Pure Competition Chapter 9 Four Market Models Pure

Pure Competition Chapter 9

Four Market Models • • Pure competition Pure monopoly Monopolistic competition Oligopoly Imperfect Competition Pure Competition Monopolistic Competition Oligopoly Pure Monopoly Market Structure Continuum 9 -2

Pure Competition 1. Very large numbers 2. Standardized product 3. “Price takers” 4. Free entry and exit 9 -3

Pure Competition • The demand schedule faced by an individual form is perfectly elastic at the market price • The demand curve for the market is still downward slopping 9 -4

Pure Competition • Average revenue – The individual demand schedule is also AR since the price per unit is the Revenue per unit • Marginal revenue – In pure competition, MR=P • TR – Slopped upwards, constant slop since addition in TR is equal to P 9 -5

Pure Competition $1179 P Firm’s Revenue Data 917 QD TR $131 0 131 1 131 2 131 3 131 4 131 5 131 6 131 7 131 8 131 9 131 10 TR 1048 $0 131 262 393 524 655 786 917 1048 1179 1310 MR ] $131 ] 131 ] 131 ] 131 Price and Revenue Firm’s Demand Schedule (Average Revenue) 786 655 524 393 262 D = MR = AR 131 2 4 6 8 10 Quantity Demanded (Sold) 12 9 -6

Short Run Profit Maximization • Market price is given • Three questions: – Should the product be produced? – If so, in what amount? – What economic profit (loss) will be realized? 9 -7

Profit Maximization • Two approaches 1. Total revenue and total cost approach – Produce where TR-TC is greatest 2. Marginal revenue and marginal cost approach – Produce where MR=MC 9 -8

Total Revenue Total Cost Approach Price = $131 (1) Total Product (Output) (Q) 0 1 2 3 4 5 6 7 8 9 10 (2) Total Fixed Cost (TFC) $100 100 100 (3) (4) (5) (6) Total Variable Total Cost Total Revenue Profit (+) Cost (TVC) (TR) or Loss (-) $0 90 170 240 300 370 450 540 650 780 930 $100 190 270 340 400 470 550 640 750 880 1030 $0 131 262 393 524 655 786 917 1048 1179 1310 $-100 -59 -8 +53 +124 +185 +236 +277 +298 +299 +280 Do You See. Graph Profit The Maximization? Now Let’s Results… 9 -9

$1800 1700 1600 1500 1400 1300 1200 1100 1000 900 800 700 600 500 400 300 200 100 Total Economic Profit Total Revenue and Total Cost Total Revenue Total Cost Approach $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 Profit $299 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 Quantity Demanded (Sold) 9 -10

Marginal Revenue Marginal Cost Approach (1) Total Product (Output) 0 1 2 3 4 5 6 7 8 9 10 (2) Average Fixed Cost (AFC) $100. 00 50. 00 33. 33 25. 00 20. 00 16. 67 14. 29 12. 50 11. 11 10. 00 (3) Average Variable Cost (AVC) (4) Average Total Cost (ATC) $90. 00 $190. 00 85. 00 135. 00 80. 00 113. 33 75. 00 100. 00 74. 00 94. 00 75. 00 91. 67 77. 14 91. 43 81. 25 93. 75 86. 67 97. 78 93. 00 103. 00 (5) Marginal Cost (MC) $90 80 70 60 70 80 90 110 130 150 (6) Marginal Revenue (MR) (7) Profit (+) or Loss (-) $131 131 131 $-100 -59 -8 +53 +124 +185 +236 +277 +298 +299 +280 Surprise - Now Let’s Graph. Now? It… Do. No You See Profit Maximization 9 -11

Marginal Revenue Marginal Cost Approach Cost and Revenue $200 MR = MC 150 P=$131 Economic Profit MC MR = P ATC 100 AVC A=$97. 78 50 0 1 2 3 4 5 6 Output 7 8 9 10 9 -12

Short Run Profit Maximization • Produce where MR (=P) = MC • Suffer loss, still produce? • Yes if loss is less than fixed cost – Cover variable cost • Shut down if loss greater than fixed cost • Produce if P > min AVC 9 -13

