Chapter 7: Pure Competition

We will be discussing all four of these market models, but first we will start with pure competition. The other market models will be discussed in future chapters. Pure competition involves a very large number of firms producing a standardized product and there is easy entry and exit. Pure monopoly is a market structure in which one firm is the sole seller of a product or service and the entry of additional firms is blocked. Monopolistic competition consists of a relatively large number of sellers producing differentiated products. Oligopoly involves only a few sellers of a standardized or differentiated product.

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Pure CompetitionChapter 7McGraw-Hill/IrwinCopyright © 2014 by The McGraw-Hill Companies, Inc. All rights reservedFour Market ModelsPure competitionPure monopolyMonopolistic competitionOligopoly7-*Pure Competition: CharacteristicsVery large numbers of sellersStandardized product“Price takers”Easy entry and exitPerfectly elastic demandFirm produces as much or little as they want at the priceDemand graphs as horizontal line7-*Average, Total, and Marginal RevenueFirm’sDemandSchedule(AverageRevenue)Firm’sRevenueDataD = MR = ARTRPQDTRMR$131131131131131131131131131131131012345678910$0131262393524655786917104811791310$131131131131131131131131131131]]]]]]]]]]7-*Average, Total, and Marginal RevenueAverage revenueRevenue per unitAR = TR/Q = PTotal revenue TR = P × QMarginal revenue Extra revenue from 1 more unitMR = ΔTR/ΔQ7-*Profit Maximization: TR-TC ApproachThree questions:Should the firm produce?If so, what amount?What economic profit (loss) will be realized?7-*Profit Maximization: MR-MC ApproachCopyright © 2013 by The McGraw-Hill Companies, Inc. All rights reservedMcGraw-Hill/IrwinLO3The Profit-Maximizing Output for a Purely Competitive Firm: Marginal Revenue– Marginal Cost Approach (Price = $131)(1)TotalProduct(Output)(2)Average Fixed Cost (AFC)(3)Average Variable Cost (AVC)(4)Average Total Cost(ATC)(5)Marginal Cost(MC)(5)Price = Marginal Revenue(MR)(6)Total Economic Profit (+)or Loss (-)0$-1001$100.00$90.00$190$90$131-59250.0085.0013580131-8333.3380.00113.3370131+53425.0075.00100.0060131+124520.0074.0094.0070131+185616.6775.0091.6780131+236714.2977.1491.4390131+277812.5081.2593.75110131+298911.1186.6797.78130131+2991010.0093.00103.00150131+2807-*Profit Maximization: MR-MC ApproachCost and Revenue$20015010050012345678910OutputEconomic ProfitMR = PMCMR = MCAVCATCP=$131A=$97.787-*Loss-Minimizing CaseLoss minimizationStill produce because P > min AVCLosses at a minimum where MR = MC7-*Profit Minimization: MR-MC ApproachLO3The Profit-Minimizing Output for a Purely Competitive Firm: Marginal Revenue– Marginal Cost Approach (Price = $81)(1)TotalProduct(Output)(2)Average Fixed Cost (AFC)(3)Average Variable Cost (AVC)(4)Average Total Cost(ATC)(5)Marginal Cost(MC)(5)Price = Marginal Revenue(MR)(6)Total Economic Profit (+)or Loss (-)0$-1001$100.00$90.00$190$90$81-109250.0085.001358081-108333.3380.00113.337081-97425.0075.00100.006081-76520.0074.0094.007081-65616.6775.0091.678081-64714.2977.1491.439081-73812.5081.2593.7511081-102911.1186.6797.7813081-1511010.0093.00103.0015081-2207-*Loss-Minimizing CaseLossMR = PMCAVCATCP=$81A=$91.67V = $757-*Shutdown Case: MR-MC ApproachLO3The Profit-Minimizing Output for a Purely Competitive Firm: Marginal Revenue– Marginal Cost Approach (Price = $71)(1)TotalProduct(Output)(2)Average Fixed Cost (AFC)(3)Average Variable Cost (AVC)(4)Average Total Cost(ATC)(5)Marginal Cost(MC)(5)Price = Marginal Revenue(MR)(6)Total Economic Profit (+)or Loss (-)0$-1001$100.00$90.00$190$90$71-119250.0085.001358071-128333.3380.00113.337071-127425.0075.00100.006071-116520.0074.0094.007071-115616.6775.0091.678071-124714.2977.1491.439071-143812.5081.2593.7511071-182911.1186.6797.7813071-2411010.0093.00103.0015071-3207-*Shutdown CaseMR = PMCAVCATCP=$71V = $74Short-Run Shutdown PointP < Minimum AVC$71 < $747-*Marginal Cost and Short-Run SupplyThe Supply Schedule of a Competitive Firm Confronted with Cost DataPriceQuantitySuppliedMaximum Profit (+)Minimum Loss (-)$15110+ $4801319+2991118+138917-3816-64710-100610-1007-*Marginal Cost and Short-Run SupplyP10MR1P2MR2P3MR3P4MR4P5MR5MCAVCATCQ2Q3Q4Q5abcdeSShut-Down Point (If P is Below)7-*3 Production QuestionsLO4Output Determination in Pure Competition in the Short RunQuestionAnswerShould 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-*Firm and Industry: EquilibriumLO4Firm and Market Supply and the Market Demand(1)QuantitySupplied, SingleFirm(2)TotalQuantitySupplied,1,000 Firms(3)ProductPrice(4)TotalQuantityDemanded1010,000$1514,00099,0001316,00088,0001118,00077,000919,00066,0008111,000007113,000006116,0007-*Firm and Industry: EquilibriumEconomicprofitdATCAVCs = MC$111$111DS = ∑ MCs88000(a) Single Firm(a) Industry7-*Profit Maximization in the Long RunEasy entry and exitThe only long-run adjustment we considerIdentical costsAll firms in the industry have identical costsConstant-cost industryEntry and exit do not affect resource prices7-*Long-Run EquilibriumEntry eliminates profitsFirms enterSupply increasesPrice fallsExit eliminates lossesFirms exitSupply decreasesPrice rises7-*Entry Eliminates Economic ProfitsATCMRMC$605040D1S1D2$605040S27-*Exit Eliminates LossesATCMRMC$605040D3S3D1$605040S17-*Long-Run SupplyConstant-cost industryEntry/exit does not affect LR ATCConstant resource priceSpecial caseIncreasing-cost industryMost industriesLR ATC increases with expansionSpecialized resourcesDecreasing-cost industry7-*LR Supply: Constant-Cost IndustryLO690,000100,000110,000Q3Q1Q2$50SZ1Z2Z3D3D1D27-*LR Supply: Increasing-Cost Industry90,000100,000110,000Q3Q1Q2$50P1SY1Y2Y3D3D1D2$40$55P2P37-*Pure Competition and Efficiency In the long run, efficiency is achievedProductive efficiency Producing where P = min ATCAllocative efficiencyProducing where P = MC7-*Dynamic AdjustmentsPurely competitive markets will automatically adjust toChanges in consumer tastesResource suppliesTechnologyRecall the “invisible hand”7-*