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Perfect Competition
aka Pure Competition
Monopolistic Competition
Oligopoly
Monopoly
Perfect
Competition
Monopolistic Competition
Oligopoly
Monopoly
Number
of Firms
Pure
Competition
Monopolistic
Competition
Many small
Many small
Oligopoly
Monopoly
A few large
one
Considers action or reaction of other firms
Product type
Homogeneous Differentiated
Diff or
Homog
one
Need to stress differences?
Barriers to
Entry
none
none
large
large
Long run profits possible?
Price
Taker/Maker
taker
taker/seeker
maker
maker
Ability to influence market price?
Non-price
Competition
no
yes
yes
As important as price?
yes
Characteristics?
1. Many Sellers
2. Identical Products
3. Easy Entry and Exit
4. No Non-Price competition
5. SR profits/losses, no LR profits
6. Price Taker
Perfect Competition
•
•
•
•
•
Market supply & demand determine price.
The firm’s demand will be perfectly elastic.
Firms can sell as much as they want at P
Above P, they lose business
Below P they lose revenue.
Firm
Price
Price
Firms must
take the
market price
P
Market
demand
Market
Market
supply
Firm’s
demand
Output
P
Output
Number
of Cakes
Marginal
Revenue
Marginal
Cost
1
40
25
2
40
10
3
40
15
4
40
25
5
40
35
6
40
45
7
40
65
8
40
91
0
Marcia’s Marginal Cost and Marginal Revenue
$120
Marginal Cost and Marginal Revenue
110
100
90
80
70
60
Losses
50
40
30
Profits
20
10
0
1
2
3
4
5
6
7
Number of Cakes
8
Long-run Equilibrium
• The two conditions necessary for long-run equilibrium in
a price-taker market are depicted here.
• The quantity supplied and the quantity demanded must be
equal in the market, as shown below at P1 with output Q1.
• At the price established in the market, firms in the
industry earn zero economic profit
Firm
Price
Price
Ssr
Market
MC ATC
P1
d1
q1
Output
P1
D
Q1
Output
Equilibrium
Price
Operating at Minimum ATC
ATC
MC
$6
$5
$4
$3
Price = Demand = MR
$2
$1
0
10
20
30
40
50
60
Quantity
Short Run Profits
Earn economic profit
MR > ATC
Normal Profit
MR = ATC
Short Run Losses
Firm
Price
MC
P3
Firm covers AVC, but not AFC:
MR
ATC
AVC
Output
MR < ATC, but MR > AVC
Shut Down
Firm can’t cover AVC, minimize losses by
shutting down
MR < AVC
The Supply Curve
• The marginal cost curve (MC) is the firm’s supply curve.
• Below MC = AVC, the firm will shut down
Output = 0 below P1,,
• At P2 MR = MC at q2.
• At P3 MR = MC at q3.
Price
Firm
MC is the firm’s
Supply Curve
MC
ATC
P3
AVC
P2
P1
q1 q2 q3
Output
Case 1: Prices rise
Profits?
Entry or Exit?
Supply
An Increase in Market Demand
• Consider the market for toothpicks. A new candy that
sticks to teeth causes the market demand for toothpicks
to increase from D1 to D2 … market price increases to P2 …
shifting the firm’s demand curve upward. At the higher
price, firms expand output to q2 and earn short-run profits.
• Economic profits will draw competitors into the industry,
shifting the market supply curve from S1 to S2.
Firm
Price
Price
S1
MC ATC
S2
P2
d2
P2
P1
d1
P1
q1 q2
Output
Market
D1 D2
Q1 Q2
Output
The Adjustment
• After the increase in market supply, a new equilibrium is
established at the original market price P1 and a larger rate
of output (Q3).
• As the market price returns to P1, the demand curve
facing the firm returns to its original level.
• In the long-run, economic profits are driven down to
zero.
