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Pure Competition in the Short Run & Long Run
08 and 09
McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
Copyright 2008 The McGraw-Hill Companies 9-2
Four Market ModelsPure CompetitionProfit Maximization in the Short-RunMarginal Cost and Short-Run SupplyChanges in SupplyProfit Maximization in the Long RunSupply ReadjustmentPure Competition and EfficiencyLong-Run EquilibriumLast Word
Key Terms
End Show
Chapter Objectives• Names and Main Characteristics of
the Four Basic Market Models• Conditions for Perfect Competition• How Do Purely Competitive Firms
Maximize Profits or Minimize Losses
• Why the Marginal Cost and Supply Curves For Competitive Firms Are Identical
• How Industry Entry and Exit Create Economic Efficiency
• Differences Between Constant-Cost, Increasing-Cost, and Decreasing-Cost Industries
Copyright 2008 The McGraw-Hill Companies 9-3
Four Market ModelsPure CompetitionProfit Maximization in the Short-RunMarginal Cost and Short-Run SupplyChanges in SupplyProfit Maximization in the Long RunSupply ReadjustmentPure Competition and EfficiencyLong-Run EquilibriumLast Word
Key Terms
End Show
Four Market Models• Pure Competition
• Pure Monopoly
• Monopolistic Competition
• Oligopoly
Market Structure Continuum
PureCompetition
MonopolisticCompetition Oligopoly
PureMonopoly
Imperfect Competition
Four Market Models
LO1
Characteristics of the Four Basic Market Models
CharacteristicPure
CompetitionMonopolistic Competition Oligopoly Monopoly
Number of firms A very large number
Many Few One
Type of product Standardized Differentiated Standardized or differentiated
Unique; no close subs.
Control over price
None Some, but within rather narrow limits
Limited by mutual inter-dependence; considerable with collusion
Considerable
Conditions of entry
Very easy, no obstacles
Relatively easy Significant obstacles
Blocked
Nonprice Competition
None Considerable emphasis on advertising, brand names, trademarks
Typically a great deal, particularly with product differentiation
Mostly public relation advertising
Examples Agriculture Retail trade, dresses, shoes
Steel, auto, farm implements
Local utilities
8-4
Pure Competition: Characteristics
• Very large numbers of sellers
• Standardized product
• “Price takers”
• Easy entry and exit
• Perfectly elastic demand
• Firm produces as much or little as they want at the price
• Demand graphs as horizontal line
LO2 8-5
Average, Total, and Marginal Revenue
• Average Revenue
• Revenue per unit
• AR = TR/Q = P
• Total Revenue
• TR = P X Q
• Marginal Revenue
• Extra revenue from 1 more unit
• MR = ΔTR/ΔQ
LO3 8-6
Copyright 2008 The McGraw-Hill Companies 9-7
Four Market ModelsPure CompetitionProfit Maximization in the Short-RunMarginal Cost and Short-Run SupplyChanges in SupplyProfit Maximization in the Long RunSupply ReadjustmentPure Competition and EfficiencyLong-Run EquilibriumLast Word
Key Terms
End Show
Firm’sDemandSchedule(AverageRevenue)
Firm’sRevenue
Data
Pure Competition
Pri
ce a
nd
Rev
enu
e
2 4 6 8 10 12
131
262
393
524
655
786
917
1048
$1179
Quantity Demanded (Sold)
D = MR = AR
TR
P QDTR MR
$131131131131131131131131131131131
0123456789
10
$0131262393524655786917
104811791310
$131131131131131131131131131131
]]]]]]]]]]
Copyright 2008 The McGraw-Hill Companies 9-8
Four Market ModelsPure CompetitionProfit Maximization in the Short-RunMarginal Cost and Short-Run SupplyChanges in SupplyProfit Maximization in the Long RunSupply ReadjustmentPure Competition and EfficiencyLong-Run EquilibriumLast Word
Key Terms
End Show
Profit Maximization in the Short Run
Total Revenue-Total Cost Approach
Consider:–Should Product Be
Produced?
–If So, In What Amount?
–What Economic Profit (Loss) Will Be Realized?
