2. Pure Competition 6 LECTURE

3. Market Structure Continuum FOUR MARKET MODELS Pure Competition

4. Market Structure Continuum Pure Competition FOUR MARKET MODELS Pure Monopoly

5. Market Structure Continuum Pure Competition Pure Monopoly FOUR MARKET MODELS Imperfect Competition

6. Market Structure Continuum Pure Competition Pure Monopoly FOUR MARKET MODELS Monopolistic Competition

7. Market Structure Continuum Pure Competition Pure Monopoly Monopolistic Competition FOUR MARKET MODELS Oligopoly

8. Market Structure Continuum Pure Competition Pure Monopoly Monopolistic Competition Oligopoly FOUR MARKET MODELS Pure Competition: Very Large Numbers Standardized Product “Price Takers” Free Entry and Exit

9. DEMAND AS SEEN BY A PURELY COMPETITIVE SELLER Perfectly Elastic Demand Price Taker Role Total Revenue Average Revenue Marginal Revenue For example...

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

11. $131 131 0 1 2 3 4 5 6 7 8 9 10 $ 0 131 262 393 524 655 786 917 1048 1179 1310 $131 131 Product Price (P) (Average Revenue) Total Revenue (TR) Marginal Revenue (MR) Quantity Demanded (Q) DEMAND AS SEEN BY A PURELY COMPETITIVE SELLER ] ] ] ] ] ] ] ] ] ] Graphically Presented…

12. DEMAND, MARGINAL REVENUE, AND TOTAL REVENUE IN PURE COMPETITION TR D = MR 1 2 3 4 5 6 7 8 9 10 1179 1048 917 786 655 524 393 262 131 0 Price and revenue Quantity Demanded (sold)

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

14. SHORT RUN PROFIT MAXIMIZATION Two Approaches... First: Total-Revenue -Total Cost Approach The Decision Rule: Produce in the short-run if it can realize 1- A profit (or) 2- A loss less than its fixed costs The Decision Process: Should the firm produce? What quantity should be produced? What profit or loss will be realized? Applied Graphically…

15. Total Cost 0 1 2 3 4 5 6 7 8 9 10 Total Product Total Fixed Cost Total Variable Cost Total Revenue Profit $ 100 100 $ 0 90 170 240 300 370 450 540 650 780 930 $ 100 190 270 340 400 470 550 640 750 880 1030 Price: $131 - $100 - 59 - 8 + 53 + 124 + 185 + 236 + 277 + 298 + 299 + 280 TOTAL REVENUE-TOTAL COST APPROACH $ 0 131 262 393 524 655 786 917 1048 1179 1310 Can you see the profit maximization?

16. Total Cost 0 1 2 3 4 5 6 7 8 9 10 Total Product Total Fixed Cost Total Variable Cost Total Revenue Profit $ 100 100 $ 0 90 170 240 300 370 450 540 650 780 930 $ 100 190 270 340 400 470 550 640 750 880 1030 Price: $131 - $100 - 59 - 8 + 53 + 124 + 185 + 236 + 277 + 298 + 299 + 280 TOTAL REVENUE-TOTAL COST APPROACH $ 0 131 262 393 524 655 786 917 1048 1179 1310 Graphing Total Cost & Revenue

17. $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 0 Total revenue and total cost Total Revenue Total Cost Maximum Economic Profits $299 Break-Even Point (Normal Profit) Break-Even Point (Normal Profit) 1 2 3 4 5 6 7 8 9 10 11 12 13 14 TOTAL REVENUE-TOTAL COST APPROACH

18. SHORT RUN PROFIT MAXIMIZATION Two Approaches... First: Total-Revenue -Total Cost Approach Three Characteristics: The rule applies only if producing is preferred to shutting down Rule applies to all markets Rule can be restated P=MC Second: Marginal-Revenue -Marginal Cost Approach MR = MC Rule

19. Average Total Cost 0 1 2 3 4 5 6 7 8 9 10 Total Product Average Fixed Cost Average Variable Cost Price = Marginal Revenue Total Economic Profit/Loss $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 75.00 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 - $100 - 59 - 8 + 53 + 124 + 185 + 236 + 277 + 298 + 299 + 280 MARGINAL REVENUE-MARGINAL COST APPROACH $ 131 131 Marginal Cost 90 80 70 60 70 80 90 110 130 150 The same profit maximizing result!

