AP MIcro Perfect Competition

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