3 Production Questions
LO3
Output Determination in Pure Competition in the Short Run
Question Answer
Should this firm produce? Yes, if price is equal to, or greater than, minimum average variable cost. This means that the firm is profitable or that its losses are less than its fixed cost.
What quantity should this firm produce? Produce where MR (=P) = MC; there, profit is maximized (TR exceeds TC by a maximum amount) or loss is minimized.
Will production result in economic profit? Yes, if price exceeds average total cost (TR will exceed TC). No, if average total cost exceeds price (TC will exceed TR).
8-9
Copyright 2008 The McGraw-Hill Companies 9-10
Four Market ModelsPure CompetitionProfit Maximization in the Short-RunMarginal Cost and Short-Run SupplyChanges in SupplyProfit Maximization in the Long RunSupply ReadjustmentPure Competition and EfficiencyLong-Run EquilibriumLast Word
Key Terms
End Show
Total Revenue-Total Cost Approach
Profit Maximization in the Short Run
(1)Total Product(Output) (Q)
(2)Total FixedCost (TFC)
(3)Total Variable
Cost (TVC)
(4)Total Cost
(TC)
(5)Total Revenue
(TR)
(6)Profit (+)
or Loss (-)
Price = $131
0123456789
10
$100100100100100100100100100100100
$090
170240300370450540650780930
$100190270340400470550640750880
1030
$0131262393524655786917
104811791310
$-100-59-8
+53+124+185+236+277+298+299+280
Now Let’s Graph The Results…Do You See Profit Maximization?
Copyright 2008 The McGraw-Hill Companies 9-11
Four Market ModelsPure CompetitionProfit Maximization in the Short-RunMarginal Cost and Short-Run SupplyChanges in SupplyProfit Maximization in the Long RunSupply ReadjustmentPure Competition and EfficiencyLong-Run EquilibriumLast Word
Key Terms
End Show
Total Revenue-Total Cost Approach
Profit Maximization in the Short Run
10 2 3 4 5 6 7 8 9 10 11 1213 14
10 2 3 4 5 6 7 8 9 10 11 1213 14
$180017001600150014001300120011001000
900800700600500400300200100
$500400300200100
To
tal
Re
ven
ue
and
To
tal
Co
stT
ota
l E
con
om
icP
rofi
t
Quantity Demanded (Sold)
Quantity Demanded (Sold)
Total Revenue, (TR)
Break-Even Point(Normal Profit)
Break-Even Point(Normal Profit)
MaximumEconomic
Profit$299
Total EconomicProfit
$299
P=$131
Total Cost,(TC)
W 9.1
G 9.1
Copyright 2008 The McGraw-Hill Companies 9-12
Four Market ModelsPure CompetitionProfit Maximization in the Short-RunMarginal Cost and Short-Run SupplyChanges in SupplyProfit Maximization in the Long RunSupply ReadjustmentPure Competition and EfficiencyLong-Run EquilibriumLast Word
Key Terms
End Show
Marginal Revenue-Marginal Cost ApproachMR = MC Rule
Profit Maximization in the Short Run
Important Features:• Firm Will max profits or
min loss where MR = MC• Profit Maximization in All
Market Structures• Can Be Restated P = MC
Copyright 2008 The McGraw-Hill Companies 9-13
Four Market ModelsPure CompetitionProfit Maximization in the Short-RunMarginal Cost and Short-Run SupplyChanges in SupplyProfit Maximization in the Long RunSupply ReadjustmentPure Competition and EfficiencyLong-Run EquilibriumLast Word
Key Terms
End Show
Marginal Revenue-Marginal Cost ApproachMR = MC Rule
Profit Maximization in the Short Run
(1)Total
Product(Output)
(2)Average
FixedCost(AFC)
(3)AverageVariable
Cost(AVC)
(4)Average
TotalCost(ATC)
(6)MarginalRevenue
(MR)
(7)Profit (+)
or Loss (-)
0123456789
10
$100.0050.0033.3325.0020.0016.6714.2912.5011.1110.00
$90.0085.0080.0075.0074.0075.0077.1481.2586.6793.00
$190.00135.00113.33100.00
94.0091.6791.4393.7597.78
103.00
$131131131131131131131131131131
$-100-59-8
+53+124+185+236+277+298+299+280
No Surprise - Now Let’s Graph It…Do You See Profit Maximization Now?
