1. # McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. Pure Competition 7

2. 7-2 Four Market Models Pure competition Pure monopoly Monopolistic competition Oligopoly LO1

3. 7-3 Pure Competition: Characteristics Very large numbers of sellers Standardized product “Price takers” Easy entry and exit Perfectly elastic demand Firm produces as much or little as they want at the price Demand graphs as horizontal line LO2

4. 7-4 Average, Total, and Marginal Revenue LO3 Firm’s Demand Schedule (Average Revenue) Firm’s Revenue Data D = MR = AR TR PQDQD MR $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 ] ] ] ] ] ] ] ] ] ]

5. 7-5 Average, Total, and Marginal Revenue Average revenue Revenue per unit AR = TR/Q = P Total revenue TR = P × Q Marginal revenue Extra revenue from 1 more unit MR = ΔTR/ΔQ LO3

6. 7-6 Profit Maximization: TR-TC Approach Three questions: Should the firm produce? If so, what amount? What economic profit (loss) will be realized? LO3

7. 7-7 Profit Maximization: MR-MC Approach LO3 The Profit-Maximizing Output for a Purely Competitive Firm: Marginal Revenue– Marginal Cost Approach (Price = $131) (1) Total Product (Output) (2) Average Fixed Cost (AFC) (3) Average Variable Cost (AVC) (4) Average Total Cost (ATC) (5) Marginal Cost (MC) (5) Price = Marginal Revenue (MR) (6) Total Economic Profit (+) or Loss (-) 0$-100 1$100.00$90.00$190$90$131-59 250.0085.0013580131-8 333.3380.00113.3370131+53 425.0075.00100.0060131+124 520.0074.0094.0070131+185 616.6775.0091.6780131+236 714.2977.1491.4390131+277 812.5081.2593.75110131+298 911.1186.6797.78130131+299 1010.0093.00103.00150131+280

8. 7-8 Profit Maximization: MR-MC Approach LO3 Cost and Revenue $200 150 100 50 0 12345678910 Output Economic Profit MR = P MC MR = MC AVC ATC P=$131 A=$97.78

9. 7-9 Loss-Minimizing Case Loss minimization Still produce because P > min AVC Losses at a minimum where MR = MC LO3

10. 7-10 Profit Minimization: MR-MC Approach LO3 The Profit-Minimizing Output for a Purely Competitive Firm: Marginal Revenue– Marginal Cost Approach (Price = $81) (1) Total Product (Output) (2) Average Fixed Cost (AFC) (3) Average Variable Cost (AVC) (4) Average Total Cost (ATC) (5) Marginal Cost (MC) (5) Price = Marginal Revenue (MR) (6) Total Economic Profit (+) or Loss (-) 0$-100 1$100.00$90.00$190$90$81-109 250.0085.001358081-108 333.3380.00113.337081-97 425.0075.00100.006081-76 520.0074.0094.007081-65 616.6775.0091.678081-64 714.2977.1491.439081-73 812.5081.2593.7511081-102 911.1186.6797.7813081-151 1010.0093.00103.0015081-220

11. 7-11 Loss-Minimizing Case LO3 Cost and Revenue $200 150 100 50 0 12345678910 Output Loss MR = P MC AVC ATC P=$81 A=$91.67 V = $75

12. 7-12 Shutdown Case: MR-MC Approach LO3 The Profit-Minimizing Output for a Purely Competitive Firm: Marginal Revenue– Marginal Cost Approach (Price = $71) (1) Total Product (Output) (2) Average Fixed Cost (AFC) (3) Average Variable Cost (AVC) (4) Average Total Cost (ATC) (5) Marginal Cost (MC) (5) Price = Marginal Revenue (MR) (6) Total Economic Profit (+) or Loss (-) 0$-100 1$100.00$90.00$190$90$71-119 250.0085.001358071-128 333.3380.00113.337071-127 425.0075.00100.006071-116 520.0074.0094.007071-115 616.6775.0091.678071-124 714.2977.1491.439071-143 812.5081.2593.7511071-182 911.1186.6797.7813071-241 1010.0093.00103.0015071-320

