Pure Competition

Pure Competiti

onBy:

Catherine Castañeda & Ana Logan

FOUR MARKET MODELS

Pure Competition

Monopolistic Competition

Oligopoly

Pure Monopoly

FOUR MARKET MODELS

Pure Competition:

• Very Large Numbers• Standardized Product• “Price Takers”• Free Entry and Exit

DEMAND AS SEEN BY APURELY COMPETITIVE SELLER

Perfectly Elastic DemandPrice Taker Role

Total RevenueAverage RevenueMarginal Revenue

$131 0 $ 0

Product Price (P)(Average Revenue)

TotalRevenue (TR)

P x Q

MarginalRevenue (MR)

▲TR

QuantityDemanded (Q)


$131 131

0 1

$ 0131

$131


TotalRevenue (TR)

P x Q


▲TR



]

$131 131131

0 1 2

$ 0131262

$131131


TotalRevenue (TR)

P x Q


▲TR



]]

$131 131131131

0 1 23

$ 0131262393

$131131131


TotalRevenue (TR)

P x Q


▲TR



]]]

$131 131131131131

0 1 234

$ 0131262393524

$131131131131


TotalRevenue (TR)

P x Q


▲TR



]]]]

$131 131131131131131131131131131131

0 1 23456789

10

$ 0131262393524655786917

104811791310

$131

131131131131131131131131131


TotalRevenue (TR)

P x Q


▲TR



]]]]]]]]]]

DEMAND, MARGINAL REVENUE, AND TOTALREVENUE 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

Pri

ce

an

d r

ev

enu

e

Quantity Demanded (sold)

SHORT-RUN PROFIT MAXIMIZATIONTwo 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?

TotalCost

TFC+TVC

0 1 23456789

10

TotalProduct

TotalFixedCost

TotalVariable

CostTotal

RevenueProfitTR-TC

$ 100 100 100100100100100100100100100

$ 090

170240300370450540650780930

$ 100190270340400470550640750880

1030

Price: $131

- $100- 59

- 8+ 53

+ 124+ 185+ 236+ 277+ 298+ 299+ 280

TOTAL REVENUE-TOTAL COST APPROACH

$ 0131262393524655786917

104811791310

TotalCost

0 1 23456789

10

TotalProduct

TotalFixedCost

TotalVariable

CostTotal

RevenueProfitTR-TC

$ 100 100 100100100100100100100100100

$ 090

170240300370450540650780930

$ 100190270340400470550640750880

1030

Price: $131

- $100- 59

- 8+ 53

+ 124+ 185+ 236+ 277+ 298+ 299+ 280


$ 0131262393524655786917

104811791310

$1,8001,7001,6001,5001,4001,3001,2001,1001,000 900 800 700 600 500 400 300 200 100 0

To

tal r

eve

nu

e a

nd

to

tal c

ost

TotalRevenue

TotalCost

MaximumEconomic

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


SHORT-RUN PROFIT MAXIMIZATIONTwo Approaches

Three Characteristics of MR=MC Rule:• 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

AverageTotalCost

0 1 23456789

10

TotalProduct

AverageFixedCost

AverageVariable

Cost

Price =MarginalRevenue

TotalEconomicProfit/Loss

$100.00

50.00 33.3325.0020.0016.6714.2912.5011.1110.00

$90.0085.0080.0075.0074.0075.0077.1481.2586.6793.00

$190.00135.00113.33100.00

94.0091.6791.4393.7597.78

103.00

- $100- 59

- 8+ 53

+ 124+ 185+ 236+ 277+ 298+ 299+ 280

MARGINAL REVENUE-MARGINAL COST APPROACH

$ 131131131131131131131131131131

MarginalCost

90807060708090

110130150

$200

150

100

50

0

Co

st a

nd

Rev

enu

e

1 2 3 4 5 6 7 8 9 10

MC

MR

AVCATC

Economic Profit

$131.00

$97.78

MR-MC APPROACH

Profit Maximization Position

the MR=MC rule still applies

If the price is lowered from $131 to $81…

…but the MR = MC point changes.

