SLIDES PREPARED BY JUDITH SKUCE, GEORGIAN COLLEGE Pure Competition SLIDES PREPARED BY JUDITH SKUCE, GEORGIAN COLLEGE ©2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 8

Four Market Structures Pure Competition Market Structure Continuum ©2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 8

Four Market Structures Pure Monopoly Pure Competition Market Structure Continuum ©2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 8

Four Market Structures Monopolistic Competition Pure Competition Monopolistic Competition Pure Monopoly Market Structure Continuum ©2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 8

Four Market Structures Oligopoly Pure Competition Monopolistic Competition Pure Monopoly Market Structure Continuum ©2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 8

Four Market Structures Pure Competition Monopolistic Competition Pure Monopoly Oligopoly Market Structure Continuum ©2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 8

Characteristics of Pure Competition very large numbers standardized product price-takers easy entry & exit Pure Competition Monopolistic Competition Pure Monopoly Oligopoly Market Structure Continuum ©2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 8

Relevance of Pure Competition closely approximates some real markets standard for evaluating efficiency ©2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 8

Demand for a Purely Competitive Firm Perfectly Elastic Demand p industry p1 p q D firm p1 S D D Q Firm can sell as much as it wants at the going price ©2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 8

Average, Total & Marginal Revenue average revenue = price marginal revenue = price total revenue = price X quantity ©2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 8

Product price, P (average revenue) Figure 8-1 Product price, P (average revenue) Quantity demanded, Q Total Revenue, TR Marginal Revenue, MR 131 ©2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 8

Product price, P (average revenue) Figure 8-1 Product price, P (average revenue) Quantity demanded, Q Total Revenue, TR Marginal Revenue, MR 131 1 ] 131 ©2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 8

Product price, P (average revenue) Figure 8-1 Product price, P (average revenue) Quantity demanded, Q Total Revenue, TR Marginal Revenue, MR 131 1 2 262 ] 131 ] 131 ©2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 8

Product price, P (average revenue) Figure 8-1 Product price, P (average revenue) Quantity demanded, Q Total Revenue, TR Marginal Revenue, MR 131 1 2 262 3 393 4 524 5 655 6 786 7 917 8 1048 9 1179 10 1310 ] 131 ] 131 ] 131 ] 131 ] 131 ] 131 ] 131 ] 131 ] 131 ] 131 ©2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 8

Profit Maximization in the Short Run purely competitive firm can maximize its profit (minimize its loss) only by adjusting output Two Approaches: total revenue-total cost approach marginal revenue-marginal cost approach ©2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 8

Microeconomics, Chapter 8 Figure 8-2 Q TFC TVC TC TR Profit or Loss 1 2 3 4 5 6 7 8 9 10 ©2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 8

Microeconomics, Chapter 8 Figure 8-2 Q TFC TVC TC TR Profit or Loss $100 1 100 2 3 4 5 6 7 8 9 10 ©2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 8

Microeconomics, Chapter 8 Figure 8-2 Q TFC TVC TC TR Profit or Loss $100 $ 0 1 100 90 2 170 3 240 4 300 5 370 6 450 7 540 8 650 9 780 10 930 ©2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 8

Microeconomics, Chapter 8 Figure 8-2 p=$131 Q TFC TVC TC TR Profit or Loss $100 $ 0 $ 100 1 100 90 190 2 170 270 3 240 340 4 300 400 5 370 470 6 450 550 7 540 640 8 650 750 9 780 880 10 930 1030 ©2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 8

Microeconomics, Chapter 8 Figure 8-2 Q TFC TVC TC TR Profit or Loss $100 $ 0 $ 100 1 100 90 190 131 2 170 270 262 3 240 340 393 4 300 400 524 5 370 470 655 6 450 550 786 7 540 640 917 8 650 750 1048 9 780 880 1179 10 930 1030 1310 ©2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 8

graphically… can you see the profit maximization? Q TFC TVC TC TR Figure 8-2 Q TFC TVC TC TR Profit or Loss $100 $ 0 $ 100 $-100 1 100 90 190 131 - 59 2 170 270 262 - 8 3 240 340 393 + 53 4 300 400 524 +124 5 370 470 655 +185 6 450 550 786 +236 7 540 640 917 +277 8 650 750 1048 +298 9 780 880 1179 +299 10 930 1030 1310 +280 can you see the profit maximization? graphically… ©2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 8

Maximum economic profit $299 Figure 8-2 Break-even point Maximum economic profit $299 TR TR TC Break-even point (normal profit) ©2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 8