(5)Marginal
Cost(MC)
$90807060708090
110130150
Copyright 2008 The McGraw-Hill Companies 9-14
Four Market ModelsPure CompetitionProfit Maximization in the Short-RunMarginal Cost and Short-Run SupplyChanges in SupplyProfit Maximization in the Long RunSupply ReadjustmentPure Competition and EfficiencyLong-Run EquilibriumLast Word
Key Terms
End Show
Co
st a
nd
Rev
enu
e$200
150
100
50
01 2 3 4 5 6 7 8 9 10
Output
Economic Profit
Marginal Revenue-Marginal Cost ApproachMR = MC Rule
Profit Maximization in the Short Run
MR = P
MCMR = MC
AVC
ATC
P=$131
A=$97.78
W 9.2
Copyright 2008 The McGraw-Hill Companies 9-15
Four Market ModelsPure CompetitionProfit Maximization in the Short-RunMarginal Cost and Short-Run SupplyChanges in SupplyProfit Maximization in the Long RunSupply ReadjustmentPure Competition and EfficiencyLong-Run EquilibriumLast Word
Key Terms
End Show
Lower the Price to $81 andObserve the Results!
Co
st a
nd
Rev
enu
e$200
150
100
50
01 2 3 4 5 6 7 8 9 10
Output
Loss
Marginal Revenue-Marginal Cost ApproachMR = MC Rule
Profit Maximization in the Short Run
MR = P
MC
AVCATC
Loss Minimizing Case
P=$81
A=$91.67
V = $75
Fixed Costs: Digging Out of a Hole
• Shutting down in the short run does not mean shutting down forever
• Low prices can be temporary
• Some firms switch production on and off depending on the market price
• Examples: oil producers, resorts, and firms that shut down during a recession
8-16
Copyright 2008 The McGraw-Hill Companies 9-17
Four Market ModelsPure CompetitionProfit Maximization in the Short-RunMarginal Cost and Short-Run SupplyChanges in SupplyProfit Maximization in the Long RunSupply ReadjustmentPure Competition and EfficiencyLong-Run EquilibriumLast Word
Key Terms
End Show
Lower the Price Further to $71 and Observe the Results!
Co
st a
nd
Rev
enu
e$200
150
100
50
01 2 3 4 5 6 7 8 9 10
Output
Marginal Revenue-Marginal Cost ApproachMR = MC Rule
Profit Maximization in the Short Run
MR = P
MC
AVC
ATC
Short-Run Shut Down Case
P=$71Short-Run
Shut Down PointP < Minimum AVC
$71 < $74
V = $74
Copyright 2008 The McGraw-Hill Companies 9-18
Four Market ModelsPure CompetitionProfit Maximization in the Short-RunMarginal Cost and Short-Run SupplyChanges in SupplyProfit Maximization in the Long RunSupply ReadjustmentPure Competition and EfficiencyLong-Run EquilibriumLast Word
Key Terms
End Show
Marginal Cost and Short-Run Supply
Continuing the Same Numeric Example…Supply Schedule of a Competitive Firm
PriceQuantitySupplied
Maximum Profit (+)or Minimum Loss (-)
$151131111
91817161
10987600
$+480+299+138
-3-64
-100-100
The Schedule Shows the Quantity a FirmWill Produce at a Variety of Prices and Results
Copyright 2008 The McGraw-Hill Companies 9-19
Four Market ModelsPure CompetitionProfit Maximization in the Short-RunMarginal Cost and Short-Run SupplyChanges in SupplyProfit Maximization in the Long RunSupply ReadjustmentPure Competition and EfficiencyLong-Run EquilibriumLast Word
Key Terms
End Show
Marginal Cost and Short-Run Supply
Generalizing the MR=MC Relationship and its Use
P1
0
Co
st a
nd
Rev
enu
es (
Do
llars
)
Quantity Supplied
MR1
P2 MR2
P3 MR3
P4 MR4
P5 MR5
MC
AVC
ATC
Q2 Q3 Q4 Q5
This Price is Below AVCAnd Will Not Be Produced
ab
c
d
e
Copyright 2008 The McGraw-Hill Companies 9-20
