1. Chapter 5: Pure Competition
Objectives of chapter 5:
Pure competition characteristics
Demand as seen by a purely competitive seller
Profit maximization in the short-run
Marginal cost and short-run supply
Profit maximization in the long-run
Pure competition and efficiency
Chapter 5 by TITH Seyla

2. Introduction
Market structures can vary in both the theoretical analysis and real world observation.
If you want to go to buy Cell-card scratch card, you can go to thousands of sellers which are present almost everywhere.
What happens in the market if one seller stop selling the scratch cards?
What happens in the market if you stop buying Cell-card scratch cards?
Chapter 5 by TITH Seyla

3. Pure competition characteristics
Very large numbers of sellers and buyers
Standardized product: identical products are produced by firms in the pure competition market.
Buyers and sellers are price takers: no influence from any individual buyer and seller on the market.
Free entry and exit in and out of the market.
Chapter 5 by TITH Seyla

4. Demand as seen by a purely competitive seller
Each purely competitive firm offers only a negligible fraction of total market supply.
It must accept the price predetermined by the market. (sellers are price-takers)
Perfectly elastic demand
The demand curve of a competitive firm is perfectly elastic. Note that the market demand curve is different from the firm demand curve. The firm demand curve shows the relationship between the price and quantity demanded of the product the firm is producing. It is a straight horizontal line a price is fixed at any quantity demanded.
Total revenue = Price x Quantity
Average revenue = Total revenue / Quantity
Marginal revenue = ∆ Total revenue / ∆ Quantity
Chapter 5 by TITH Seyla

5. Demand as seen by a purely competitive seller
Chapter 5 by TITH Seyla

6. Profit maximization in the short-run
Because the purely competitive firm is a price take, it can maximize its economic profit only by adjusting its output.
In the short-run, the firm has a fixed plant; therefore, the firm must adjust the variable resources (materials and labor) to adjust the level of output.
There are two ways to determine the level of output at which a competitive firm will realize maximum profit or minimum loss (in case of loss).
Total revenue and total cost comparison
Marginal revenue and marginal cost comparison
Chapter 5 by TITH Seyla

7. Total revenue and total cost comparison
Economic profit = Total revenue – Total cost
The firm will choose an output level (Q) that makes its economic profit maximum.
Chapter 5 by TITH Seyla

8. Chapter 5 by TITH Seyla

9. Marginal revenue and marginal cost comparison
The firm will make maximum economic profit when marginal revenue = marginal cost
If the marginal revenue is greater than the marginal cost, this means that producing one more unit of the product will add economic profit to the firm (economic profit increases).
If the marginal revenue is less than the marginal cost, this means that producing one more unit of the product will add negative economic profit (or economic loss) to the firm (economic profit decreases)
Chapter 5 by TITH Seyla

10. Marginal revenue and marginal cost comparison
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11. Short-run equilibrium
MR = P
MR = MC
P = MC
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12. Shutdown point This point is where AVC is at its minimum.
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13. Marginal cost and short-run supply
The short-run market supply curve shows the quantity supplied by all firms in the market at each price when each firm’s plant and the number of firms remain the same.
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14. Chapter 5 by TITH Seyla

15. Market supply curve
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16. Market equilibrium
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17. Profit maximization in the long-run
Entry and exit only: entry and exit of the firm are the only adjustments for profit maximization in the long-run.
Identical cost: all the firms have the same cost.
Constant-cost industry: the entry and exit of the firm do not affect the prices of the resources.
Chapter 5 by TITH Seyla

18. Profit maximization in the long-run
Entry eliminates economic profits.
Chapter 5 by TITH Seyla

19. Profit maximization in the long-run
Entry eliminates economic profits.
Chapter 5 by TITH Seyla

20. Profit maximization in the long-run
Exit eliminates economic losses.
Chapter 5 by TITH Seyla

21. Profit maximization in the long-run
Exit eliminates economic losses.
Chapter 5 by TITH Seyla

22. A permanent change in demand
A decrease in demand shifts the market demand curve leftward. The market price falls, and each firm decreases the quantity it produces.
Chapter 5 by TITH Seyla

23. A permanent change in demand
Economic losses induce some firms to exit in the long run, which decreases the market supply and the price starts to rise.
Chapter 5 by TITH Seyla

24. A permanent change in demand
A new long-run equilibrium occurs when the price has risen to equal minimum average total cost. Firms make zero economic profits, and firms no longer exit the market.
Chapter 5 by TITH Seyla

25. A permanent change in demand
A new long-run equilibrium occurs when the price has risen to equal minimum average total cost. Firms make zero economic profits, and firms no longer exit the market.
Chapter 5 by TITH Seyla

26. External Economies and Diseconomies
The change in the long-run equilibrium price following a permanent change in demand depends on external economies and external diseconomies.
External economies are factors beyond the control of an individual firm that lower the firm’s costs as the industry output increases.
External diseconomies are factors beyond the control of a firm that raise the firm’s costs as industry output increases.
Chapter 5 by TITH Seyla

27. The long-run market supply curve
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28. The long-run market supply curve
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29. The long-run market supply curve
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30. Long-run equilibrium
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31. Long-run equilibrium
P = MC = Minimum ATC
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32. Pure competition and efficiency
Efficient Use of Resources
Resources are used efficiently when no one can be made better off without making someone else worse off.
Productive efficiency: P = Minimum ATC
In the long-run, pure competition forces firms to produce at minimum average total cost of production. This means that the minimum amount of resources will be used to produce any particular output.
Allocative efficiency: P = MC
Underallocation: P > MC (the firm is not yet at the maximum profit point)
Overallocation: P < MC (the firm is over the maximum profit point)
Dynamic adjustment: ability to restore efficiency.
Chapter 5 by TITH Seyla