1. Pure Competition in the Short Run
Chapter 10
Explanations and characteristics of the four models are outlined at the beginning of this chapter, then the characteristics of a purely competitive industry are detailed. There is an introduction to the concept of the perfectly elastic demand curve facing an individual firm in a purely competitive industry. Next, the total, average, and marginal revenue schedules are presented in numeric and graphic form. Using the cost schedules from the previous chapter, the idea of profit maximization is explored.
The total revenue and total cost approach is analyzed first because of its simplicity. More space is devoted to explaining the MR = MC rule, and to demonstrating how this rule applies in all market structures, not just in pure competition.
Next, the firm’s short‑run supply schedule is shown to be the same as its marginal-cost curve at all points above the average-variable-cost curve. Then the short‑run competitive equilibrium is discussed at the firm and industry levels.
Finally, this chapter’s Last Word discusses firms’ decisions to shut down in the short run and the losses incurred due to fixed costs.
Pure Competition in the Short Run

2. Market Structure Continuum
Four Market Models
Pure competition
Pure monopoly
Monopolistic competition
Oligopoly
After an overview of all 4 market models, the chapter focuses on pure competition. The other market models are examples of imperfect competition and will be discussed in future chapters.
Oligopoly
Pure
Competition
Monopolistic
Competition
Pure
Monopoly
Market Structure Continuum
LO1

3. Pure Competition: Characteristics
Very large numbers of sellers
Standardized product
“Price takers”
Easy entry and exit
Very large numbers of independent sellers each acting alone cannot influence the market price by increasing or decreasing their output because each has such a miniscule part of the entire market.
A standardized product is a product for which all other products in the market are identical and thus are perfect substitutes. The consequence of this is that buyers are indifferent as to whom they buy from.
Price takers are sellers that have no pricing power; in other words, they do not have the ability to price their product.
Easy entry and exit means that there are no obstacles to entry or to exit the industry.
LO2

4. Purely Competitive Demand
Perfectly elastic demand
Firm produces as much or little as they wish at the market price
Demand graphs as horizontal line
Perfectly elastic demand means that firm has no power to influence price so the firm merely chooses to produce a certain level of output at the price that is given. The demand curve is not perfectly elastic for the industry; it only appears that way to the individual firm, since they must take the market price no matter what quantity they produce. The firm faces a perfectly elastic demand because each individual firm makes up such a small part of the total market and the goods are perfect substitutes. Note that this perfectly elastic demand curve is a horizontal line at the price.
LO3

5. Average, Total, and Marginal Revenue
Average revenue
Revenue per unit
AR = TR/Q = P
Total revenue
TR = P X Q
Marginal revenue
Extra revenue from 1 more unit
MR = ΔTR/ΔQ
When a firm charges the same price for each unit of output, the average revenue is just the price of the good. Total revenue refers to the total amount of money that the firm collects for the sale of all of the units of their good. Marginal revenue reflects the additional revenue that the firm will receive by producing one more unit of output. When the firm is deciding how much to produce, the firm considers the marginal revenue in their decision.
LO3

6. Profit Maximization: TR – TC Approach
The competitive producer will ask three questions
Should the firm produce?
If so, in what amount?
What economic profit (loss) will be realized?
When looking at profit maximization there are essentially 3 questions that the firm must answer. The first question is whether or not the firm should produce at all in the short run. In the short run, the firm should shut-down under certain circumstances. If it has been determined that the firm should produce in the short run, then the firm must determine how much to produce. Lastly, based on the answers to the first two questions, it is necessary to calculate the profit or loss for the firm. Part of the profit-maximization rule is producing an output that minimizes losses in the short run when that is the best option.
LO4

7. Loss-Minimizing Case Loss minimization
Still produce because MR > minimum AVC
Losses at a minimum where MR = MC
Producing adds more to revenue than to costs
In the short run the firm only has two choices: produce or shut-down. There is not enough time in the short run for the firm to get out of business. Given these options, sometimes the firm will produce, but still make a loss. In these situations, the loss from producing is smaller than the loss if the firm shut-down so this is the firm’s best choice.
LO5

8. 3 Production Questions
Output Determination in Pure Competition in the Short Run
Question
Answer
Should this firm produce?
Yes, if price is equal to, or greater than, minimum average variable cost. This means that the firm is profitable or that its losses are less than its fixed cost.
What quantity should this firm produce?
Produce where MR (=P) = MC; there, profit is maximized (TR exceeds TC by a maximum amount) or loss is minimized.
Will production result in economic profit?
Yes, if price exceeds average total cost (TR will exceed TC). No, if average total cost exceeds price (TC will exceed TR).
We must work through these 3 questions sequentially every time we are confronted with a new market price. This is a table that summarizes the steps that you need to go through to determine profit maximizing output.
LO6
LO3

9. Firm and Industry: Equilibrium
Firm and Market Supply and Market Demand
(1)
Quantity
Supplied,
Single
Firm
(2)
Total
1000 Firms
(3)
Product
Price
(4)
Demanded 10
10,000
$151
4000 9
9000
131
6000 8
8000
111 7
7000 91 6 81
11,000 71
13,000 61
16,000
The market equilibrium condition is where quantity demanded equals quantity supplied. This will occur at a price of $111 and this price is the equilibrium, or market clearing price. We can see that the industry demand curve is a typical, downward sloping demand even though, for the firm, the demand curve is perfectly elastic and horizontal.
LO6

10. Firm versus Industry: Equilibrium
S = ∑ MC’s
s = MC
Economic
profit
ATC d
$111
$111
AVC
Short-run competitive equilibrium for (a) a firm and (b) the industry. The horizontal sum of the 1000 firms’ individual supply curves (s) determines the industry supply curve (S). Given industry demand (D), the short-run equilibrium price and output for the industry are $111 and 8000 units. Taking the equilibrium price as given, the individual firm establishes its profit-maximizing output at 8 units and, in this case, realizes the economic profit represented by the green area.
Individual firms must take price as given, but the supply plans of all competitive producers as a group are a major determinant of product price. D 8
8000
LO6

11. Fixed Costs: Digging Out of a Hole
Shutting down in the short run does not mean shutting down forever
Low prices can be temporary
Some firms switch production on and off depending on the market price
Examples: oil producers, resorts, and firms that shut down during a recession
Firms have to determine whether or not producing in the short run will make their losses bigger or smaller. Firms hope that producing will help to reduce their losses, but if they are wrong their losses (their hole) might grow greater. If firms are forced to shut-down, the shut-down might be temporary. The firm may re-open when prices rise and therefore will be large enough for the firm to reap profits.