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Pure Competition
Pure Monopoly
Monopolistic Competition
Oligopoly
Characteristics:
Rare in the real world
But…helps analyze industries which are similar to pure competition
Many sellers means that no one seller has an impact on price by its decisions alone
Products are standardized
Firms are “price-takers” – must accept the market price
Firms can freely enter and exit the market
Individual firm will view its demand as perfectly elastic
BUT…the demand curve is not perfectly elastic for the industry
WHY the difference??
Individual Firm’s Demand Curve
Industry’s Demand Curve
Industry’s Supply Curve
Firm is a “PRICE TAKER”
IMPORTANT:
When you graph this for a quiz/test, you want to put the industry first and then the firm!!!
Total Revenue (TR) = Price multiplied by quantity sold (TR = P x Q)
Average Revenue (AR)= price per unit for each firm in pure competition
Marginal Revenue (MR) = ∆ in TR for each additional quantity sold
AND will equal the unit price in conditions of pure competition
Assumptions of the Firm
Fixed plant
By adjusting output:
Will maximize profits OR
Will minimize losses
Profits = TR-TC
3 Questions each firm must answer:
1. Should the firm produce
2. If so, how much?
3. What will be the profit or loss?
Total Cost vs. Total Revenue
Firms should produce if the difference between TR and TC results in a profit (TR > TC)
Firms should produce that output which maximizes its profit or minimizes its loss
Profit (or loss) = TR – TC
So where do firms maximize profit?
Marginal Revenue vs. Marginal Cost
The firm will keep producing if MR > MC (the firm is still seeking profits)
The firm will stop producing at the point where MR < MC (i.e. the firm does not want to incur losses)
The Profit Maximization/Loss Minimization Rule =
In the short run, the firm may keep producing even if Total Cost is higher than Total Revenue
However, the firm may choose to “SHUT DOWN” if increases in Total Revenue does not cover Average Variable Costs at the production output
The “Shut Down” Rule:
For ALL Firms: If MR < AVC (average variable cost) at the
production output, the firm will “shut down”
In perfect competition – then P < AVC
Equilibrium price is where total QS = total QD
Sum of individual firms production = industry (or total) QS
Individual firms must take equilibrium price (“price takers”)
Supply plans of all competitive producers is a major determinant of product price
Assumptions:
1. Entry and exit of firms are the only long-run adjustments
2. Firms in the industry have identical cost curves
3. The industry is a constant-cost industry (i.e. entry and exit of firms doesn’t affect costs of the individual firms)
Product price = Each firm’s point of minimum long run average total cost (LRATC) – i.e. NORMAL PROFITS
In the Short Run though: If short term losses occur, firms leave the
industry Qs decreases, P increases, profits increase
If short term economic profits occur, firms will enter the industry Qs increases, P decreases, profits decrease or losses
occur/increase
Long run Supply:
Constant cost industry
Perfectly elastic supply curve (HORIZONTAL)
Level of output will not affect the price in the long run
Expansion or contraction does not affect resource prices or production costs
Entry/exit will affect quantity of output but price will always revert to equilibrium price
Long run Supply:
Increasing cost industry
Average cost curves shift upward as industry expands and downwards when it contracts
If D increases, ATC increase as firms enter the industry, and P increases to maintain normal profit
If D decreases, ATC decreases as firms exit the industry, P decreases, firms cannot attain above-normal profit
Long-run Supply
Decreasing cost industry
Supply will be downward sloping
ATC falls as the industry expands
Firms will enter until price is driven down to maintain normal profits
Regardless of cost model, long run equilibrium will have the same characteristics: The firm will make only NORMAL PROFITS
Productive efficiency occurs when P = minimum LRATC
Allocative efficiency occurs when P = MC If P > MC, then society values more units of good X and
resources are underallocated to the production of good X
If P < MC, then society values other goods more highly than good X and resources are overallocated to good X
Allocative efficiency implies maximum consumer and supplier surplus
Combined consumer and supplier surplus is maximized at the equilibrium price
On a piece of paper, draw the following graphs The perfectly competitive market
The perfectly competitive firm Show the relationship between the market price and the
firm’s price
Include on the firm’s graph the following: The Demand and Marginal Revenue Curve (D/MR)
The LONG RUN Avg Total Cost Curve (LRATC)
The LONG RUN Avg Varible Cost Curve (LRATC)
The LONG RUN Avg Fixed Cost Curve (LRAFC)
The Marginal Cost Curve (MC)
On a piece of paper, draw the following graphs The perfectly competitive market
The perfectly competitive firm Show the relationship between the market price and the
firm’s price
Include on the firm’s graph the following: The Demand and Marginal Revenue Curve (D/MR)
Show the firm making economic profits by drawing: The SHORT RUN Avg Total Cost Curve (SRATC)
The SHORT RUN Avg Varible Cost Curve (SRATC)
The SHORT RUN Avg Fixed Cost Curve (SRAFC)
The Marginal Cost Curve (MC)
On a piece of paper, draw the following graphs The perfectly competitive market
The perfectly competitive firm Show the relationship between the market price and the
firm’s price
Include on the firm’s graph the following: The Demand and Marginal Revenue Curve (D/MR)
Show the firm making economic losses by drawing: The SHORT RUN Avg Total Cost Curve (SRATC)
The SHORT RUN Avg Varible Cost Curve (SRATC)
The SHORT RUN Avg Fixed Cost Curve (SRAFC)
The Marginal Cost Curve (MC)
On a piece of paper, draw the following graphs The perfectly competitive market
The perfectly competitive firm Show the relationship between the market price and the
firm’s price
Include on the firm’s graph the following: The Demand and Marginal Revenue Curve
Show the firm making following the SHUT DOWN RULE by drawing: The SHORT RUN Avg Total Cost Curve (SRATC)
The SHORT RUN Avg Varible Cost Curve (SRATC)
The SHORT RUN Avg Fixed Cost Curve (SRAFC)
The Marginal Cost Curve (MC)