Firm
Price
Price
S1
MC ATC
P2
d2
P1
d1
q1 q2
Output
Market
S2
P2
Slr
P1
D1 D2
Q1 Q2 Q3
Output
Price
$6
1. Price goes up
2. Firms enter, Supply increases
3. Price goes down
ATC
MC
$5
$4
SR Profits
$3
$2
$1
0
Price = Demand = MR
4. No LR Profits
10
20
30
40
50
60
Quantity
Case 2: Prices fall
Profits?
Entry or Exit?
Supply
A Decrease in Demand
• If, instead, something causes market demand for toothpicks
the market price falls to P2
to decrease from D1 to D2 …
shifting the firm’s demand curve downward, leading to a
reduction in output to q2. The firm is now making losses.
• Short-run losses cause some competitors to exit the market,
and others to reduce the scale of their operation, shifting the
market supply curve from S1 to S2.
Firm
Price
Price
S2 S1
Market
MC ATC
P1
d1
P1
P2
d2
P2
q2
q1
Output
D2
Q2 Q1
D1
Output
The Adjustment:
• After the decrease in market supply, a new equilibrium is
established at the original market price P1 and a smaller
rate of output Q3.
• As the market price returns to P1, the demand curve facing
the firm returns to its original level.
• In the long-run, economic profit returns to zero.
• Note the long-run market supply curve is flat Slr.
Firm
Price
Price
S2 S1
Market
MC ATC
P1
d1
P1
P2
d2
P2
q2
q1
Output
Slr
D2
Q3 Q2 Q1
D1
Output
Price
$6
1. Price goes down
2. Firms leave, Supply decreases
3. Price goes up
ATC
MC
$5
$4
P = D = MR
$3
$2
$1
0
SR Losses
4. No LR Losses
10
20
30
40
50
60
Quantity
Short Run Profits
Cause firms to enter the market
Supply shifts out and price drops
Short Run Losses
Cause firms to leave the market
Supply shifts in and price rises
In competitive price-taker markets, firms
a. can sell all of their output at the market price.
b. produce differentiated products.
c. can influence the market price by altering their output level.
d. are large relative to the total market.
When we say that a firm is a price taker, we are indicating that the
a. firm takes the price established in the market then tries to increase
that price through advertising.
b. firm can change output levels without having any significant effect on
price.
c. demand curve faced by the firm is perfectly inelastic.
d. firm will have to take a lower price if it wants to increase the number
of units that it sells.
In price-taker markets, individual firms have no control over price.
Therefore, the firm’s marginal revenue curve is
a. a downward-sloping curve.
b. indeterminate.
c. constant at the market price of the product.
d. precisely the same as the firm’s total revenue curve.
If marginal revenue exceeds marginal cost, a price-taker firm should
a. expand output
output.
b.
reduce output.
c. lower its price.
d.
do both a and c.
When firms in a price-taker market are temporarily able to charge prices
that exceed their production costs,
a. the firms will earn long-run economic profit.
b. additional firms will be attracted into the market until price falls to the
level of per-unit production cost.
c. the firms will earn short-run economic profits that will be offset by
long-run economic losses.
d. the existing firms must be colluding or rigging the market, otherwise,
they would be unable to charge such high prices.
Suppose a restaurant that is highly profitable during the summer months is
unable to cover its total cost during the winter months. If it wants to
maximize profits, the restaurant should
a. shut down during the winter, even if it is able to cover its variable costs
during that period.
b. continue operating during the winter months if it is able to cover its
variable costs.
c. go a out of business immediately; losses should never be tolerated.
d. lower its prices during the summer months.
This graph illustrates a firm
a. capable of earning economic profit.
b. that is only able to break even when
it maximizes profit.
c. taking economic losses.
d. that should shut down immediately
This graph depicts the cost curves of a
firm in a price-taker industry. At what
output would the firm’s per-unit cost be
at a minimum?
a.
100
c.
150
b.
125
d.
an output > 150
For the above graph, if the market price is $30, what is the firm’s
profit-maximizing output and maximum profit.
a.
output, 125; economic profit, zero
b.
output, 125; economic profit, between $1,000 and $1,250
c.
output, 150; economic profit, $1,500
d.
output, 150; economic profit, between $1,250 and $1,500