Four Market ModelsPure CompetitionProfit Maximization in the Short-RunMarginal Cost and Short-Run SupplyChanges in SupplyProfit Maximization in the Long RunSupply ReadjustmentPure Competition and EfficiencyLong-Run EquilibriumLast Word
Key Terms
End Show
Marginal Cost and Short-Run Supply
Generalizing the MR=MC Relationship and its Use
P1
0
Co
st a
nd
Rev
enu
es (
Do
llars
)
Quantity Supplied
MR1
P2 MR2
P3 MR3
P4 MR4
P5 MR5
MC
AVC
ATC
Q2 Q3 Q4 Q5
This Price is Below AVCAnd Will Not Be Produced
ab
c
d
e
MC Above AVC Becomesthe Short-Run Supply Curve S
Examine the MC for the Competitive Firm
Break-even(Normal Profit) Point
Shut-Down Point (If P is Below)
Copyright 2008 The McGraw-Hill Companies 9-21
Four Market ModelsPure CompetitionProfit Maximization in the Short-RunMarginal Cost and Short-Run SupplyChanges in SupplyProfit Maximization in the Long RunSupply ReadjustmentPure Competition and EfficiencyLong-Run EquilibriumLast Word
Key Terms
End Show
Changes in Supply• Firm and Industry
–Equilibrium Price
–Market Price and Profits
–Firm Versus Industry
Graphically…
Copyright 2008 The McGraw-Hill Companies 9-22
Four Market ModelsPure CompetitionProfit Maximization in the Short-RunMarginal Cost and Short-Run SupplyChanges in SupplyProfit Maximization in the Long RunSupply ReadjustmentPure Competition and EfficiencyLong-Run EquilibriumLast Word
Key Terms
End Show
Single Firm Industryp P
p P0 0
Changes in Supply
EconomicProfit
d
ATC
AVC
s = MC
$111 $111
D
S = ∑ MC’s
8 8000
Competitive Firm Must Take the Price that isEstablished By Industry Supply and Demand
W 9.3
Pure Competition in the Long Run
09
McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
Note to Students:
• The following material will not be covered, nor is it required reading:
– Long Run Supply: Constant-Cost Industry– Long Run Supply: Increasing-Cost Industry– Long Run Supply: Decreasing-Cost
Industry
Copyright 2008 The McGraw-Hill Companies 9-25
Four Market ModelsPure CompetitionProfit Maximization in the Short-RunMarginal Cost and Short-Run SupplyChanges in SupplyProfit Maximization in the Long RunSupply ReadjustmentPure Competition and EfficiencyLong-Run EquilibriumLast Word
Key Terms
End Show
Profit Maximization in the Long Run
• Assumptions–Entry and Exit Only–Identical Costs–Constant-Cost Industry
• Goal of the Analysis• Long-Run Equilibrium
–Entry Eliminates Profits–Exit Eliminates Losses
Copyright 2008 The McGraw-Hill Companies 9-26
Four Market ModelsPure CompetitionProfit Maximization in the Short-RunMarginal Cost and Short-Run SupplyChanges in SupplyProfit Maximization in the Long RunSupply ReadjustmentPure Competition and EfficiencyLong-Run EquilibriumLast Word
Key Terms
End Show
Single Firm Industryp P
p P0 0100 90,00080,000 100,000
Supply Readjustment
ATC
MR
MC
$60
50
40
D1
S1
An Increase in Demand Temporarily Raises PriceHigher Prices Draw in New CompetitorsIncreased Supply Returns Price to Equilibrium
D2
$60
50
40
S2
Copyright 2008 The McGraw-Hill Companies 9-27
Four Market ModelsPure CompetitionProfit Maximization in the Short-RunMarginal Cost and Short-Run SupplyChanges in SupplyProfit Maximization in the Long RunSupply ReadjustmentPure Competition and EfficiencyLong-Run EquilibriumLast Word
Key Terms
End Show
Single Firm Industryp P
p P0 0100 90,00080,000 100,000
Supply Readjustment
ATC
MR
MC
$60
50
40
D3
S3