Short Run Loss Minimizing Case Cost and Revenue $200 Lower the Price to $81 and Observe the Results! 150 Loss A=$91. 67 ATC AVC 100 P=$81 50 0 MC MR = P V = $75 1 2 3 4 5 6 Output 7 8 9 10 9 -14

Short Run Shut Down Case Cost and Revenue $200 Lower the Price Further to $71 and Observe the Results! MC 150 ATC 100 V = $74 AVC MR = P P=$71 Short-Run Shut Down Point P < Minimum AVC $71 < $74 50 0 1 2 3 4 5 6 Output 7 8 9 10 9 -15

Short-Run Supply Curve Continuing the Same Example… Supply Schedule of a Competitive Firm Quantity Maximum Profit (+) Price Supplied or Minimum Loss (-) $151 10 $+480 131 9 +299 111 8 +138 91 7 -3 81 6 -64 71 0 -100 61 0 -100 The schedule shows the quantity a firm will produce at a variety of prices 9 -16

Short-Run Supply Curve Cost and Revenues (Dollars) Firms produce where MR=MC e P 5 d P 4 P 3 P 2 P 1 MC MR 5 ATC c MR 4 AVC MR 3 MR 2 MR 1 b a This Price is Below AVC And Will Not Be Produced 0 Q 2 Q 3 Q 4 Quantity Supplied Q 5 9 -17

Short-Run Supply Curve Firms produce where MR=MC Cost and Revenues (Dollars) Examine the MC for the Competitive Firm MC Above AVC Becomes the Short-Run Supply Curve Break-even (Normal Profit) Point e P 5 d P 4 P 3 P 2 P 1 S MC MR 5 ATC c MR 4 AVC MR 3 MR 2 MR 1 b a Shut-Down Point (If P is Below) 0 Q 2 Q 3 Q 4 Quantity Supplied Q 5 9 -18

Firm and Industry Supply • Changes in firm supply – Shifts in marginal cost – Input price or technology • The industry (total) supply curve – Sum of individual supply • Industry supply and demand – Determine market price 9 -19

Firm and Industry Supply Single Firm Industry p P S = ∑ MC’s s = MC Economic Profit ATC d $111 AVC D 0 8 p 0 8000 P Competitive firm must take the price that is Established by industry supply and demand 9 -20

Long Run Profit Maximization • Assumptions – Entry and exit only – Identical costs – Constant-cost industry • Goal of the analysis – In the long run, P = min ATC – Entry eliminates profits – Exit eliminates losses 9 -21

Entry Eliminates Profits Single Firm Industry p P S 1 MC ATC S 2 $60 50 MR 50 D 2 40 40 D 1 0 100 p 0 80, 000 90, 000 100, 000 P An increase in demand temporarily raises price Higher prices draw in new competitors Increased supply returns price to equilibrium 9 -22

Exit Eliminates Losses Single Firm Industry p P S 3 MC ATC S 1 $60 50 MR 50 D 1 40 40 D 3 0 100 p 0 80, 000 90, 000 100, 000 P A decrease in demand temporarily lowers price Lower prices drive away some competitors Decreased supply returns price to equilibrium 9 -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 industry 9 -24

Long-Run Supply Curve Constant-Cost Industry P P 1 P 2 $50 Z 3 Z 1 Z 2 S P 3 D 3 0 Q 3 90, 000 D 1 Q 1 100, 000 D 2 Q 2 110, 000 Q 9 -25

Long-Run Supply Curve Increasing-Cost Industry P P 2 $55 P 1 $50 P 3 $40 S Y 2 Y 1 Y 3 D 2 D 1 D 3 0 Q 3 90, 000 Q 1 100, 000 Q 2 110, 000 Q How would a decreasing-cost industry look? 9 -26

Pure Competition and Efficiency • Productive efficiency P = minimum ATC • Allocative efficiency P = MC • Maximum consumer and producer surplus • Dynamic adjustments • “Invisible Hand” revisited 9 -27

Long-Run Equilibrium Single Firm P=MC=Minimum ATC (Normal Profit) Market MC S Price ATC MR P P D 0 Qf Quantity 0 Qe Quantity Productive Efficiency: Price = minimum ATC Allocative Efficiency: Price = MC Pure competition has both in its long-run equilibrium 9 -28