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Pure Competition. By: 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.

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Pure competition

Pure Competition

By:

Catherine Castañeda & Ana Logan


Pure competition

FOUR MARKET MODELS

Pure Competition

Monopolistic Competition

Oligopoly

Pure Monopoly


Pure competition

FOUR MARKET MODELS

Pure Competition:

  • Very Large Numbers

  • Standardized Product

  • “Price Takers”

  • Free Entry and Exit


Pure competition

DEMAND AS SEEN BY APURELY COMPETITIVE SELLER

  • Perfectly Elastic Demand

Price Taker Role

  • Total Revenue

  • Average Revenue

  • Marginal Revenue


Pure competition

DEMAND AS SEEN BY APURELY COMPETITIVE SELLER

Total

Revenue (TR)

P x Q

Marginal

Revenue (MR)

▲TR

Product Price (P)

(Average Revenue)

Quantity

Demanded (Q)

$131

0

$ 0


Pure competition

DEMAND AS SEEN BY APURELY COMPETITIVE SELLER

]

Total

Revenue (TR)

P x Q

Marginal

Revenue (MR)

▲TR

Product Price (P)

(Average Revenue)

Quantity

Demanded (Q)

$131

131

0

1

$ 0

131

$131


Pure competition

DEMAND AS SEEN BY APURELY COMPETITIVE SELLER

]

]

Total

Revenue (TR)

P x Q

Marginal

Revenue (MR)

▲TR

Product Price (P)

(Average Revenue)

Quantity

Demanded (Q)

$131

131

131

0

1

2

$ 0

131

262

$131

131


Pure competition

DEMAND AS SEEN BY APURELY COMPETITIVE SELLER

]

]

]

Total

Revenue (TR)

P x Q

Marginal

Revenue (MR)

▲TR

Product Price (P)

(Average Revenue)

Quantity

Demanded (Q)

$131

131

131

131

0

1

2

3

$ 0

131

262

393

$131

131

131


Pure competition

DEMAND AS SEEN BY APURELY COMPETITIVE SELLER

]

]

]

]

Total

Revenue (TR)

P x Q

Marginal

Revenue (MR)

▲TR

Product Price (P)

(Average Revenue)

Quantity

Demanded (Q)

$131

131

131

131

131

0

1

2

3

4

$ 0

131

262

393

524

$131

131

131

131


Pure competition

]

]

]

]

]

]

]

]

]

]

DEMAND AS SEEN BY APURELY COMPETITIVE SELLER

Total

Revenue (TR)

P x Q

Marginal

Revenue (MR)

▲TR

Product Price (P)

(Average Revenue)

Quantity

Demanded (Q)

0

1

2

3

4

5

6

7

8

9

10

$131

131

131

131

131

131

131

131

131

131

131

$ 0

131

262

393

524

655

786

917

1048

1179

1310

$131

131

131

131

131

131

131

131

131

131


Pure competition

DEMAND, MARGINAL REVENUE, AND TOTAL

REVENUE IN PURE COMPETITION

TR

1179

1048

917

786

655

524

393

262

131

0

Price and revenue

D = MR

1 2 3 4 5 6 7 8 9 10

Quantity Demanded (sold)


Pure competition

SHORT-RUN PROFIT MAXIMIZATION

Two Approaches

First:

Total-Revenue -Total Cost Approach

  • The Decision Process:

  • Should the firm produce?

  • What quantity should be produced?

  • What profit or loss will be realized?

The Decision Rule:

Produce in the short-run if it can realize

1- A profit (or)