20. Average Total Cost 0 1 2 3 4 5 6 7 8 9 10 Total Product Average Fixed Cost Average Variable Cost Price = Marginal Revenue Total Economic Profit/Loss $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 75.00 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 - $100 - 59 - 8 + 53 + 124 + 185 + 236 + 277 + 298 + 299 + 280 MARGINAL REVENUE-MARGINAL COST APPROACH $ 131 131 Marginal Cost 90 80 70 60 70 80 90 110 130 150 Graphically

21. $200 150 100 50 0 Cost and Revenue 1 2 3 4 5 6 7 8 9 10 MC MR AVC ATC Economic Profit $131.00 $97.78 MARGINAL REVENUE-MARGINAL COST APPROACH Profit Maximization Position

22. $200 150 100 50 0 Cost and Revenue 1 2 3 4 5 6 7 8 9 10 MC MR AVC ATC Economic Profit $131.00 $97.78 MARGINAL REVENUE-MARGINAL COST APPROACH MR = MC Optimum Solution Profit Maximization Position

23. The MR=MC rule still applies If the price is lowered from $131 to $81 …But the MR = MC point changes MARGINAL REVENUE-MARGINAL COST APPROACH Loss Minimization Position

24. $200 150 100 50 0 Cost and Revenue 1 2 3 4 5 6 7 8 9 10 MC MR AVC ATC Economic Loss $81.00 $91.67 MARGINAL REVENUE-MARGINAL COST APPROACH Loss Minimization Position

25. $200 150 100 50 0 Cost and Revenue 1 2 3 4 5 6 7 8 9 10 MC MR AVC ATC $71.00 MARGINAL REVENUE-MARGINAL COST APPROACH Short-Run Shut Down Point Minimum AVC is the Shut-Down Point

26. MARGINAL REVENUE-MARGINAL COST APPROACH Marginal Cost & Short-Run Supply Price Quantity Supplied Maximum Profit (+) Or Minimum Loss (-) Observe the impact upon profitability as price is changed $151 131 111 91 81 71 61 10 9 8 7 6 0 $+480 +299 +138 -3 -64 -100

27. Cost and Revenue, (dollars) MC MR 1 AVC ATC MARGINAL REVENUE-MARGINAL COST APPROACH Quantity Supplied MR 2 MR 3 MR 4 MR 5 P1P1 P2P2 P3P3 P4P4 P5P5 Q2Q2 Q3Q3 Q4Q4 Q5Q5 Marginal Cost & Short-Run Supply Do not Produce – Below AVC

28. Cost and Revenue, (dollars) MC MR 1 MARGINAL REVENUE-MARGINAL COST APPROACH Quantity Supplied MR 2 MR 3 MR 4 MR 5 P1P1 P2P2 P3P3 P4P4 P5P5 Q2Q2 Q3Q3 Q4Q4 Q5Q5 Marginal Cost & Short-Run Supply Yields the Short-Run Supply Curve Supply No Production Below AVC

29. MARGINAL REVENUE-MARGINAL COST APPROACH Marginal Cost & Short-Run Supply AVC 2 MC 2 Higher Costs Move the Supply Curve to the Left Cost and Revenue, (dollars) MC 1 AVC 1 Quantity Supplied S1S1 S2S2

30. MARGINAL REVENUE-MARGINAL COST APPROACH Marginal Cost & Short-Run Supply AVC 2 MC 2 Lower Costs Move the Supply Curve to the Right Cost and Revenue, (dollars) MC 1 AVC 1 Quantity Supplied S1S1 S2S2

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

32. P Q S=MC AVC ATC 8 D P Q 8000 D S=  MC’s Industry Firm (price taker) Economic Profit $111 SHORT RUN COMPETITIVE EQUILIBRIUM The Competitive Firm “Takes” it’s Price from the Industry Equilibrium How about the long-run?

33. PROFIT MAXIMIZATION IN THE LONG-RUN Goal... Price = Minimum ATC Zero Economic Profit Model

34. Temporary Profits and the Reestablishment Of Long-Run Equilibrium S1S1 MC ATC P Q 100 P Q 100,000 Industry Firm (price taker) $60 50 40 $60 50 40 PROFIT MAXIMIZATION IN THE LONG-RUN MR D1D1

35. An increase in demand increases profits… MR D1D1 MC ATC P Q 100 P Q 100,000 Industry Firm (price taker) $60 50 40 $60 50 40 PROFIT MAXIMIZATION IN THE LONG-RUN D2D2 Economic Profits S1S1

36. New Competitors increase supply and lower Prices decrease economic profits MR D1D1 MC ATC P Q 100 P Q 100,000 Industry Firm (price taker) $60 50 40 $60 50 40 PROFIT MAXIMIZATION IN THE LONG-RUN D2D2 Zero Economic Profits S1S1 S2S2

37. Decreases in demand, Losses and the Reestablishment of Long-Run Equilibrium S1S1 MC ATC P Q 100 P Q 100,000 Industry Firm (price taker) $60 50 40 $60 50 40 PROFIT MAXIMIZATION IN THE LONG-RUN D1D1 MR

38. A decrease in demand creates losses… MR D1D1 MC ATC P Q 100 P Q 100,000 Industry Firm (price taker) $60 50 40 $60 50 40 PROFIT MAXIMIZATION IN THE LONG-RUN D2D2 Economic Losses S1S1

39. MR D1D1 MC ATC P Q 100 P Q 100,000 Industry Firm (price taker) $60 50 40 $60 50 40 PROFIT MAXIMIZATION IN THE LONG-RUN D2D2 Return to Zero Economic Profits S1S1 S3S3 Competitors with losses decrease supply and prices return to zero economic profits

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