Pure Competition 6 LECTURE

Market Structure Continuum FOUR MARKET MODELS Pure Competition

Market Structure Continuum Pure Competition FOUR MARKET MODELS Pure Monopoly

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

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

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

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

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

$ $ $ Product Price (P) (Average Revenue) Total Revenue (TR) Marginal Revenue (MR) Quantity Demanded (Q) DEMAND AS SEEN BY A PURELY COMPETITIVE SELLER ] ] ] ] ] ] ] ] ] ]

$ $ $ Product Price (P) (Average Revenue) Total Revenue (TR) Marginal Revenue (MR) Quantity Demanded (Q) DEMAND AS SEEN BY A PURELY COMPETITIVE SELLER ] ] ] ] ] ] ] ] ] ] Graphically Presented…

DEMAND, MARGINAL REVENUE, AND TOTAL REVENUE IN PURE COMPETITION TR D = MR Price and revenue Quantity Demanded (sold)

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?

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…

Total Cost Total Product Total Fixed Cost Total Variable Cost Total Revenue Profit $ $ $ Price: $131 - $ TOTAL REVENUE-TOTAL COST APPROACH $ Can you see the profit maximization?

Total Cost Total Product Total Fixed Cost Total Variable Cost Total Revenue Profit $ $ $ Price: $131 - $ TOTAL REVENUE-TOTAL COST APPROACH $ Graphing Total Cost & Revenue

$1,800 1,700 1,600 1,500 1,400 1,300 1,200 1,100 1, Total revenue and total cost Total Revenue Total Cost Maximum Economic Profits $299 Break-Even Point (Normal Profit) Break-Even Point (Normal Profit) TOTAL REVENUE-TOTAL COST APPROACH

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

Average Total Cost Total Product Average Fixed Cost Average Variable Cost Price = Marginal Revenue Total Economic Profit/Loss $ $ $ $ MARGINAL REVENUE-MARGINAL COST APPROACH $ Marginal Cost The same profit maximizing result!

Average Total Cost Total Product Average Fixed Cost Average Variable Cost Price = Marginal Revenue Total Economic Profit/Loss $ $ $ $ MARGINAL REVENUE-MARGINAL COST APPROACH $ Marginal Cost Graphically

$ Cost and Revenue MC MR AVC ATC Economic Profit $ $97.78 MARGINAL REVENUE-MARGINAL COST APPROACH Profit Maximization Position

$ Cost and Revenue MC MR AVC ATC Economic Profit $ $97.78 MARGINAL REVENUE-MARGINAL COST APPROACH MR = MC Optimum Solution Profit Maximization Position

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

$ Cost and Revenue MC MR AVC ATC Economic Loss $81.00 $91.67 MARGINAL REVENUE-MARGINAL COST APPROACH Loss Minimization Position

$ Cost and Revenue MC MR AVC ATC $71.00 MARGINAL REVENUE-MARGINAL COST APPROACH Short-Run Shut Down Point Minimum AVC is the Shut-Down Point

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 $ $

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

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

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

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

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

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?

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

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

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

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) $ $ PROFIT MAXIMIZATION IN THE LONG-RUN D2D2 Zero Economic Profits S1S1 S2S2

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) $ $ PROFIT MAXIMIZATION IN THE LONG-RUN D1D1 MR

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

MR D1D1 MC ATC P Q 100 P Q 100,000 Industry Firm (price taker) $ $ 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

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