2- A loss less than its fixed costs


Pure competition

TOTAL REVENUE-TOTAL COST APPROACH

Total

Fixed

Cost

Total

Variable

Cost

Total

Cost

TFC+TVC

Price: $131

Total

Product

Total

Revenue

Profit

TR-TC

$ 100

100

100

100

100

100

100

100

100

100

100

0

1

2

3

4

5

6

7

8

9

10

$ 0

131

262

393

524

655

786

917

1048

1179

1310

$ 0

90

170

240

300

370

450

540

650

780

930

- $100

- 59

- 8

+ 53

+ 124

+ 185

+ 236

+ 277

+ 298

+ 299

+ 280

$ 100

190

270

340

400

470

550

640

750

880

1030


Pure competition

TOTAL REVENUE-TOTAL COST APPROACH

Total

Fixed

Cost

Total

Variable

Cost

Price: $131

Total

Cost

Total

Product

Total

Revenue

Profit

TR-TC

$ 100

100

100

100

100

100

100

100

100

100

100

0

1

2

3

4

5

6

7

8

9

10

$ 0

131

262

393

524

655

786

917

1048

1179

1310

$ 0

90

170

240

300

370

450

540

650

780

930

- $100

- 59

- 8

+ 53

+ 124

+ 185

+ 236

+ 277

+ 298

+ 299

+ 280

$ 100

190

270

340

400

470

550

640

750

880

1030


Pure competition

TOTAL REVENUE-TOTAL COST APPROACH

Break-Even Point

(Normal Profit)

$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

Maximum

Economic

Profits

$299

Total revenue and total cost

Total

Cost

Break-Even Point

(Normal Profit)

1 2 3 4 5 6 7 8 9 10 11 12 13 14


Pure competition

SHORT-RUN PROFIT MAXIMIZATION

Two Approaches

Second:

Marginal-Revenue -Marginal Cost Approach

MR = MC Rule

  • 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


Pure competition

MARGINAL REVENUE-MARGINAL COST APPROACH

Average

Fixed

Cost

Average

Variable

Cost

Average

Total

Cost

Price =

Marginal

Revenue

Total

Economic

Profit/Loss

Total

Product

Marginal

Cost

0

1

2

3

4

5

6

7

8

9

10

$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

90

80

70

60

70

80

90

110

130

150

$ 131

131

131

131

131

131

131

131

131

131

- $100

- 59

- 8

+ 53

+ 124

+ 185

+ 236

+ 277

+ 298

+ 299

+ 280


Pure competition

MR-MC APPROACH

Profit Maximization Position

$200

150

100

50

0

Economic Profit

MC

MR

$131.00

Cost and Revenue

ATC

AVC

$97.78

1 2 3 4 5 6 7 8 9 10


Pure competition

MR-MC APPROACH

Loss Minimization Position

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

the MR=MC rule still applies

…but the MR = MC point changes.


Pure competition

MR-MC APPROACH

Loss Minimization Position

$200

150

100

50

0

Economic Loss

MC

ATC

Cost and Revenue

AVC

$91.67

MR

$81.00

1 2 3 4 5 6 7 8 9 10


Pure competition

MR-MC APPROACH

Short-Run Shut Down Point

$200

150

100

50

0

MC

ATC

Cost and Revenue

AVC

MR

$71.00

Minimum AVC

is the Shut-Down

Point

1 2 3 4 5 6 7 8 9 10


Pure competition

MR-MC APPROACH

Marginal Cost & Short-Run Supply

Observe the impact upon profitability as price is changed…

Quantity

Supplied

Maximum Profit (+)

Or Minimum Loss (-)

Price

$151

131

111

91

81

71

61

10

9

8

7

6

0

0

$+480

+299

+138

-3

-64

-100

-100


Pure competition

MR-MC APPROACH

Marginal Cost & Short-Run Supply

Break-even

(Normal Profit)

Point

MC

MR5

P5

ATC

MR4

P4

Cost and Revenue, (dollars)

AVC

MR3

P3

MR2

P2

MR1

P1

Do not

Produce –

Below AVC

Q2

Q3

Q4

Q5

Quantity Supplied


Pure competition

MR-MC APPROACH

Marginal Cost & Short-Run Supply

Yields the

Short-Run

Supply Curve

Supply

MC

MR5

P5

MR4

P4

Cost and Revenue, (dollars)

MR3

P3

MR2

P2

MR1

P1

No

Production

Below AVC

Q2

Q3

Q4

Q5

Quantity Supplied


Pure competition

MR-MC APPROACH

MC1

S1

Cost and Revenue, (dollars)

