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Chapter 10
Pure Competition in the Short Run
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Four Market Models
•
•
•
•
Pure competition
Pure monopoly
Monopolistic competition
Oligopoly
Pure
Competition
Monopolistic
Competition
Oligopoly
Pure
Monopoly
Market Structure Continuum
LO1
10-2
Four Market Models
Characteristics of the Four Basic Market Models
Characteristic
Pure
Competition
Monopolistic Competition
Oligopoly
Monopoly
Number of firms
A very large
number
Many
Few
One
Type of product
Standardized
Differentiated
Standardized or
differentiated
Unique; no
close subs.
Control over price
None
Some, but within rather
narrow limits
Limited by mutual
inter-dependence;
considerable with
collusion
Considerable
Conditions of entry
Very easy, no
obstacles
Relatively easy
Significant obstacles
Blocked
Nonprice
Competition
None
Considerable emphasis on
advertising, brand names,
trademarks
Typically a great
deal, particularly
with product
differentiation
Mostly public
relation
advertising
Examples
Agriculture
Retail trade, dresses, shoes
Steel, auto, farm
implements
Local utilities
10-3
Pure Competition: Characteristics
•
•
•
•
LO2
Very large numbers of sellers
Standardized product
“Price takers”
Easy entry and exit
10-4
Purely Competitive Demand
• Perfectly elastic demand
• Firm produces as much or little as they wish
at the market price
• Demand graphs as horizontal line
LO3
10-5
Average, Total, and Marginal
Revenue
• Average revenue
• Revenue per unit
• AR = TR/Q = P
• Total revenue
• TR = P X Q
• Marginal revenue
• Extra revenue from 1 more unit
• MR = ΔTR/ΔQ
LO3
10-6
Average, Total, and Marginal
Revenue
P
Firm’s
Revenue
Data
QD
TR
0 $131
1 131
2 131
3 131
4 131
5 131
6 131
7 131
8 131
9 131
10 131
$0
131
262
393
524
655
786
917
1048
1179
1310
$1179
MR
]
]
]
]
]
]
]
]
]
]
$131
131
131
131
131
131
131
131
131
131
TR
1048
917
Price and revenue
Firm’s
Demand
Schedule
(Average
Revenue)
786
655
524
393
262
D = MR = AR
131
2
4
6
8
10
12
Quantity demanded (sold)
10-7
Profit Maximization: TR – TC
Approach
• The competitive producer will ask three
questions
• Should the firm produce?
• If so, in what amount?
• What economic profit (loss) will be
realized?
LO4
10-8
Profit Maximization: TR-TC Approach
The Profit-Maximizing Output for a Purely Competitive Firm: Total Revenue – Total Cost
Approach (Price = $131)
(1)
Total Product
(Output) (Q)
(2)
Total Fixed Cost
(TFC)
(3)
Total Variable
Costs (TVC)
(4)
Total Cost
(TC)
(5)
Total Revenue
(TR)
(6)
Profit (+)
or Loss (-)
0
$100
$0
$100
$0
$-100
1
100
90
190
131
-59
2
100
170
270
262
-8
3
100
240
340
393
+53
4
100
300
400
524
+124
5
100
370
470
655
+185
6
100
450
550
786
+236
7
100
540
640
917
+277
8
100
650
750
1048
+298
9
100
780
880
1179
+299
10
100
930
1030
1310
+280
10-9
LO3
Total economic
profit
Total revenue and total cost
Profit Maximization: TR–TC Approach
LO4
$1800
1700
1600
1500
1400
1300
1200
1100
1000
900
800
700
600
500
400
300
200
100
$500
400
300
200
100
Break-even point
(Normal profit)
Total revenue, (TR)
Maximum
economic
profit
$299
Total cost,
(TC)
P=$131
Break-even point
(Normal profit)
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14
Quantity demanded (sold)
Total
economic
$299
profit
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14
Quantity demanded (sold)
10-10
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 Costs
(AVC)
(4)
Average Total
Cost
(ATC)
(5)
Marginal Cost
(MC)
(5)
Price =
Marginal
Revenue
(MR)
0
(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
10-11
LO3
Profit Maximization: MR-MC Approach
Cost and revenue
$200
MR = MC
150
P=$131
MC
MR = P
ATC
Economic profit
100
AVC
A=$97.78
50
0
LO5
1
2
3
4
5
Output
6
7
8
9
10
10-12
Loss-Minimizing Case
•
•
•
•
LO5
Loss minimization
Still produce because MR > minimum AVC
Losses at a minimum where MR = MC
Producing adds more to revenue than to costs
10-13
Loss-Minimizing Case
Cost and revenue
$200
MC
150
Loss
A=$91.67
ATC
AVC
100
P=$81
50
0
MR = P
V = $75
1
2
3
4
5
6
7
8
9
10
Output
LO5
10-14
Shutdown Case
$200
MC
Cost and revenue
150
ATC
AVC
V = $74
100
MR = P
P=$71
50
0
Short-run shut down point
P < minimum AVC
$71 < $74
1
2
3
4
5
6
7
8
9
10
Output
LO5
10-15
Marginal Cost and Short Run
Supply
The Supply Schedule of a Competitive Firm Confronted with Cost Data from Table
LO6
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
10-16
Cost and revenues (dollars)
Marginal Cost and Short-Run Supply
MC
e
P5
d
P4
P3
P2
P1
MR5
ATC
c
AVC
b
a
0
Q2
Q3
Q4
MR4
MR3
MR2
MR1
Q5
Quantity supplied
LO6
10-17
Cost and revenues (dollars)
Marginal Cost and Short-Run Supply
S
MC
e
P5
d
P4
P3
P2
P1
MR5
ATC
c
AVC
b
a
MR4
MR3
MR2
MR1
Shut-down point
(If P is below)
0
Q2
Q3
Q4
Q5
Quantity supplied
LO6
10-18
3 Production Questions
Output Determination in Pure Competition in the Short Run
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).
LO6
LO3
10-19
Firm and Industry: Equilibrium
Firm and Market Supply and Market Demand
LO6
LO4
(1)
Quantity
Supplied,
Single
Firm
(2)
Total
Quantity
Supplied,
1000 Firms
(3)
Product
Price
(4)
Total
Quantity
Demanded
10
10,000
$151
4000
9
9000
131
6000
8
8000
111
8000
7
7000
91
9000
6
6000
81
11,000
0
0
71
13,000
0
0
61
16,000
10-20
Firm versus Industry: Equilibrium
S = ∑ MC’s
s = MC
Economic
profit
ATC
d
$111
$111
AVC
D
8
LO6
8000
10-21
Fixed Costs: Digging Out of a Hole
• Shutting down in the short run does not mean
shutting down forever
• Low prices can be temporary
• Some firms switch production on and off
depending on the market price
• Examples: oil producers, resorts, and firms
that shut down during a recession
10-22