Total Revenue-Total Cost Approach profit = TR - TC profit is maximized where the vertical distance between TR & TC is maximized break-even points where TR=TC now, the marginal revenue-marginal cost approach… ©2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 8

Microeconomics, Chapter 8 Figure 8-3 Q TFC TVC TC $100 $ 0 $ 100 1 100 90 190 2 170 270 3 240 340 4 300 400 5 370 470 6 450 550 7 540 640 8 650 750 9 780 880 10 930 1030 ©2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 8

Microeconomics, Chapter 8 Figure 8-3 Q TFC TVC TC $100 $ 0 $ 100 1 100 90 190 2 170 270 3 240 340 4 300 400 5 370 470 6 450 550 7 540 640 8 650 750 9 780 880 10 930 1030 MC $ 90 80 70 60 90 110 130 150 ] ] ] ] ] ] ] ] ] ©2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 8

should the firm produce the 1st unit? Figure 8-3 Q TFC TVC TC $100 $ 0 $ 100 1 100 90 190 2 170 270 3 240 340 4 300 400 5 370 470 6 450 550 7 540 640 8 650 750 9 780 880 10 930 1030 MC MR $ 90 $131 80 131 70 60 90 110 130 150 should the firm produce the 1st unit? ] ] ] ] ] ] ] ] ] ©2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 8

Microeconomics, Chapter 8 Figure 8-3 Q TFC TVC TC $100 $ 0 $ 100 1 100 90 190 2 170 270 3 240 340 4 300 400 5 370 470 6 450 550 7 540 640 8 650 750 9 780 880 10 930 1030 MC MR $ 90 $131 80 131 70 60 90 110 130 150 ] what about the 2nd unit? ] ] ] ] ] ] ] ] ©2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 8

Microeconomics, Chapter 8 Figure 8-3 Q TFC TVC TC $100 $ 0 $ 100 1 100 90 190 2 170 270 3 240 340 4 300 400 5 370 470 6 450 550 7 540 640 8 650 750 9 780 880 10 930 1030 MC MR $ 90 $131 80 131 70 60 90 110 130 150 ] ] ] ] ] ] ] what about the 9th unit? ] ] ©2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 8

what about the 10th unit? 9 units will maximize profits Figure 8-3 Q TFC TVC TC $100 $ 0 $ 100 1 100 90 190 2 170 270 3 240 340 4 300 400 5 370 470 6 450 550 7 540 640 8 650 750 9 780 880 10 930 1030 MC MR $ 90 $131 80 131 70 60 90 110 130 150 9 units will maximize profits the same profit-maximizing result as with the TR-TC approach! ] ] ] ] ] ] ] ] what about the 10th unit? ] ©2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 8

Microeconomics, Chapter 8 MR-MC Approach Short run profit maximization occurs where MR=MC applies only if producing is preferable to shutting down guide to profit maximization for ALL firms rule can be restated as P=MC for purely competitive firms, since MR=P ©2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 8

Microeconomics, Chapter 8 MC 131 9 ATC Find the quantity where MR=MC AVC AFC ©2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 8

Microeconomics, Chapter 8 MC 131 ATC 97.78 AVC Find ATC AFC 9 ©2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 8

Microeconomics, Chapter 8 MC 131 Profit = 9 X (131 - 97.78) = 299 ATC 97.78 AVC AFC 9 ©2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 8

Microeconomics, Chapter 8 Loss-Minimizing Case Suppose price falls from $131 to $81… ©2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 8

firm should produce the first 6 units Figure 8-4 Q TFC TVC TC $100 $ 0 $ 100 1 100 90 190 2 170 270 3 240 340 4 300 400 5 370 470 6 450 550 7 540 640 8 650 750 9 780 880 10 930 1030 MC MR $ 90 $81 80 81 70 60 90 110 130 150 ] ] ] firm should produce the first 6 units ] ] ] ] ] ] ©2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 8

Microeconomics, Chapter 8 MC Loss = 6 X (81 - 91.67) = -64.02 < TFC ATC 91.67 81 AVC AFC ©2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 8

Microeconomics, Chapter 8 Shutdown Case Suppose the price falls even further, to $71 ©2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 8

Microeconomics, Chapter 8 MC ATC 94 Loss = 5 X (71 - 94) = -115>TFC AVC 71 AFC When price is below minimum AVC, the firm should shut down 5 ©2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 8

indicates the quantity being produced.... Figure 8-6 P ATC MC Costs and revenues (dollars) AVC At every price, the MR = MC point indicates the quantity being produced.... Q ©2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 8

Microeconomics, Chapter 8 Figure 8-6 P ATC MC Costs and revenues (dollars) AVC P3 MR3 Q3 Record the quantity being supplied for each price Q ©2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 8

