1. PURE CompetITion

2. 4 Types of Basic Market Models
Pure Competition
Pure Monopoly
Monopolistic Competition
Oligopoly

3. Pure Competition Characteristics: Rare in the real world
But…helps analyze industries which are similar to pure competition
Many sellers means that no one seller has an impact on price by its decisions alone
Products are standardized
Firms are “price-takers” – must accept the market price
Firms can freely enter and exit the market

4. Analyzing Pure Competition
To examine:
Demand from the seller’s viewpoint
Competitive producer responses to market price in the short run
Long run adjustments in a competitive industry
The efficiency of competitive markets

5. Demand (as Competitive Seller)
Individual firm will view its demand as perfectly elastic
BUT…the demand curve is not perfectly elastic for the industry
WHY the difference??
Individual Firm’s Demand Curve
Industry’s Demand Curve

6. Definitions of Revenue
Total Revenue (TR) = Price multiplied by quantity sold (TR = P x Q)
Average Revenue (AR)= price per unit for each firm in pure competition
Marginal Revenue (MR) = ∆ in TR for each additional quantity sold
AND will equal the unit price in conditions of pure competition

7. Profit Maximization in the Short Run
Assumptions of the Firm
Fixed plant
By adjusting output:
Will maximize profits OR
Will minimize losses
Profits = TR-TC
3 Questions each firm must answer:
Should the firm produce
If so, how much?
What will be the profit or loss?

8. Profit Maximization Total Cost vs. Total Revenue
Firms should produce if the difference between TR and TC results in a profit (TR > TC)
Firms should produce that output which maximizes its profit or minimizes its loss
Profit (or loss) = TR – TC
Firms should not produce (“shut down”) if
TR – TC <Average fixed costs
Loss = Average fixed costs

9. TR – (ATC x Q) Profit Maximization Marginal Revenue vs. Marginal Cost
MR = MC means that the firm will maximize profits (or minimize losses) at the point where MR = MC
If MR < AVC (average variable cost), the firm will shut down
In pure competition, P = MR (and P = MC)
The firm will stop producing at the point where MR < MC
Profit maximization =
TR – (ATC x Q)

10. Determining Equilibrium Price
Equilibrium price is where total QS = total QD
Sum of individual firms production = industry (or total) QS
Individual firms must take equilibrium price (“price takers”)
Supply plans of all competitive producers is a major determinant of product price

11. Profit Maximization in the Long Run
Assumptions:
Entry and exit of firms are the only long-run adjustments
Firms in the industry have identical cost curves
The industry is a constant-cost industry (i.e. entry and exit of firms doesn’t affect costs of individual firms)

12. Profit Maximization in the Long Run
Product price = Each firm’s point of minimum average total cost (ATC)
If short term losses occur, firms leave the industry
Qs decreases, P increases, profits increase
If short term economic profits occur, firms will enter the industry
Qs increases, P decreases, profits decrease or losses occur/increase

13. Profit Maximization in the Long Run
Long run Supply:
Constant cost industry
Perfectly elastic supply curve
Level of output will not affect the price in the long run
Expansion or contraction does not affect resource prices or production costs
Entry/exit will affect quantity of output but price will always revert to equilibrium price

14. Profit Maximization in the Long Run
Long run Supply:
Increasing cost industry
Average cost curves shift upward as industry expands and downwards when it contracts
If D increases, ATC increase as firms enter the industry, and P increases to maintain normal profit
If D decreases, ATC decreases as firms exit the industry, P decreases, firms cannot attain above-normal profit

15. Profit Maximization in the Long Run
Long-run Supply
Decreasing cost industry
Supply will be downward sloping
ATC falls as the industry expands
Firms will enter until price is driven down to maintain normal profits

16. Pure Competition and Efficiency
Regardless of cost model, long run equilibrium will have the same characteristics:
Productive efficiency occurs when P = minimum ATC
Allocative efficiency occurs when P = MC
If P > MC, then society values more units of good X and resources are underallocated to the production of good X
If P < MC, then society values other goods more highly than good X and resources are overallocated to good X

17. Pure Competition and Efficiency
Allocative efficiency implies maximum consumer and supplier surplus
Combined consumer and supplier surplus is maximized at the equilibrium price