1. Chapter 9 Pure Competition McGraw-Hill/Irwin
Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

2. Chapter Objectives The four basic market models
Conditions for pure competition
Profit maximization for competitive firms
The competitive firm supply curve
Industry entry and exit
Industry cost structure
Economic efficiency
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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
9-3

4. Pure Competition
Although instances of “pure competition” are rare in the real world, it serves as a model for the other three types of market models
Consists of very large numbers of firms
Standardized product; one producer’s product looks pretty much like everyone else’s
Agricultural products are a classic example; raising corn
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5. Firms in pure competition are“Price takers”
There are so many sellers that no single seller can affect the price by its decision alone
Individual firms must accept the market price
Firms can freely enter and exit from pure competition; there are no barriers to becoming a farmer and raising corn

6. Pure Competition from the viewpoint of a competitive seller
The demand curve for the firm is perfectly elastic (horizontal)
A horizontal demand curve means that the firm can sell as much product as it wants but only at a fixed price (because it cannot affect price
However, as you will see later, the demand curve for the industry is not perfectly elastic
Some Definitions:
Average revenue is the price per unit for each firm in pure competition
Total revenue is the price multiplied by the quantity sold
Marginal revenue is the change in total revenue and will also equal the unit price in conditions of pure competition.

7. 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
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8. Short Run Profit Maximization The Firm’s Viewpoint
The market price for the firm is fixed
In the short run, the firm has a fixed plant (limited acreage)
Since the firm cannot change the price, it can only increase total revenue by producing more of the product
Profit can be defined as the difference between total costs and total revenue
Three questions a firm will face
Should the product be produced?
If so, in what amount?
What economic profit (loss) will be realized?; how to maximize profit
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9. Profit Maximization Two approaches Total revenue – total cost approach
Firms should produce if the difference between total revenue and total cost is profitable; i.e. the greatest difference
In the short run, the firm should produce that output at which it maximizes its profits or minimizes its losses
The profit or loss can be established by subtracting total cost from total revenue at each output level
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10. Profit Maximization
Firms operating at the profit maximization level may still experiences overall losses in profits
They are then faced with the decision as to whether to continue production or go out of business
In the short run, firms have fixed costs which are unavoidable and variable costs attributable to producing more of a product
if the firm’s losses exceeds its fixed costs, the firm should not produce but should shut down
By shutting down, its losses will just equal those fixed costs (there will be no variable costs because the firm is not producing

11. Profit Maximization Marginal Revenue – Marginal Cost approach
The MR=MC rule states that firms will maximize profits or minimize losses by producing at the point at which marginal revenue equals marginal cost in the short run
Three features of the MR=MC rule
It assumes that marginal revenue must be equal to or exceed the minimum average variable cost or the firm will shut down
The rule works in any type of industry, not just pure competition
In pure competition, price = MR. Then, it follows that firms should produce that output where p = MC because P = MR

12. 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…
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13. Total Revenue Total Cost Approach1 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)
Total Revenue, (TR)
Maximum
Economic
Profit
$299
Total Cost,
(TC)
P=$131
Break-Even Point
(Normal Profit)
Total Economic
Profit
$299
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14. Marginal Revenue Marginal Cost Approach
(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…
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15. Marginal Revenue Marginal Cost Approach
$200
150
100 50
MR = MC MC
P=$131
Economic Profit
MR = P
ATC
Cost and Revenue
AVC
A=$97.78 1 2 3 4 5 6 7 8 9 10
Output
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16. Short Run Profit Maximization
Maximum profit at point where MR (=P) = MC
If the firm suffers loss at that point, should it still produce?
Yes if loss is less than fixed cost
Cover variable cost of production
Shut down if loss greater than fixed cost
Produce if P > min AVC
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17. Short Run 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
P=$81
MR = P
V = $75
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18. 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
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19. Short-Run Supply Curve
Continuing the Same 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
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20. Short-Run Supply Curve
Firms produce where MR=MC
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
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21. Short-Run Supply Curve
Firms produce where MR=MC
Examine the MC for the Competitive Firm
Cost and Revenues (Dollars)
Quantity Supplied
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) Q2 Q3 Q4 Q5
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22. Firm and Industry Supply
Changes in the price of variable inputs such as labor costs or technology can alter prices
Increases or decreases in prices of resources can shift the marginal cost in or out
The industry (total) supply curve
Sum of the supply by all individual firms
Industry supply and demand
Determine market price
The demand curve for the industry is not perfectly elastic
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23. Firm and Industry Supply
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
9-23

24. Long Run Profit Maximization
Assumptions
Entry and exit of firms into the industry are the only long-run adjustments
Firms in the industry have identical cost curves
The industry is a constant-cost industry, which means that the entry and exit of firms will not affect resource prices
Goal of the analysis
In the long run, P = min ATC
Entry eliminates profits
Exit eliminates losses
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25. Entry Eliminates Profits
Single Firm
Industry p P
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
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26. Exit Eliminates Losses
Single Firm
Industry p P
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
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27. Long Run Supply Constant cost industry
In a constant cost industry, the entry or exit of firms does not change the price of resources, and therefore, does not change production costs
This could occur when the resource used in the constant-cost industry is only a small amount of the total resource available
If production costs do not change, then neither does the Long Run ATC curve
The long run supply curve of a constant-cost industry if perfectly elastic (horizontal)
This means that costs are constant; if demand increases, there is no increased costs to produce more of anything
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28. Long Run Supply Increasing cost industry
Most industries are increasing cost industries
LR ATC increases with the entrance of new firms because the resources are scarce, and demand for them by the firms drives up the price
This is particularly true for resources that are not freely available (may be difficult to process) and supply cannot keep up with demand
Because each firm experiences increasing costs with increased production, their ATC tends to shift upward
Because of the increased costs of production, the industry will require higher prices and the supply curve is upward sloping

29. Long Run Supply Decreasing Cost Industries
For some industries such as those producing computer chips, costs actually decreased as technology improved
The great demand for chips has allowed producers to enjoy great benefits of economies of scale
Because costs decreased, the supply curve for decreasing cost industries is downward sloping

30. 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
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31. 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?
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32. Pure Competition and Efficiency
Productive efficiency
P = minimum ATC
Allocative efficiency
P = MC
Maximum consumer and producer surplus
Dynamic adjustments
“Invisible Hand” revisited
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33. Long-Run Equilibrium Pure competition has both in
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
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34. Key Terms pure competition pure monopoly long-run supply curve
monopolistic competition
oligopoly
imperfect competition
price taker
average revenue
total revenue
marginal revenue
break-even point
MR=MC rule
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
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35. Next Chapter Preview…
Pure
Monopoly
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