1. 23
Pure
Competition

2. FOUR MARKET MODELS Pure Competition Monopolistic Competition Oligopoly
Pure Monopoly

3. I. Main Characteristics
Perfect Competition
I. Main Characteristics
Very large numbers
Very large number of independently acting sellers (e.g. farm products, stock market, foreign exchange market.
Standardized product
Identical or homogeneous product. As long as the price is the same, consumers will be indifferent about which seller they buy the product from

4. Price takers
- Individual firms have no significant control over the market price. Each firm’s quantity is too small to affect the market supply or price.
- Competitive firms are price takers, they cannot affect the price, but adjust their own price to it.
- None of the sellers can ask for a higher price because it will lose all consumers.
- None will sell at a lower price because it will incur a loss.

5. Free entry and exit
New firms can freely enter and existing firms can freely leave the market.
No significant legal, technological, financial, or other obstacles prohibit new firms from selling their output in the market.

6. II. Revenue Total Revenue (TR)
Equals the price times the quantity (TR=P x Q).
Total revenue increases by a constant amount for each unit sold.
Average Revenue (AR)
Revenue per unit sold (AR = TR/Q).
The firm’s demand schedule is its revenue schedule.
Price and average revenue are the same (P=AR).
Marginal Revenue (MR)
The change in total revenue due to the change in the quantity sold by one unit (MR = ΔTR/ Δ Q).
Marginal revenue is constant because price is constant.
Marginal revenue equals the price.

7. Price = Average revenue = Marginal revenue
Note
Only in a competitive market:
Price = Average revenue = Marginal revenue

8. III. DEMAND AS SEEN BY A PURELY COMPETITIVE SELLER
Product Price (P)
(Average Revenue)
Quantity
Demanded (Q)
Total
Revenue (TR)
Marginal
Revenue (MR)
$131
$ 0

9. DEMAND AS SEEN BY A PURELY COMPETITIVE SELLER
Product Price (P)
(Average Revenue)
Quantity
Demanded (Q)
Total
Revenue (TR)
Marginal
Revenue (MR)
$131
131 1
$ 0
131 ]
$131

10. DEMAND AS SEEN BY A PURELY COMPETITIVE SELLER
Product Price (P)
(Average Revenue)
Quantity
Demanded (Q)
Total
Revenue (TR)
Marginal
Revenue (MR)
$131
131 1 2
$ 0
131
262 ]
$131
131 ]

11. DEMAND AS SEEN BY A PURELY COMPETITIVE SELLER
Product Price (P)
(Average Revenue)
Quantity
Demanded (Q)
Total
Revenue (TR)
Marginal
Revenue (MR)
$131
131 1 2 3
$ 0
131
262
393 ]
$131
131 ] ]

12. DEMAND AS SEEN BY A PURELY COMPETITIVE SELLER
Product Price (P)
(Average Revenue)
Quantity
Demanded (Q)
Total
Revenue (TR)
Marginal
Revenue (MR)
$131
131 1 2 3 4
$ 0
131
262
393
524 ]
$131
131 ] ] ]

13. DEMAND AS SEEN BY A PURELY COMPETITIVE SELLER
Product Price (P)
(Average Revenue)
Quantity
Demanded (Q)
Total
Revenue (TR)
Marginal
Revenue (MR)
$131
131 1 2 3 4 5 6 7 8 9 10
$ 0
131
262
393
524
655
786
917
1048
1179
1310 ]
$131
131 ] ] ] ]

14. DEMAND AS SEEN BY A PURELY COMPETITIVE SELLER
Product Price (P)
(Average Revenue)
Quantity
Demanded (Q)
Total
Revenue (TR)
Marginal
Revenue (MR)
$131
131 1 2 3 4 5 6 7 8 9 10
$ 0
131
262
393
524
655
786
917
1048
1179
1310 ]
$131
131 ] ] ] ]

15. Based on the table above; Perfectly elastic demand
A firm cannot obtain a higher price by restricting its output, nor does it need to lower its price to increase its sales volume.
Demand curve faced by the individual competitive firm is perfectly elastic at the market price
Note that competitive market demand curve is a downward sloping curve.

16. Quantity Demanded (sold)
1179
1048
917
786
655
524
393
262
131 TR
Price and revenue
D = MR
Quantity Demanded (sold)

17. IV. SHORT RUN PROFIT MAXIMIZATION
Two Approaches...
First: Total-Revenue -Total Cost Approach:
The Decision Process:
Should the firm produce? If YES,
What quantity should be produced? and,
What profit or loss will be realized?
The Decision Rule:
Produce in the short-run if you can realize:
1- A profit (or)
2- A loss less than the fixed cost

18. Can you see the profit maximization?
TOTAL REVENUE-TOTAL COST APPROACH
Total
Fixed
Cost
Total
Variable
Cost
Price: $131
Total
Product
Total
Cost
Total
Revenue
Profit
Can you see the
profit maximization? 1 2 3 4 5 6 7 8 9 10
$ 100
100
$ 0 90
170
240
300
370
450
540
649
780
930
$ 100
190
270
340
400
470
550
640
749
880
1030
$ 0
131
262
393
524
655
786
917
1048
1179
1310
- $100
- 59
- 8
+ 53
+ 124
+ 185
+ 236
+ 277
+ 299
+ 280

