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McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.

Pure Competition

7

7-2

Four Market Models

• Pure competition• Pure monopoly• Monopolistic competition• Oligopoly

LO1

7-3

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

7-4

Average, Total, and Marginal Revenue

LO3

Firm’sDemandSchedule(AverageRevenue)

Firm’sRevenue

Data

D = MR = AR

TR

P QD TR MR

$131131131131131131131131131131131

0123456789

10

$0131262393524655786917

104811791310

$131131131131131131131131131131

]]]]]]]]]]

7-5

Average, Total, and Marginal Revenue

• Average revenue•Revenue per unit•AR = TR/Q = P

• Total revenue •TR = P × Q

• Marginal revenue •Extra revenue from 1 more unit•MR = ΔTR/ΔQ

LO3

7-6

Profit Maximization: TR-TC Approach

• Three questions:•Should the firm produce?• If so, what amount?•What economic profit (loss) will be

realized?

LO3

7-7

Profit Maximization: MR-MC Approach

LO3

The Profit-Maximizing Output for a Purely Competitive Firm: Marginal Revenue– Marginal Cost Approach (Price = $131)

(1)Total

Product(Output)

(2)Average

Fixed Cost (AFC)

(3)Average Variable

Cost (AVC)

(4)Average

Total Cost(ATC)

(5)Marginal

Cost(MC)

(5)Price =

Marginal Revenue

(MR)

(6)Total Economic

Profit (+)or Loss (-)

0 $-100

1 $100.00 $90.00 $190 $90 $131 -59

2 50.00 85.00 135 80 131 -8

3 33.33 80.00 113.33 70 131 +53

4 25.00 75.00 100.00 60 131 +124

5 20.00 74.00 94.00 70 131 +185

6 16.67 75.00 91.67 80 131 +236

7 14.29 77.14 91.43 90 131 +277

8 12.50 81.25 93.75 110 131 +298

9 11.11 86.67 97.78 130 131 +29910 10.00 93.00 103.00 150 131 +280

7-8

Profit Maximization: MR-MC Approach

LO3

Cos

t and

Rev

enue

$200

150

100

50

01 2 3 4 5 6 7 8 9 10

Output

Economic Profit MR = P

MCMR = MC

AVC

ATC

P=$131

A=$97.78

7-9

Loss-Minimizing Case

• Loss minimization•Still produce because P > min AVC• Losses at a minimum where MR =

MC

LO3

7-10

Profit Minimization: MR-MC Approach

LO3

The Profit-Minimizing Output for a Purely Competitive Firm: Marginal Revenue– Marginal Cost Approach (Price = $81)

(1)Total

Product(Output)

(2)Average

Fixed Cost (AFC)

(3)Average Variable

Cost (AVC)

(4)Average

Total Cost(ATC)

(5)Marginal

Cost(MC)

(5)Price =

Marginal Revenue

(MR)

(6)Total

Economic Profit (+)

or Loss (-)0 $-100

1 $100.00 $90.00 $190 $90 $81 -109

2 50.00 85.00 135 80 81 -108

3 33.33 80.00 113.33 70 81 -97

4 25.00 75.00 100.00 60 81 -76

5 20.00 74.00 94.00 70 81 -65

6 16.67 75.00 91.67 80 81 -64

7 14.29 77.14 91.43 90 81 -73

8 12.50 81.25 93.75 110 81 -102

9 11.11 86.67 97.78 130 81 -151

10 10.00 93.00 103.00 150 81 -220

7-11

Loss-Minimizing Case

LO3

Cos

t and

Rev

enue

$200

150

100

50

0 1 2 3 4 5 6 7 8 9 10Output

Loss

MR = P

MC

AVC

ATC

P=$81

A=$91.67

V = $75

7-12

Shutdown Case: MR-MC Approach

LO3

The Profit-Minimizing Output for a Purely Competitive Firm: Marginal Revenue– Marginal Cost Approach (Price = $71)

(1)Total

Product(Output)

(2)Average

Fixed Cost (AFC)

(3)Average Variable

Cost (AVC)

(4)Average

Total Cost(ATC)

(5)Marginal

Cost(MC)

(5)Price =

Marginal Revenue

(MR)