A Decrease in Demand Temporarily Lowers PriceLower Prices Drive Away Some CompetitorsDecreased Supply Returns Price to Equilibrium
D1
$60
50
40
S1
Copyright 2008 The McGraw-Hill Companies 9-30
Four Market ModelsPure CompetitionProfit Maximization in the Short-RunMarginal Cost and Short-Run SupplyChanges in SupplyProfit Maximization in the Long RunSupply ReadjustmentPure Competition and EfficiencyLong-Run EquilibriumLast Word
Key Terms
End Show
Pure Competition and Efficiency
• Productive EfficiencyP = Minimum ATC
• Allocative EfficiencyP = MC
• Maximum Consumer and Producer Surplus
• Dynamic Adjustments• “Invisible Hand” Revisited
O 9.1
Copyright 2008 The McGraw-Hill Companies 9-31
Four Market ModelsPure CompetitionProfit Maximization in the Short-RunMarginal Cost and Short-Run SupplyChanges in SupplyProfit Maximization in the Long RunSupply ReadjustmentPure Competition and EfficiencyLong-Run EquilibriumLast Word
Key Terms
End Show
Single Firm MarketP
rice
Pri
ce
Quantity Quantity
0 0
Long-Run EquilibriumCompetitive Firm and Market
P MR
D
S
QeQf
ATC
Productive Efficiency: Price = Minimum ATCAllocative Efficiency: Price = MCPure Competition Has Both in
Its Long-Run Equilibrium
MCP=MC=MinimumATC (Normal Profit)
P
Copyright 2008 The McGraw-Hill Companies 9-32
Four Market ModelsPure CompetitionProfit Maximization in the Short-RunMarginal Cost and Short-Run SupplyChanges in SupplyProfit Maximization in the Long RunSupply ReadjustmentPure Competition and EfficiencyLong-Run EquilibriumLast Word
Key Terms
End Show
Efficiency Gains From Entry:
• Competitive Model Predicts Lower Price and Greater Output With Increased Efficiency When New Producers Enter Market
• Example is Patented Drugs• Patents Enable Greater Profits in
Support of R&D and Accelerated Cost Recovery
• After Patent Period Generics Enter Market
• Profits Decrease and Quantities Increase
• Combined Consumer and Producer Surpluses Increase
The Case of Generic Drugs
Copyright 2008 The McGraw-Hill Companies 9-33
Four Market ModelsPure CompetitionProfit Maximization in the Short-RunMarginal Cost and Short-Run SupplyChanges in SupplyProfit Maximization in the Long RunSupply ReadjustmentPure Competition and EfficiencyLong-Run EquilibriumLast Word
Key Terms
End Show
Pri
ce
Quantity
Efficiency Gains From Entry:The Case of Generic Drugs
P1
P2
D
S
Q1 Q2
f
a
d
cb
• As Price Decreases to f,
• Consumer Surplus abcIncreases to adf
• Producer and ConsumerSurplus is MaximizedTogether as Shown bythe Gray Triangle
Initial Patent Price
Results: Greater Quantity at Lower Pricesas Predicted by the Competitive Model
New Producers Enter Market
Copyright 2008 The McGraw-Hill Companies 9-34
Four Market ModelsPure CompetitionProfit Maximization in the Short-RunMarginal Cost and Short-Run SupplyChanges in SupplyProfit Maximization in the Long RunSupply ReadjustmentPure Competition and EfficiencyLong-Run EquilibriumLast Word
Key Terms
End Show
Key Terms• pure competition• pure monopoly• monopolistic com
petition• oligopoly• imperfect
competition• price taker• average revenue• total revenue• marginal revenue• break-even point• MR=MC• short-run supply
curve
• long-run supply curve
• constant-cost industry
• increasing-cost industry
• decreasing-cost industry
• productive efficiency
• allocative efficiency
• consumer surplus• producer surplus