19. Graphing Total Cost & Revenue
TOTAL REVENUE-TOTAL COST APPROACH
Total
Fixed
Cost
Total
Variable
Cost
Price: $131
Total
Product
Total
Cost
Total
Revenue
Profit
Graphing Total
Cost & Revenue 1 2 3 4 5 6 7 8 9 10
$ 100
100
$ 0 90
170
240
300
370
450
540
649
780
930
$ 100
190
270
340
400
470
550
640
749
880
1030
$ 0
131
262
393
524
655
786
917
1048
1179
1310
- $100
- 59
- 8
+ 53
+ 124
+ 185
+ 236
+ 277
+ 299
+ 280

20. TOTAL REVENUE-TOTAL COST APPROACH
Break-Even Point
(Normal Profit)
$1,800
1,700
1,600
1,500
1,400
1,300
1,200
1,100
1,000
900
800
700
600
500
400
300
200
100
Total
Revenue
Maximum
Economic
Profits
$299
Total revenue and total cost
Total
Cost
Break-Even Point
(Normal Profit)

21. MR = MC Rule SHORT RUN PROFIT MAXIMIZATION Two Approaches...
First: Total-Revenue -Total Cost Approach
Second Approach:
Marginal-Revenue Marginal-Cost Approach
MR = MC Rule
Three Characteristics:
The rule applies only if producing is preferred to shutting down (otherwise the firm will shut down)
Rule applies to all markets
Rule can be restated as: P=MC

22. MR = MC rule In the short run, the firm will maximize profit or
minimize losses by producing the output at which
marginal revenue equals marginal cost.

23. The same profit maximizing result!
MARGINAL REVENUE-MARGINAL COST APPROACH
Average
Fixed
Cost
Average
Variable
Cost
Average
Total
Cost
Price =
Marginal
Revenue
Total
Economic
Profit/Loss
Total
Product
Marginal
Cost
The
same profit
maximizing
result! 1 2 3 4 5 6 7 8 9 10
$100.00
50.00
33.33
25.00
20.00
16.67
14.29
12.50
11.11
10.00
$90.00
85.00
80.00
75.00
74.00
77.14
81.25
86.67
93.00
$190.00
135.00
113.33
100.00
94.00
91.67
91.43
93.75
97.78
103.00 90 80 70 60
110
131
150
$ 131
131
- $100
- 59
- 8
+ 53
+ 124
+ 185
+ 236
+ 277
+ 299
+ 280

24. MARGINAL REVENUE-MARGINAL COST APPROACH
Average
Fixed
Cost
Average
Variable
Cost
Average
Total
Cost
Price =
Marginal
Revenue
Total
Economic
Profit/Loss
Total
Product
Marginal
Cost 1 2 3 4 5 6 7 8 9 10
$100.00
50.00
33.33
25.00
20.00
16.67
14.29
12.50
11.11
10.00
$90.00
85.00
80.00
75.00
74.00
77.14
81.25
86.67
93.00
$190.00
135.00
113.33
100.00
94.00
91.67
91.43
93.75
97.78
103.00 90 80 70 60
110
131
150
$ 131
131
- $100
- 59
- 8
+ 53
+ 124
+ 185
+ 236
+ 277
+ 299
+ 280

25. Two Ways to Calculate Profit
First: Calculate total profit
TR = P x Q
TC = ATC x Q
Π = TR – TC
Second: calculate profit per unit
Π /Q = TR/Q – TC/Q
Π /Q = P (or AR) – ATC
Π = (Π /Q) x Q

26. Profit Maximization Position
MARGINAL REVENUE-MARGINAL COST APPROACH
Profit Maximization Position
$200
150
100 50
Economic Profit MC
$131.00 MR
ATC
Cost and Revenue
AVC
$97.78

27. MR = MC Optimum Solution
MARGINAL REVENUE-MARGINAL COST APPROACH
Profit Maximization Position
$200
150
100 50
Economic Profit MC
MR = MC
Optimum
Solution
$131.00 MR
ATC
Cost and Revenue
AVC
$97.78

28. The MR=MC rule still applies
MARGINAL REVENUE-MARGINAL COST APPROACH
Loss Minimization Position
If the price is lowered from $131 to $81
The MR=MC rule still applies
…But the MR = MC point changes
Note: π = π per unit x Q

29. Loss Minimization Position
MARGINAL REVENUE-MARGINAL COST APPROACH
Loss Minimization Position
$200
150
100 50
Economic Loss MC
ATC
Cost and Revenue
AVC
$91.67 MR
$81.00

30. Short-Run Shut Down Point
MARGINAL REVENUE-MARGINAL COST APPROACH
Short-Run Shut Down Point
$200
150
100 50 MC
ATC
Cost and Revenue
AVC MR
$71.00
Minimum AVC
is the Shut-Down
Point