(6)Total

Economic Profit (+)

or Loss (-)0 $-100

1 $100.00 $90.00 $190 $90 $71 -119

2 50.00 85.00 135 80 71 -128

3 33.33 80.00 113.33 70 71 -127

4 25.00 75.00 100.00 60 71 -116

5 20.00 74.00 94.00 70 71 -115

6 16.67 75.00 91.67 80 71 -124

7 14.29 77.14 91.43 90 71 -143

8 12.50 81.25 93.75 110 71 -182

9 11.11 86.67 97.78 130 71 -241

10 10.00 93.00 103.00 150 71 -320

7-13

Shutdown Case

LO3

Cos

t and

Rev

enue

$200

150

100

50

0 1 2 3 4 5 6 7 8 9 10

Output

MR = P

MC

AVC

ATC

P=$71

V = $74

Short-Run Shutdown PointP < Minimum AVC

$71 < $74

7-14

Marginal Cost and Short-Run Supply

LO4

The Supply Schedule of a Competitive Firm Confronted with Cost Data

PriceQuantitySupplied

Maximum Profit (+)Minimum Loss (-)

$151 10 + $480

131 9 +299

111 8 +138

91 7 -3

81 6 -64

71 0 -100

61 0 -100

7-15

Marginal Cost and Short-Run Supply

LO4

P1

0

Cos

t and

Rev

enue

s (D

olla

rs)

Quantity Supplied

MR1

P2 MR2

P3 MR3

P4 MR4

P5 MR5

MC

AVC

ATC

Q2 Q3 Q4 Q5

ab

c

d

e

S

Shut-Down Point (If P is Below)

7-16

3 Production Questions

LO4

Output Determination in Pure Competition in the Short RunQuestion AnswerShould 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).

7-17

Firm and Industry: Equilibrium

LO4

Firm and Market Supply and the Market Demand(1)

QuantitySupplied,

SingleFirm

(2)Total

QuantitySupplied,

1,000 Firms

(3)Product

Price

(4)Total

QuantityDemanded

10 10,000 $151 4,0009 9,000 131 6,0008 8,000 111 8,0007 7,000 91 9,0006 6,000 81 11,0000 0 71 13,0000 0 61 16,000

7-18

Firm and Industry: Equilibrium

LO4

Economicprofit

dATC

AVC

s = MC

$111 $111

D

S = ∑ MCs

8 8000

(a) Single Firm (a) Industry

7-19

Profit Maximization in the Long Run

• Easy entry and exit•The only long-run adjustment we

consider• Identical costs

•All firms in the industry have identical costs

• Constant-cost industry•Entry and exit do not affect resource

pricesLO5

7-20

Long-Run Equilibrium• Entry eliminates profits

•Firms enter•Supply increases•Price falls

• Exit eliminates losses•Firms exit•Supply decreases•Price rises

LO5

7-21

Entry Eliminates Economic Profits

LO5

(a)Single firm

(b)Industry

P P

q Q0 0100 90,00080,000 100,000

ATC

MR

MC

$60

50

40D1

S1

D2

$60

50

40

S2

7-22

Exit Eliminates Losses

LO5

(a)Single Firm

(b)Industry

P P

q Q0 0100 90,00080,000 100,000

ATC

MR

MC

$60

50

40D3

S3

D1

$60

50

40

S1

7-23

Long-Run Supply• Constant-cost industry

• Entry/exit does not affect LR ATC• Constant resource price• Special case

• Increasing-cost industry• Most industries• LR ATC increases with expansion• Specialized resources

• Decreasing-cost industryLO6

7-24

LR Supply: Constant-Cost Industry

LO6

P

0 Q90,000 100,000 110,000

Q3 Q1 Q2

$50

P1

P2

P3

SZ1 Z2Z3

D3 D1 D2

7-25

LR Supply: Increasing-Cost Industry

LO6

P

0 Q90,000 100,000 110,000

Q3 Q1 Q2

$50P1

S

Y1

Y2

Y3

D3D1

D2

$40

$55P2

P3

7-26

Pure Competition and Efficiency

• In the long run, efficiency is achieved• Productive efficiency

•Producing where P = min ATC• Allocative efficiency

•Producing where P = MC

LO6

7-27

Dynamic Adjustments

• Purely competitive markets will automatically adjust to•Changes in consumer tastes•Resource supplies•Technology

• Recall the “invisible hand”

LO6