1. Chapter 8 & 9 Pure Competition
What are the four basic market models of competition?
What are the characteristics of purely competitive markets?
How do purely competitive firms maximize profits (or minimize losses?)
When will a firm shut-down?
What are the long run adjustments to short run outcomes?
How does long run equilibrium lead to economic efficiency?

2. Four Market Models
How does a firm compete? In which market structure does it compete?
I. Pure Competition (sometimes called “perfect competition”)
Large number of firms/sellers/producers
Standardized product (commodity) like wheat, apples, roofing nails
Easy entry and exit, few barriers to entry or exit from industry
No control over price

3. II. Monopolistic Competition (sometimes called “differentiated competition”)
Relatively large number of sellers producing differentiated products like restaurants, clothing, shampoo
Nonprice competition—attributes such as quality, location, design. Emphasis on advertising, brand names, trademarks
Few barriers to entry
Some control over price

4. III. Oligopoly A few sellers usually producing differentiated products
Each firm is affected by the decisions of its rivals and must take those decisions into account when determining pricing and output policies
Significant obstacles to entry and exit
Some price control
If you were JetBlue, from whom would you buy your fleet of airplanes?

5. IV. Pure Monopoly
One producer, one firm in the industry
Unique product—no need to differentiate
Control over price
High barriers to entry
Pure monopoly, monopolistic competition, and oligopoly are often referred to as imperfect competition (most of the real economy is imperfect!)

6. Pure Competition: Demand
Perfectly elastic for the firm!
The firm can’t get a higher price by restricting output
The influence of one firm on total market supply and market price is negligible.
Average, Total and Marginal Revenue
AR (per unit revenue) = P
TR = P X Q or AR X Q
MR = change in TR that results from selling one more unit of output.

7. Marginal Revenue
Because P is constant in a purely competitive industry, MR is constant.
Therefore, for the firm,
MR = D = AR = P
Graph:

8. Marginal Revenue—Marginal Cost Approach
As long as MR exceeds MC, the firm should continue producing.
Key micro output determining rule:
MR = MC (Know this or else!!)
In the short run, as long as the firm chooses to produce, it will maximize profit or minimize loss by producing that output where MR = MC
Graph:

9. Short Run Profit Max
The purely competitive firm can maximize economic profit only by adjusting output. (It has no control over price.)
In the S/R, changing the amounts of variable resources (labor, materials) alters Q.
Economic Profit = TR - TC

10. Marginal Cost and S/R Supply
The short run supply curve for a firm is the portion of the MC curve above its average variable cost curve. Upward sloping due to law of DMR; firm will produce more when price rises.
Changes in prices of variable inputs or technology will change MC and cause a shift in the MC (supply) curve.

11. Profit Max in the Long Run
Simplifying assumptions: all firms have identical costs and constant cost industry (resource prices unaffected by entry and exit of firms.)
Key understanding: after long run adjustments are complete, market price will be exactly equal to, and production will occur at, each firm’s minimum ATC.

12. Graphically… Long Run Equilibrium
Entry of firms eliminates economic profits (shifts market supply curve to right)
Exit of firms eliminates loss (shifts market supply curve to left)
In the real world, inferior entrepreneurs incur higher costs, are more inefficient and will be the first to exit.

13. Total Revenue – Total Cost Approach
In a purely competitive industry with a given market price, the firm faces 3 questions:
1. Should we produce?
2. If yes, what amount should we produce?
3. What profit or loss will be realized?
Break-even point: TR = TC
The firm makes only a normal profit.
Graph:

14. Shutdown Point
If price is less than AVC at all levels of output, the firm should not produce.
MR = MC Rule (revised): A competitive firm will maximize profit or minimize loss in the short run by producing that output at which MR = MC, provided that market price exceeds minimum AVC.

15. Loss Minimization
The firm will produce at a loss as long as the firm’s total loss is less than total fixed costs.
If at MR = MC, MR exceeds AVC and the firm can pay all of its variable costs and part of its fixed costs.
Graphically:

16. Long Run Supply Constant Cost Industry (special case)
Contraction or expansion does not affect resource prices, therefore does not shift ATC curve of the firm
Constant cost occurs in industries where the industry’s demand for resources is small in relation to the total demand for those resources

17. Long Run Supply Increasing Cost Industry (usual case)
Most industries are increasing cost— entry of new firms bids up resource prices (and shift ATC higher. ) Exit of firms lower costs.
Upsloping supply curve for resources

18. Pure Competition and Efficiency
A competitive market economy uses society’s scarce resources in a way which maximizes consumer satisfaction. (Also maximizes the total consumer and producer surplus.)
There are 2 types of efficiency…

19. Productive Efficiency
P = min. ATC : goods produced in the least costly way.
In the long run, pure competition forces firms to produce at and charge a price equal to min. ATC.
Min. ATC forces firms to use the most efficient production techniques available to survive.
Consumers benefit by paying the lowest product price possible.

20. Allocative Efficiency
P = MC : mix of goods most wanted by society—resources allocated efficiently.
Price reflects marginal benefit of the good
Marginal cost reflects an opportunity cost (because other goods could be produced)
When P > MC, there is an underallocation of resources to that good
When P < MC, there is an overallocation
Ideally, P = MC to reflect what consumers really want, i.e. efficient resource allocation.