31. Marginal Cost & Short-Run Supply
MARGINAL REVENUE-MARGINAL COST APPROACH
Marginal Cost & Short-Run Supply
Observe the impact upon profitability as price is changed
Quantity
Supplied
Maximum Profit (+)
Or Minimum Loss (-)
Price
$151
131
111 91 81 71 61 10 9 8 7 6
$+480
+299
+138 -3
-64
-100

32. Marginal Cost & Short-Run Supply
MARGINAL REVENUE-MARGINAL COST APPROACH
Marginal Cost & Short-Run Supply MC P5
MR5
ATC
MR4 P4
Cost and Revenue, (dollars)
AVC P3
MR3 P2
MR2
MR1 P1
Do not
Produce –
Below AVC Q2 Q3 Q4 Q5
Quantity Supplied

33. Marginal Cost & Short-Run Supply
MARGINAL REVENUE-MARGINAL COST APPROACH
Marginal Cost & Short-Run Supply
Yields the
Short-Run
Supply Curve
Supply MC P5
MR5
MR4 P4
Cost and Revenue, (dollars) P3
MR3 P2
MR2
MR1 P1 No
Production
Below AVC Q2 Q3 Q4 Q5
Quantity Supplied

34. Supply Curve to the Left
MARGINAL REVENUE-MARGINAL COST APPROACH
Marginal Cost & Short-Run Supply
MC2
Cost and Revenue, (dollars)
MC1
AVC1
Quantity Supplied S1 S2
AVC2
Higher Costs Move the
Supply Curve to the Left

35. Lower Costs Move the Supply Curve to the Right
MARGINAL REVENUE-MARGINAL COST APPROACH
Marginal Cost & Short-Run Supply
Cost and Revenue, (dollars)
MC1
AVC1
Quantity Supplied S1
Lower Costs Move
the Supply Curve
to the Right
MC2 S2
AVC2

36. V. SHORT RUN COMPETITIVE EQUILIBRIUM
The Competitive Firm “Takes” its Price from the Industry Equilibrium
S= MC’s P P
Economic
Profit
ATC
S=MC D
$111
$111
AVC D Q 8 Q
8000
Firm
(price taker)
Industry

37. The Competitive Firm “Takes” it’s Price from the Industry Equilibrium
S= MC’s P P
Economic
Profit
ATC
S=MC D
$111
$111
AVC D Q Q 8
8000
Firm
(price taker)
Industry

38. Assumptions... Goal... VI. PROFIT MAXIMIZATION IN THE LONG-RUN
Entry and Exit Only: the only long run adjustment is the entry and exit of firms.
Identical Costs: all firms in the industry have identical cost curves.
Constant-Cost Industry: entry and exit does not affect resource prices.
Goal...
Price = Minimum ATC
Zero Economic Profit Model

39. Temporary Profits and the Reestablishment Of Long-Run Equilibrium
100
100,000
Industry
Firm
(price taker)
$60 50 40 MC
ATC MR D1

40. Firm Industry An increase in demand increases profits… EconomicQ
100
100,000
Industry
Firm
(price taker)
$60 50 40 MC
ATC MR D2 D1

41. New Competitors increase supply and lower Prices decrease economic profits
Zero Economic
Profits S1 P Q
100
100,000
Industry
Firm
(price taker)
$60 50 40 S2 MC
ATC MR D2 D1

42. Decreases in demand, Losses and the Reestablishment of Long-Run EquilibriumP Q
100
100,000
Industry
Firm
(price taker)
$60 50 40 MC
ATC MR D1

43. Firm Industry A decrease in demand creates losses… Economic Losses P Q
100
100,000
Industry
Firm
(price taker)
$60 50 40 MC
ATC MR D1 D2

44. Competitors with losses decrease supply and prices return to zero economic profitsQ
100
100,000
Industry
Firm
(price taker)
$60 50 40 MC
ATC MR D1 D2

45. VII. LONG-RUN SUPPLY SUPPLY
CASE ONE:
Constant Cost Industry
Perfectly Elastic Long-Run Supply: entry and exit will set the price back to its original level
Graphically...

46. CONSTANT COST INDUSTRY
LONG-RUN SUPPLY IN A
CONSTANT COST INDUSTRY P P2 P1 P3 Z3 Z1 Z2
=$50 S D3 D1 D2 Q Q3 Q1 Q2
90,000
100,000
110,000

47. CASE TWO:
LONG-RUN SUPPLY IN AN INCREASING COST INDUSTRY P S P2 P1 P3
$55 50 45 Y2 Y1 Y3 D3 D1 D2 Q Q3 Q1 Q2
90,000
100,000
110,000

48. LONG-RUN EQUILIBRIUM FOR A COMPETITIVE FIRMMC
ATC
Price P MR
Price = MC = Minimum ATC
(normal profit) Q
Quantity

49. efficiently allocated Under pure competition
PURE COMPETITION AND EFFICIENCY
Productive Efficiency:
Price = Minimum ATC
Allocative Efficiency:
Price = MC
Underallocation:
Price > MC
Overallocation:
Price < MC
Resources are
efficiently allocated
Under pure competition