Loss Minimization PositionMR-MC APPROACH

$200

150

100

50

0

Co

st a

nd

Rev

enu

e

1 2 3 4 5 6 7 8 9 10

MC

MRAVCATC

Economic Loss

$81.00$91.67

Loss Minimization Position

MR-MC APPROACH

$200

150

100

50

0

Co

st a

nd

Rev

enu

e

1 2 3 4 5 6 7 8 9 10

MC

MR

AVCATC

$71.00

Short-Run Shut Down Point

Minimum AVCis the Shut-Down

Point

MR-MC APPROACH

Marginal Cost & Short-Run Supply

PriceQuantitySupplied

Maximum Profit (+)Or Minimum Loss (-)

Observe the impact upon profitability as price is changed…

$151 131 111 91 81 71 61

10987600

$+480+299

+138 -3

-64 -100 -100

MR-MC APPROACH

Co

st a

nd

Rev

enu

e, (

do

llar

s) MC

MR1

AVC

ATC

Quantity Supplied

MR2

MR3

MR4

MR5

P1

P2

P3

P4

P5

Q2 Q3 Q4 Q5


Do notProduce –

Below AVC

Break-even(Normal Profit)Point

MR-MC APPROACH

Co

st a

nd

Rev

enu

e, (

do

llar

s)

MC

MR1

Quantity Supplied

MR2

MR3

MR4

MR5

P1

P2

P3

P4

P5

Q2 Q3 Q4 Q5

Marginal Cost & Short-Run SupplyYields theShort-Run

Supply Curve

Supply

NoProductionBelow AVC

MR-MC APPROACH


AVC2

MC2

Higher Costs Move theSupply Curve to the LeftC

ost

an

d R

even

ue,

(d

oll

ars)

MC1

AVC1

Quantity Supplied

S1

S2

MR-MC APPROACH


AVC2

MC2

Lower Costs Movethe Supply Curve

to the Right

Co

st a

nd

Rev

enu

e, (

do

llar

s)

MC1

AVC1

Quantity Supplied

S1

S2

MR-MC APPROACH

P

Q

S=MC

AVC

ATC

8

D

P

Q8000

D

S= MCs

IndustryFirm(price taker)

EconomicProfit

$111$111

SHORT-RUN COMPETITIVE EQUILIBRIUM

The Competitive Firm “Takes” itsPrice from the Industry Equilibrium

PROFIT MAXIMIZATION IN THE LONG RUN

Assumptions... Entry and Exit Only Identical Costs Constant-Cost Industry

Goal of the AnalysisP= Minimum ATCLong-Run Equilibrium - TheZero Economic Profit Model

Temporary profits and the reestablishmentof long-run equilibrium

S1

MCATC

P

Q100

P

Q100,000


$60

50

40

$60

50

40


MR

D1

An increase in demand increases profits

MR

D1

MCATC

P

Q100

P

Q100,000


$60

50

40

$60

50

40


D2

EconomicProfits

S1

New competitors increase supply, and lower prices decrease economic profits

MR

D1

MCATC

P

Q100

P

Q100,000


$60

50

40

$60

50

40


D2

Zero EconomicProfits

S1

S2

Decreases in demand, losses, and the reestablishment of long-run equilibrium

S1

MCATC

P

Q100

P

Q100,000


$60

50

40

$60

50

40


D1

MR

A decrease in demand creates losses

MR

D1

MCATC

P

Q100

P

Q100,000


$60

50

40

$60

50

40


D2

EconomicLosses

S1

MR

D1

MCATC

P

Q100

P

Q100,000


$60

50

40

$60

50

40


D2

Return to ZeroEconomic Profits

S1

S3

Competitors with losses decrease supply, andprices return to zero economic profits

LONG-RUN SUPPLY IN ACONSTANT COST INDUSTRY

Constant Cost Industry

Perfectly Elastic Long-Run Supply

Graphically...

P

Q

=$50 S

D1

Z1

Q1

D2

Z2

Q2Q3

D3

Z3

100,000 110,00090,000

LONG-RUN SUPPLY IN ACONSTANT COST INDUSTRY

P1

P2

P3

LONG-RUN SUPPLY IN ANINCREASING COST INDUSTRY

P

Q

$555045

S

D1

Y1

Q1

D2

Y2

Q2Q3

D3

Y3

100,000 110,00090,000

P1

P2

P3

Pri

ce

LONG-RUN EQUILIBRIUM FOR A COMPETITIVE FIRM

P MR

Q

MCATC

Quantity

P = MC = Minimum ATC(normal profit)

PURE COMPETITION & EFFICIENCY

Productive EfficiencyP = Minimum ATC

Allocative EfficiencyP = MC

Underallocation:

P > MCOverallocation:

P < MC

Work CitedMcConnell, R. Campbell and Stanley L. Brue.

Economics. New York: McGraw-Hill, 2005: 413-33

Pure Competition

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