AVC1

Quantity Supplied

Marginal Cost & Short-Run Supply

MC2

S2

AVC2

Higher Costs Move the

Supply Curve to the Left


Pure competition

MR-MC APPROACH

MC1

S1

Cost and Revenue, (dollars)

AVC1

Quantity Supplied

Marginal Cost & Short-Run Supply

Lower Costs Move

the Supply Curve

to the Right

MC2

S2

AVC2


Pure competition

SHORT-RUN COMPETITIVE EQUILIBRIUM

The Competitive Firm “Takes” its

Price from the Industry Equilibrium

S= MCs

P

P

Economic

Profit

ATC

S=MC

D

$111

$111

AVC

D

Q

Q

8

8000

Firm

(price taker)

Industry


Pure competition

PROFIT MAXIMIZATION IN THE

LONG RUN

Assumptions...

  • Entry and Exit Only

  • Identical Costs

  • Constant-Cost Industry

Goal of the Analysis

P= Minimum ATC

Long-Run Equilibrium - The

Zero Economic Profit Model


Pure competition

PROFIT MAXIMIZATION IN THE LONG RUN

P

P

$60

50

40

$60

50

40

Q

Q

100

100,000

Firm

(price taker)

Industry

Temporary profits and the reestablishment

of long-run equilibrium

S1

MC

ATC

MR

D1


Pure competition

P

P

$60

50

40

$60

50

40

Q

Q

100

100,000

Firm

(price taker)

Industry

PROFIT MAXIMIZATION IN THE LONG RUN

An increase in demand increases profits

Economic

Profits

S1

MC

ATC

MR

D2

D1


Pure competition

PROFIT MAXIMIZATION IN THE LONG RUN

P

P

$60

50

40

$60

50

40

Q

Q

100

100,000

Firm

(price taker)

Industry

New competitors increase supply, and lower prices decrease economic profits

Zero Economic

Profits

S1

S2

MC

ATC

MR

D2

D1


Pure competition

PROFIT MAXIMIZATION IN THE LONG RUN

P

P

$60

50

40

$60

50

40

Q

Q

100

100,000

Firm

(price taker)

Industry

Decreases in demand, losses, and the

reestablishment of long-run equilibrium

S1

MC

ATC

MR

D1


Pure competition

PROFIT MAXIMIZATION IN THE LONG RUN

P

P

$60

50

40

$60

50

40

Q

Q

100

100,000

Firm

(price taker)

Industry

A decrease in demand creates losses

Economic

Losses

S1

MC

ATC

MR

D1

D2


Pure competition

PROFIT MAXIMIZATION IN THE LONG RUN

P

P

$60

50

40

$60

50

40

Q

Q

100

100,000

Firm

(price taker)

Industry

Competitors with losses decrease supply, and

prices return to zero economic profits

S3

Return to Zero

Economic Profits

S1

MC

ATC

MR

D1

D2


Pure competition

LONG-RUN SUPPLY IN A

CONSTANT COST INDUSTRY

Constant Cost Industry

Perfectly Elastic

Long-Run Supply

Graphically...


Pure competition

LONG-RUN SUPPLY IN A

CONSTANT COST INDUSTRY

P

P1

P2

P3

Z3

Z1

Z2

S

=$50

D3

D1

D2

Q

Q3

Q1

Q2

90,000

100,000

110,000


Pure competition

LONG-RUN SUPPLY IN AN

INCREASING COST INDUSTRY

P

S

P1

P2

P3

$55

50

45

Y2

Y1

Y3

D1

D2

D3

Q

Q3

Q1

Q2

90,000

100,000

110,000


Pure competition

LONG-RUN EQUILIBRIUM

FOR A COMPETITIVE FIRM

MC

ATC

Price

MR

P

P = MC = Minimum ATC

(normal profit)

Q

Quantity


Pure competition

PURE COMPETITION & EFFICIENCY

  • Productive Efficiency

P = Minimum ATC

  • Allocative Efficiency

P = MC

Underallocation:

P > MC

Overallocation:

P < MC


Work cited

Work Cited

McConnell, R. Campbell and Stanley L. Brue. Economics. New York: McGraw-Hill, 2005: 413-33


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