Microeconomics, Chapter 8 Figure 8-6 P ATC MC Costs and revenues (dollars) AVC P3 MR3 P2 MR2 At a lower price a lower quantity will be supplied Q Q2 Q3 ©2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 8

Microeconomics, Chapter 8 Figure 8-6 P ATC MC Costs and revenues (dollars) P4 AVC MR4 P3 MR3 P2 MR2 At a higher price a higher quantity will be supplied Q Q2 Q3 Q4 ©2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 8

Microeconomics, Chapter 8 Figure 8-6 P ATC MC P5 MR5 Costs and revenues (dollars) P4 AVC MR4 P3 MR3 P2 MR2 Q Q2 Q3 Q4 Q5 ©2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 8

Microeconomics, Chapter 8 Figure 8-6 P ATC MC P5 MR5 Costs and revenues (dollars) P4 AVC MR4 P3 MR3 P2 MR2 P1 MR1 Firm should not produce below P2 Q Q2 Q3 Q4 Q5 ©2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 8

Cost Curve at points above AVC represents the Short-run Figure 8-6 P ATC MC P5 MR5 Costs and revenues (dollars) The Marginal Cost Curve at points above AVC represents the Short-run Supply Curve P4 AVC MR4 P3 MR3 P2 MR2 P1 MR1 Q Q2 Q3 Q4 Q5 ©2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 8

Microeconomics, Chapter 8 Figure 8-6 P Short-run Supply Curve (blue) ATC MC P5 MR5 Costs and revenues (dollars) P4 AVC MR4 P3 MR3 P2 MR2 P1 MR1 Q Q2 Q3 Q4 Q5 ©2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 8

Microeconomics, Chapter 8 Supply Curve Shifts MC2 AVC2 P Q MC1 AVC1 If costs increase.... the supply curve effectively shifts to the left ©2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 8

Microeconomics, Chapter 8 Supply Curve Shifts P Q MC1 MC2 If costs decrease.... the supply curve effectively shifts to the right AVC1 AVC2 ©2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 8

Firm & Industry: Equilibrium Price Total Industry Demand D Firm (price taker) Industry ©2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 8

Firm & Industry: Equilibrium Price S=MCs Q P MC $111 8000 D Firm (price taker) Industry ©2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 8

Firm & Industry: Equilibrium Price S=MCs The firm “takes” the industry price Q P MC $111 AVC D 8000 Firm (price taker) Industry ©2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 8

Firm & Industry: Equilibrium Price S=MCs Q P MC D $111 $111 AVC D 8 8000 Firm (price taker) Industry 1000 firms ©2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 8

Firm & Industry: Equilibrium Price what happens in the long run? S=MCs Q P Economic Profit ATC MC D $111 $111 AVC D 8 8000 Firm (price taker) Industry ©2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 8

Profit Maximization in the Long Run Assumptions: entry and exit only identical costs constant-cost industry ©2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 8

The Goal of Our Analysis in the long run, p = minimum ATC because firms seek profit & avoid losses firms are free to enter & exit the industry ©2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 8

What happens if demand increases.... Figure 8-8 What happens if demand increases.... P P S1 MC ATC $60 $50 $40 $60 $50 $40 MR D1 Q Q 100 100,000 Firm (price taker) Industry 1,000 firms ©2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 8

Economic profits at higher prices.... Figure 8-8 Economic profits at higher prices.... P P D2 S1 MC ATC $60 $50 $40 $60 $50 $40 MR D1 Q Q 100 100,000 Firm (price taker) Industry 1,000 firms ©2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 8

.…new firms enter, S increases, p falls.... Figure 8-8 .…new firms enter, S increases, p falls.... P P S1 MC S2 ATC $60 $50 $40 $60 $50 $40 MR D2 D1 Q Q 100 100,000 Firm (price taker) Industry ©2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 8

... new equilibrium with more firms Figure 8-8 ... new equilibrium with more firms P P S1 MC S2 ATC $60 $50 $40 $60 $50 $40 MR D2 D1 Q Q 100 100,000 110,000 Firm (price taker) Industry 1100 firms vs. 1000 firms ©2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 8

What happens if demand decreases.... Figure 8-9 What happens if demand decreases.... P P S1 MC ATC $60 $50 $40 $60 $50 $40 MR D1 Q Q 100 100,000 Firm (price taker) Industry 1,000 firms ©2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 8

Short-run losses at lower prices.... Figure 8-9 Short-run losses at lower prices.... P P S1 MC D2 ATC $60 $50 $40 $60 $50 $40 MR D1 Q Q 100 100,000 Firm (price taker) Industry 1,000 firms ©2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 8