13. 7-13 Shutdown Case LO3 Cost and Revenue $200 150 100 50 0 12345678910 Output MR = P MC AVC ATC P=$71 V = $74 Short-Run Shutdown Point P < Minimum AVC $71 < $74

14. 7-14 Marginal Cost and Short-Run Supply LO4 The Supply Schedule of a Competitive Firm Confronted with Cost Data Price Quantity Supplied Maximum Profit (+) Minimum Loss (-) $15110+ $480 1319+299 1118+138 917-3 816-64 710-100 610-100

15. 7-15 Marginal Cost and Short-Run Supply LO4 P1P1 0 Cost and Revenues (Dollars) Quantity Supplied MR 1 P2P2 MR 2 P3P3 MR 3 P4P4 MR 4 P5P5 MR 5 MC AVC ATC Q2Q2 Q3Q3 Q4Q4 Q5Q5 a b c d e S Shut-Down Point (If P is Below)

16. 7-16 3 Production Questions LO4 Output Determination in Pure Competition in the Short Run QuestionAnswer 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).

17. 7-17 Firm and Industry: Equilibrium LO4 Firm and Market Supply and the Market Demand (1) Quantity Supplied, Single Firm (2) Total Quantity Supplied, 1,000 Firms (3) Product Price (4) Total Quantity Demanded 1010,000$1514,000 99,0001316,000 88,0001118,000 77,000919,000 66,0008111,000 007113,000 006116,000

18. 7-18 Firm and Industry: Equilibrium LO4 Economic profit d ATC AVC s = MC $111 D S = ∑ MCs 8 8000 (a) Single Firm(a) Industry

19. 7-19 Profit Maximization in the Long Run Easy entry and exit The only long-run adjustment we consider Identical costs All firms in the industry have identical costs Constant-cost industry Entry and exit do not affect resource prices LO5

20. 7-20 Long-Run Equilibrium Entry eliminates profits Firms enter Supply increases Price falls Exit eliminates losses Firms exit Supply decreases Price rises LO5

21. 7-21 Entry Eliminates Economic Profits LO5 (a) Single firm (b) Industry P P q Q 0 0 100 90,00080,000100,000 ATC MR MC $60 50 40 D1D1 S1S1 D2D2 $60 50 40 S2S2

22. 7-22 Exit Eliminates Losses LO5 (a) Single Firm (b) Industry P P q Q 0 0 100 90,00080,000100,000 ATC MR MC $60 50 40 D3D3 S3S3 D1D1 $60 50 40 S1S1

23. 7-23 Long-Run Supply Constant-cost industry Entry/exit does not affect LR ATC Constant resource price Special case Increasing-cost industry Most industries LR ATC increases with expansion Specialized resources Decreasing-cost industry LO6

24. 7-24 LR Supply: Constant-Cost Industry LO6 P 0 Q 90,000 100,000110,000 Q3Q3 Q1Q1 Q2Q2 $50 P1P2P3P1P2P3 S Z1Z1 Z2Z2 Z3Z3 D3D3 D1D1 D2D2

25. 7-25 LR Supply: Increasing-Cost Industry LO6 P 0 Q 90,000 100,000110,000 Q3Q3 Q1Q1 Q2Q2 $50P1P1 S Y1Y1 Y2Y2 Y3Y3 D3D3 D1D1 D2D2 $40 $55P2P2 P3P3

26. 7-26 Pure Competition and Efficiency In the long run, efficiency is achieved Productive efficiency Producing where P = min ATC Allocative efficiency Producing where P = MC LO6

27. 7-27 Dynamic Adjustments Purely competitive markets will automatically adjust to Changes in consumer tastes Resource supplies Technology Recall the “invisible hand” LO6