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7
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Pure Competition
McGraw-Hill/Irwin
Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.
Four Market Models
• Pure competition
• Pure monopoly
• Monopolistic competition
• Oligopoly
LO1
7-2
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
7-3
Average, Total, and Marginal Revenue
Firm’s
Demand
Schedule
(Average
Revenue)
P
QD
Firm’s
Revenue
Data
TR
MR
0 $131
$0
] $131
1 131 131
] 131
2 131 262
] 131
3 131 393
] 131
4 131 524
] 131
5 131 655
] 131
6 131 786
] 131
7 131 917
] 131
8 131 1048
] 131
9 131 1179
131
10 131 1310 ]
LO3
TR
D = MR = AR
7-4
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
7-5
Profit Maximization: TR-TC Approach
• Three questions:
• Should the firm produce?
• If so, what amount?
• What economic profit (loss) will be
realized?
LO3
7-6
Profit Maximization: MR-MC Approach
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)
0
LO3
(6)
Total Economic
Profit (+)
or Loss (-)
$-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
+299
10
10.00
93.00
103.00
150
131
+280
7-7
Profit Maximization: MR-MC Approach
Cost and Revenue
$200
MR = MC
150
MC
P=$131
MR = P
ATC
Economic Profit
100
AVC
A=$97.78
50
0
1
2
3
4
5
6
7
8
9
10
Output
LO3
7-8
Loss-Minimizing Case
• Loss minimization
• Still produce because P > min AVC
• Losses at a minimum where MR =
MC
LO3
7-9
Profit Minimization: MR-MC Approach
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)
0
LO3
(6)
Total
Economic
Profit (+)
or Loss (-)
$-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
7-10
Loss-Minimizing Case
$200
Cost and Revenue
MC
150
Loss
A=$91.67
AVC
100
P=$81
50
0
LO3
ATC
MR = P
V = $75
1
2
3
4
5
6
Output
7
8
9
10
7-11
Shutdown Case: MR-MC Approach
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)
0
LO3
(6)
Total
Economic
Profit (+)
or Loss (-)
$-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
7-12
Shutdown Case
Cost and Revenue
$200
MC
150
ATC
V = $74
100
AVC
MR = P
P=$71
Short-Run Shutdown Point
P < Minimum AVC
$71 < $74
50
0
1
2
3
4
5
6
7
8
9
10
Output
LO3
7-13
Marginal Cost and Short-Run Supply
The Supply Schedule of a Competitive Firm
Confronted with Cost Data
LO4
Price
Quantity
Supplied
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
7-14
Cost and Revenues (Dollars)
Marginal Cost and Short-Run Supply
S
e
P5
P3
P2
P1
MR5
d
P4
MC
ATC
c
AVC
b
a
MR4
MR3
MR2
MR1
Shut-Down Point
(If P is Below)
0
Q2
Q3
Q4
Q5
Quantity Supplied
LO4
7-15
3 Production Questions
Output Determination in Pure Competition in the Short
Run
LO4
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).
7-16
Firm and Industry: Equilibrium
Firm and Market Supply and the Market Demand
LO4
(1)
Quantity
Supplied,
Single
Firm
(2)
Total
Quantity
Supplied,
1,000 Firms
(3)
Product
Price
(4)
Total
Quantity
Demanded
10
10,000
$151
4,000
9
9,000
131
6,000
8
8,000
111
8,000
7
7,000
91
9,000
6
6,000
81
11,000
0
0
71
13,000
0
0
61
16,000
7-17
Firm and Industry: Equilibrium
S = ∑ MCs
s = MC
Economic
profit
ATC
d
$111
$111
AVC
D
8
(a) Single Firm
LO4
8000
(a) Industry
7-18
Profit Maximization in the Long Run
• Easy entry and exit
• The only long-run adjustment we
•
•
LO5
consider
Identical costs
• All firms in the industry have identical
costs
Constant-cost industry
• Entry and exit do not affect resource
prices
7-19
Long-Run Equilibrium
• Entry eliminates profits
• Firms enter
• Supply increases
• Price falls
• Exit eliminates losses
• Firms exit
• Supply decreases
• Price rises
LO5
7-20
Entry Eliminates Economic Profits
P
P
S1
MC
ATC
$60
50
MR
40
S2
$60
50
D2
40
D1
0
100
(a)
Single firm
LO5
q
0
80,000 90,000 100,000
Q
(b)
Industry
7-21
Exit Eliminates Losses
P
P
S3
MC
ATC
$60
S1
$60
50
50
MR
D1
40
40
D3
0
100
(a)
Single Firm
LO5
q
0
80,000
90,000
100,000
Q
(b)
Industry
7-22
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 industry
LO6
7-23
LR Supply: Constant-Cost Industry
P
P1
P2
$50
Z3
Z1
Z2
S
P3
D1
D3
0
LO6
Q3
90,000
Q1
100,000
D2
Q2
110,000
Q
7-24
LR Supply: Increasing-Cost Industry
P
S
P2 $55
Y2
P1 $50
Y1
P3 $40
Y3
D2
D1
D3
0
LO6
Q3
90,000
Q1
100,000
Q2
110,000
Q
7-25
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
7-26
Dynamic Adjustments
• Purely competitive markets will
•
LO6
automatically adjust to
• Changes in consumer tastes
• Resource supplies
• Technology
Recall the “invisible hand”
7-27