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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


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 Demand

Price Taker Role

  • Total Revenue

  • Average Revenue

  • Marginal Revenue


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


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


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


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


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


]

]

]

]

]

]

]

]

]

]

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


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)


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


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


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


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


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


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


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


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.


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


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


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


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


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


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


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


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


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


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


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


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


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


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


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


LONG-RUN SUPPLY IN A

CONSTANT COST INDUSTRY

Constant Cost Industry

Perfectly Elastic

Long-Run Supply

Graphically...


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


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


LONG-RUN EQUILIBRIUM

FOR A COMPETITIVE FIRM

MC

ATC

Price

MR

P

P = MC = Minimum ATC

(normal profit)

Q

Quantity


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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