.…some firms exit, S decreases, p rises.... Figure 8-9 .…some firms exit, S decreases, p rises.... S3 P P S1 MC ATC $60 $50 $40 $60 $50 $40 MR 90,000 D1 D2 Q Q 100 100,000 Firm (price taker) Industry 900 firms ©2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 8

... new equilibrium with fewer firms Figure 8-9 ... new equilibrium with fewer firms S3 P P S1 MC ATC $60 $50 $40 $60 $50 $40 MR D1 D2 Q Q 100 90,000 100,000 Firm (price taker) Industry 900 firms vs. 1000 firms ©2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 8

Microeconomics, Chapter 8 Long-run Equilibrium if price > min ATC profits attract new firms as S increases, price drops to min ATC if price < min ATC losses cause firms to exit as S decreases, price rises to min ATC so, in the long run, p=min ATC ©2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 8

Microeconomics, Chapter 8 Long-run Supply crucial factor is whether the number of firms in the industry affects the costs of individual firms ©2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 8

Long-run Supply for a Constant-cost Industry Q Q1 Q2 ©2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 8

Long-run Supply for a Constant-cost Industry Demand increases P S1 P>$50 P=$50 D2 D1 Q Q1 Q2 ©2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 8

Long-run Supply for a Constant-cost Industry Profits attract new firms S1 S2 P>$50 P=$50 D2 D1 Q Q1 Q2 ©2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 8

Long-run Supply for a Constant-cost Industry how does an increasing cost industry differ? S2 long-run S P=$50 D2 D1 price remains the same in the long run Q Q1 Q2 ©2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 8

Long-run Supply for an Increasing-cost Industry Demand increases P P=$50 D1 Q Q1 ©2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 8

Long-run Supply for an Increasing-cost Industry Q Q1 ©2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 8

Long-run Supply for an Increasing-cost Industry Profits attract new firms P>>$50 P>$50 P=$50 D2 D1 but cost curves shift UP, so final price is still higher than initial price Q Q1 Q2 ©2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 8

Long-run Supply for an Increasing-cost Industry how does a decreasing cost industry differ? long-run S P>$50 P=$50 D2 D1 in the long run, greater supply is offered at a higher price Q Q1 Q2 ©2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 8

Long-run Supply for a Decreasing-cost Industry Demand increases P P=$50 D1 Q Q1 ©2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 8

Long-run Supply for a Decreasing-cost Industry Q Q1 ©2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 8

Long-run Supply for a Decreasing-cost Industry Profits attract new firms P>$50 P=$50 P<$50 D1 D2 but cost curves shift DOWN, so final price is still higher than initial price Q Q1 Q2 ©2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 8

Long-run Supply for a Decreasing-cost Industry in the long run, greater supply is offered at a lower price Q Q1 Q2 ©2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 8

Pure Competition & Efficiency MC ATC P MR Price = MC = Minimum ATC (normal profit) Q Q ©2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 8

Pure Competition & Efficiency Productive Efficiency P=Minimum ATC Allocative Efficiency P=MC ©2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 8

Testing for Allocative Efficiency when price = marginal cost, the value of the last unit to the purchaser just offsets the opportunity cost of producing it P > MC  underproduction P < MC  overproduction P = MC  “just right” ©2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 8

Pure Competition & Efficiency resources are efficiently allocated under pure competition Productive Efficiency P=Minimum ATC Allocative Efficiency P=MC Dynamic Adjustments purely competitive markets adjust to restore efficiency when disrupted by changes in the economy ©2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 8

Allocative Efficiency & Consumer & Producer Surplus consumer surplus is the difference between what the consumer is willing to pay, & the market price producer surplus is the difference between the marginal cost of production, & the market price ©2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 8

Microeconomics, Chapter 8 Figure 8-13 P ΣMC market price Acme’s producer surplus D=MB Q Q ©2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 8

Microeconomics, Chapter 8 Figure 8-13 P ΣMC producer surplus cost of production D=MB Q* Q ©2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 8

Microeconomics, Chapter 8 Figure 8-14 P efficient allocation ΣMC consumer surplus producer surplus D=MB Q* Q ©2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 8

Microeconomics, Chapter 8 Figure 8-14 P ΣMC consumer surplus underproduction producer surplus D=MB Q* Q ©2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 8

loss of producer surplus loss of consumer surplus Figure 8-14 P ΣMC consumer surplus loss of producer surplus overproduction producer surplus loss of consumer surplus D=MB Q* Q ©2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 8