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Extremely Competitive Markets
Part 1: Closed Economies
Characteristics of
Extremely Competitive Markets
 Many buyers and sellers, or
 “Easy” entry and exit in the presence of
significant extranormal profits
 Little or no product differentiation
Price takers
Profit Maximization for a Firm in an
Extremely Competitive Market
Price
MC
P = AR = MR
0
Qc
Quantity
Why Qc is the Profit Maximizing Output Level
Price
MC
MC(Q2)
At Q2: MC(Q2) > MR(Q2)
Pc
P = AR = MR
At Q1: MC(Q1) < MR(Q1)
MC(Q1)
0
Q
Qc
Q2
Quantity
The Marginal Cost Curve is the Competitive Firm’s Supply Curve
Because it shows how much the firm is willing to produce at any given price
Price
MC
P2=MR2
P1=MR1
0
Q1
Q2
Quantity
Measuring Profit for the Competitive Firm
Price
MC
Profit
Pc
ATC
P = AR = MR
ATC
0
Qc
Quantity
The Firm’s Short Run Supply Decision
Price
If P > ATC,
keep producing
In the longer run,
at a profit
If P > AVC,
keep producing
in the short run
MC
ATC
AVC
If P < AVC,
shut down
0
Quantity
The Firm’s Short Run & Long Run Supply Curves
Price
The firm’s LR supply curve
MC
ATC
AVC
The firm’s SR supply curve
0
Quantity
Individual Firm and Industry Supply
Firm Type A
P/Q
Firm Type B
MCB
P/Q
MCA
Firms Types A and B together
P/Q
$20
$20
$15
$15
$10
$10
4 6 8
Q/t
2 3 4
6
Q/t
Total Industry Supply
Total industry =
50 firms type A
50 firms type B
P/Q
$20
$15
$10
300 400 500 600
Q/t
9
12
Q/t
Extremely Competitive Market Outcome
Price
Industry supply
$20
$15
$10
Market demand
100 200 300 450 500 600
Quantity
Industry LR Supply, all firms identical
Individual identical firms
Industry
MC
$/Q
AC
$/Q
Industry Demand
LR Supply
q
Q/t
Q=nq
Q/t
Industry LR Supply, all firms not identical
Individual non-identical firms
P/Q
MC
Industry
AC2
LR Supply
AC1
D1
q1 q2
Q/t
Q1
D2
Q2
D3
Q/t
Strategy: What Size Plant to Build
Avg. total cost
ATC with
small plant
0
ATC with
medium plant
Small plant Medium plant
ATC with
large plant
Large plant
Output/day
Strategy: Identifying Economies of Scale
Average
total cost
Economies
of scale
0
Constant Returns
to scale
Diseconomies
of scale
Output per day
Strategy: Identifying Economies of Scope
Cost of producing x alone = C(x)
Cost of producing y alone = C(y)
Cost of producing 2 goods together = C(x,y)
Economies of scope are present if:
C(x,y) < C(x) + C(y)
Measure or degree of economies of scope:
[C(x) + C(y)] – C(x,y)
C(x,y)