1. 21
Pure
Competition

2. Chapter Objectives
Names and Main Characteristics of the Four Basic Market Models
Conditions for Perfect Competition
How Do Purely Competitive Firms Maximize Profits or Minimize Losses
Why the Marginal Cost and Supply Curves For Competitive Firms Are Identical
How Industry Entry and Exit Create Economic Efficiency
Differences Between Constant-Cost, Increasing-Cost, and Decreasing-Cost Industries

3. Market Structure Continuum
Four Market Models
Pure Competition
Pure Monopoly
Monopolistic Competition
Oligopoly
Imperfect Competition
Pure
Competition
Monopolistic
Competition
Pure
Monopoly
Oligopoly
Market Structure Continuum

4. Pure Competition Very Large Numbers Standardized Product
“Price Takers”
Free Entry and Exit
Perfectly Elastic Demand
Average Revenue
Total Revenue
Marginal Revenue
Graphically…

5. Pure Competition P QD TR MR TR Price and Revenue ] D = MR = AR2 4 6 8 10 12
131
262
393
524
655
786
917
1048
$1179
Quantity Demanded (Sold)
Firm’s
Demand
Schedule
(Average
Revenue)
Revenue
Data TR P QD TR MR
$131
131 1 2 3 4 5 6 7 8 9 10 $0
131
262
393
524
655
786
917
1048
1179
1310 ]
$131
131
D = MR = AR

6. Profit Maximization in the Short Run
Total Revenue-Total Cost Approach
Consider:
Should Product Be Produced?
If So, In What Amount?
What Economic Profit (Loss) Will Be Realized?

7. Profit Maximization in the Short Run
Total Revenue-Total Cost Approach
Price = $131
(1)
Total Product
(Output) (Q)
(2)
Total Fixed
Cost (TFC)
(3)
Total Variable
Cost (TVC)
(4)
Total Cost
(TC)
(5)
Total Revenue
(TR)
(6)
Profit (+)
or Loss (-) 1 2 3 4 5 6 7 8 9 10
$100
100 $0 90
170
240
300
370
450
540
650
780
930
$100
190
270
340
400
470
550
640
750
880
1030 $0
131
262
393
524
655
786
917
1048
1179
1310
$-100
-59 -8
+53
+124
+185
+236
+277
+298
+299
+280
Do You See Profit Maximization?
Now Let’s Graph The Results…

8. Profit Maximization in the Short Run
Total Revenue-Total Cost Approach 1 2 3 4 5 6 7 8 9 10 11 12 13 14
$1800
1700
1600
1500
1400
1300
1200
1100
1000
900
800
700
600
500
400
300
200
100
$500
Total Revenue and Total Cost
Total Economic
Profit
Quantity Demanded (Sold)
Break-Even Point
(Normal Profit)
W 21.1
Total Revenue, (TR)
Maximum
Economic
Profit
$299
G 21.1
Total Cost,
(TC)
P=$131
Break-Even Point
(Normal Profit)
Total Economic
Profit
$299

9. Profit Maximization in the Short Run
Marginal Revenue-Marginal Cost Approach
MR = MC Rule
Important Features:
Firm Will Shut Down Unless MR at Least Meets MC
Profit Maximization in All Market Structures
Can Be Restated P = MC

10. Profit Maximization in the Short Run
Marginal Revenue-Marginal Cost Approach
MR = MC Rule
(2)
Average
Fixed
Cost
(AFC)
(3)
Average
Variable
Cost
(AVC)
(4)
Average
Total
Cost
(ATC)
(1)
Total
Product
(Output)
(5)
Marginal
Cost
(MC)
(6)
Marginal
Revenue
(MR)
(7)
Profit (+)
or Loss (-) 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
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 90
110
130
150
$131
131
$-100
-59 -8
+53
+124
+185
+236
+277
+298
+299
+280
Do You See Profit Maximization Now?
No Surprise - Now Let’s Graph It…

11. Profit Maximization in the Short Run
Marginal Revenue-Marginal Cost Approach
MR = MC Rule
W 21.2
Cost and Revenue
$200
150
100 50 1 2 3 4 5 6 7 8 9 10
Output
P=$131
MR = MC MC
Economic Profit
MR = P
ATC
AVC
A=$97.78

12. Profit Maximization in the Short Run
Marginal Revenue-Marginal Cost Approach
MR = MC Rule
Loss Minimizing Case
Cost and Revenue
$200
150
100 50 1 2 3 4 5 6 7 8 9 10
Output
Lower the Price to $81 and
Observe the Results! MC
Loss
A=$91.67
ATC
AVC
MR = P
P=$81
V = $75

13. Profit Maximization in the Short Run
Marginal Revenue-Marginal Cost Approach
MR = MC Rule
Short-Run Shut Down Case
Cost and Revenue
$200
150
100 50 1 2 3 4 5 6 7 8 9 10
Output
Lower the Price Further to
$71 and Observe the Results! MC
ATC
V = $74
AVC
MR = P
P=$71
Short-Run
Shut Down Point
P < Minimum AVC
$71 < $74

