SLIDES PREPARED BY JUDITH SKUCE, GEORGIAN COLLEGE

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

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

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

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

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 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

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

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

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

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

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

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

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

Firm & Industry: Equilibrium Price
Total Industry Demand D 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 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 firms ©2005 McGraw-Hill Ryerson Ltd. 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

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 a Decreasing-cost Industry
Demand increases P P=$50 D1 Q Q1 ©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

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

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

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

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