into an industry, resourcefirms into an industry, resource

prices will:prices will:

A) Rise

B) Fall

C) Stay the same

D) All of the above are

possible



Of increasing, constant, or Of increasing, constant, or decreasing cost industries, thedecreasing cost industries, the

most common is:most common is:

C) Decreasing Cost

D) All cost industries

are equally common

A) Increasing Cost

B) Constant Cost

A) Increasing Cost

B) Constant Cost



Perfect competition differs fromPerfect competition differs frompure competition in that the modelpure competition in that the model

assumes:assumes:

A) A large number of small firms

B) A homogeneous

product

C) Costless entry andexit

D) All information is

fully and freely

available



99..5 5 EXPLORE & APPLYEXPLORE & APPLYDiscriminationDiscrimination ± ± Not Likely in Pure CompetitionNot Likely in Pure Competition

Two features of purely competitive firm¶sTwo features of purely competitive firm¶sprevents racialprevents racial discrimination.discrimination.

One feature is the homogeneous product, whichOne feature is the homogeneous product, whichmeans that the firm has no opportunity to varymeans that the firm has no opportunity to varythe product in discriminatory ways.the product in discriminatory ways.

Pure competition gives firms a strong profitPure competition gives firms a strong profitincentive to avoid discrimination.incentive to avoid discrimination.

In pure competition a firm that inflicts higher In pure competition a firm that inflicts higher

input cost on itself can find itself going frominput cost on itself can find itself going fromprofit to loss. profit to loss. Discrimination lowers profits.Discrimination lowers profits.



DiscriminationDiscrimination ± ± What a DifferenceWhat a Difference

Market Structure MakesMarket Structure Makes

Price

Marginal Cost

Average cost

$

Firm¶s

quantity

Profit

Loss

Discrimination

can turn a profit

into a loss

By increasing

costs«



Terms Along the Way

homogenous producthomogenous product

differentiated productdifferentiated product

market structuremarket structure

monopolymonopoly oligopolyoligopoly

monopolisticmonopolisticcompetitioncompetition

pure competitionpure competition

market power market power

constantconstant--costcostindustryindustry

increasingincreasing--costcostindustryindustry

decreasingdecreasing--costcostindustryindustry

perfect competitionperfect competition longlong--run supplyrun supply



Test Yourself Test Yourself

1.1. Price takers are found inPrice takers are found in

a.a. pure competition.pure competition.

b.b. monopolistic competition.monopolistic competition.c.c. oligopoly.oligopoly.

d.d. all of the above.all of the above.




22.. In pure competition the firm¶s demandIn pure competition the firm¶s demandcurve will becurve will be

a.a. upward sloping.upward sloping.

b.b. downward sloping.downward sloping.

c.c. hump shaped.hump shaped.

d.d. horizontal.horizontal.




33.. For a price taking firm, demand isFor a price taking firm, demand is

a.a. equal to price.equal to price.

b.b. less than price.less than price.

c.c. greater than price.greater than price.

d.d. unrelated to price.unrelated to price.




44. . A price taking firm¶s shortA price taking firm¶s short--run supplyrun supply

curve is associated with itscurve is associated with its

a.a. total revenue curve.total revenue curve.

b.b. average cost curve.average cost curve.

c.c. marginal revenue curve.marginal revenue curve.

d.d. marginal cost curve.marginal cost curve.




55.. Profit maximization calls for theProfit maximization calls for the

purely competitive firm to produce atpurely competitive firm to produce at

the point where its demand curvethe point where its demand curveintersects itsintersects its

a.a. total revenue curve.total revenue curve.

b.b. average cost curve.average cost curve.

c.c. marginal revenue curve.marginal revenue curve.

d.d. marginal cost curve.marginal cost curve.




66.. Which statement best describes the longWhich statement best describes the long

run in a purely competitive market?run in a purely competitive market?

a.a. The firm¶s demand curve is downwardThe firm¶s demand curve is downwardsloping.sloping.

b.b. The market will shrink as firms exit.The market will shrink as firms exit.

c.c. The number of firms will be stable becauseThe number of firms will be stable because

there no incentive for entry or exit.there no incentive for entry or exit.

d.d. In the long run, the market will slowlyIn the long run, the market will slowly

become a monopoly.become a monopoly.



Home workHome work

PagePage 233233 questionquestion 55,, 99



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Chapter 9 PPT[1]