14. Marginal Cost and Short-Run Supply
Continuing the Same Numeric Example…
Supply Schedule of a Competitive Firm
Quantity
Supplied
Maximum Profit (+)
or Minimum Loss (-)
Price
$151
131
111 91 81 71 61 10 9 8 7 6
$+480
+299
+138 -3
-64
-100
The Schedule Shows the Quantity a Firm
Will Produce at a Variety of Prices and Results

15. Marginal Cost and Short-Run Supply
Generalizing the MR=MC Relationship and its Use
Cost and Revenues (Dollars)
Quantity Supplied MC e P5
MR5 d
ATC P4
MR4 c
AVC P3
MR3 b P2
MR2 a P1
MR1
This Price is Below AVC
And Will Not Be Produced Q2 Q3 Q4 Q5

16. Marginal Cost and Short-Run Supply
Generalizing the MR=MC Relationship and its Use
Cost and Revenues (Dollars)
Quantity Supplied
Examine the MC for the Competitive Firm
MC Above AVC Becomes
the Short-Run Supply Curve S
Break-even
(Normal Profit) Point MC e P5
MR5 d
ATC P4
MR4 c
AVC P3
MR3 b P2
MR2 a P1
MR1
Shut-Down Point
(If P is Below)
This Price is Below AVC
And Will Not Be Produced Q2 Q3 Q4 Q5

17. Changes in Supply Firm and Industry Equilibrium Price
Market Price and Profits
Firm Versus Industry
Graphically…

18. Changes in Supply Single Firm Industry
W 21.3
Single Firm
Industry p P
S = ∑ MC’s
s = MC
Economic
Profit
ATC d
$111
$111
AVC D 8
8000
Competitive Firm Must Take the Price that is
Established By Industry Supply and Demand

19. Profit Maximization in the Long Run
Assumptions
Entry and Exit Only
Identical Costs
Constant-Cost Industry
Goal of the Analysis
Long-Run Equilibrium
Entry Eliminates Profits
Exit Eliminates Losses

20. Supply Readjustment Single Firm Industry
100
90,000
80,000
100,000 S1 MC
$60 50 40
ATC
$60 50 40 S2 MR D2 D1
An Increase in Demand Temporarily Raises Price
Higher Prices Draw in New Competitors
Increased Supply Returns Price to Equilibrium

21. Supply Readjustment Single Firm Industry
100
90,000
80,000
100,000 S3 MC
$60 50 40
ATC
$60 50 40 S1 MR D1 D3
A Decrease in Demand Temporarily Lowers Price
Lower Prices Drive Away Some Competitors
Decreased Supply Returns Price to Equilibrium

22. Long-Run Supply Curve Constant-Cost Industry S P P1 P2 P3 Q $50 Z3 Z1Q P1 P2 P3
$50 S Z3 Z1 Z2 D3 D1 D2 Q3 Q1 Q2
90,000
100,000
110,000

23. Long-Run Supply Curve Increasing-Cost IndustryQ S P2
$55 Y2 P1
$50 Y1 P3
$40 Y3 D2 D1 D3 Q3 Q1 Q2
90,000
100,000
110,000
How Would a Decreasing-Cost Industry Look?

24. Pure Competition and Efficiency
Productive Efficiency
P = Minimum ATC
Allocative Efficiency
P = MC
Maximum Consumer and Producer Surplus
Dynamic Adjustments
“Invisible Hand” Revisited
O 21.1

25. Long-Run Equilibrium Competitive Firm and Market
Single Firm
Market
Price
Quantity MC
P=MC=Minimum
ATC (Normal Profit) S
ATC P MR P D Qf Qe
Productive Efficiency: Price = Minimum ATC
Allocative Efficiency: Price = MC
Pure Competition Has Both in
Its Long-Run Equilibrium

26. Efficiency Gains From Entry:
Last
Word
The Case of Generic Drugs
Competitive Model Predicts Lower Price and Greater Output With Increased Efficiency When New Producers Enter Market
Example is Patented Drugs
Patents Enable Greater Profits in Support of R&D and Accelerated Cost Recovery
After Patent Period Generics Enter Market
Profits Decrease and Quantities Increase
Combined Consumer and Producer Surpluses Increase

27. Efficiency Gains From Entry:
Last
Word
The Case of Generic Drugs
New Producers Enter Market a
Price
Quantity
As Price Decreases to f,
Consumer Surplus abc
Increases to adf
Producer and Consumer
Surplus is Maximized
Together as Shown by
the Gray Triangle S
Initial Patent Price b c P1 d P2 f D Q1 Q2
Results: Greater Quantity at Lower Prices
as Predicted by the Competitive Model

28. Key Terms pure competition pure monopoly monopolistic competition
oligopoly
imperfect competition
price taker
average revenue
total revenue
marginal revenue
break-even point
MR=MC
short-run supply curve
long-run supply curve
constant-cost industry
increasing-cost industry
decreasing-cost industry
productive efficiency
allocative efficiency
consumer surplus
producer surplus

29. Next Chapter Preview…
Pure
Monopoly
Chapter 22!