1. CHAPTER 21
PURE
COMPETITION
COMPETITION

2. 4 Market Structures
Economists group industries into four distinct market structures based on: * the number of firms in the industry * Whether those firms produce a standardized product or try to differentiate from each other * How easy or difficult it is for firms to enter the industry

3. 4 Market Structures The 4 market structures are:
1. Pure (Perfect) Competition – a large number of usually smaller firms producing a product identical to other producers (ex. farmers)
2. Pure Monopoly – one firm is the sole seller of a product or service (MLB, satellite radio)

4. 4 Market Structures
3. Oligopoly – a middle ground between capitalism and monopoly; only a few sellers of a standardized or differentiated product so each firm is affected by the decisions of its rivals (steel, film, cell phone industries)
4. Monopolistic Competition – a larger number of sellers producing differentiated products (clothing, furniture, books)

5. FOUR MARKET STRUCTURES
Perfect
Competition
Monopolistic
Competition
Pure
Monopoly
Oligopoly
Every product is sold in a market that can be considered one of the above market structures.
What is the market structure for each?
Fast Food Market
The Market for Cars
Microsoft Operating Systems
Strawberry Market
Cereal Market
Monopolistic Competition
Oligopoly
Monopolistic Competition (differentiated products)
Oligopoly
Monopoly
Perfect Competition
Oligopoly (3 main producers)
Monopoly
Perfect Competition
Oligopoly (a few main producers)

6. Perfect Competition

7. Imperfect Competition The seller has NO control over price.
FOUR MARKET STRUCTURES
Perfect
Competition
Monopolistic
Competition
Pure
Monopoly
Oligopoly
Imperfect Competition
Characteristics of Perfect Competition:
Examples of Perfect Competition: Avocado farmers, sunglass huts, and hammocks in Mexico
Many small firms
Identical products (perfect substitutes)
Easy for firms to enter and exit the industry
Seller has no need to advertise
Firms are “Price Takers”
The seller has NO control over price.

8. Law of One Price
In an efficient market, all identical goods must have only one price.
Result: Each firm is a price taker. Firms have no control of the price
Traffic Analogy
When there is heavy traffic, why do all lanes seem to go the same speed?
Cars leave slower lanes and enter faster lanes.
Similarly, what happens in perfectly competitive markets if firms earn excessive profit? 8

10. Perfectly Competitive Firms
Example:
Say you go to Mexico to buy a hammock.
After visiting at few different shops you find that the buyers and sellers always agree on $15.
This is the market price (where demand and supply meet)
Is it likely that any shop can sell hammocks for $20?
Is it likely that any shop will sell hammocks for $10?
What happens if a shop prices hammocks too high?
Do you think that these firms make a large profit off of hammocks? Why?
These firms are “price takers” because the sell their products at a price set by the market.

11. Demand for Perfectly Competitive Firms (A Horizontal straight line)
Why are they Price Takers?
If a firm charges above the market price, NO ONE will buy. They will go to other firms
There is no reason to price low because consumers will buy just as much at the market price.
Since the price is the same at all quantities demanded, the demand curve for each firm is…
Perfectly Elastic
(A Horizontal straight line)

12. The Competitive Firm is a Price Taker Price is set by the Industry
Demand
$15
$15 D Q
5000 Q
Firm
(price taker)
Industry

13. The Competitive Firm is a Price Taker Price is set by the Industry
What is the additional revenue for selling an additional unit?
1st unit earns $15
2nd unit earns $15
Marginal revenue is constant at $15
Notice:
Total revenue increases at a constant rate
MR equal Average Revenue P
Demand
$15
MR=D=AR=P Q
Firm
(price taker) 13 13

14. For Perfect Competition: Demand = MR (Marginal Revenue)
The Competitive Firm is a Price Taker
Price is set by the Industry
What is the additional revenue for selling an additional unit?
1st unit earns $15
2nd unit earns $15
Marginal revenue is constant at $15
Notice:
Total revenue increases at a constant rate
MR equal Average Revenue P
Demand
$15
MR=D=AR=P Q
Firm
(price taker) 14 14

15. Maximizing PROFIT! 15

16. Short-Run Profit Maximization
What is the goal of every business?
To Maximize Profit!!!!!!
To maximize profit firms must make the right output
Firms should continue to produce until the additional revenue from each new output equals the additional cost.
Example (Assume the price is $10)
Should you produce…
…if the additional cost of another unit is $5
…if the additional cost of another unit is $9
…if the additional cost of another unit is $11

17. Profit Maximizing Rule Short-Run Profit Maximization
MR=MC
Short-Run Profit Maximization
What is the goal of every business?
To Maximize Profit!!!!!!
To maximum profit firms must make the right output
Firms should continue to produce until the additional revenue from each new output equals the additional cost.
Example (Assume the price is $10)
Should you produce…
…if the additional cost of another unit is $5
…if the additional cost of another unit is $9
…if the additional cost of another unit is $11 17

18. Lets put costs and revenue together on a graph to calculate profit.

19. Don’t forget that averages show PER UNIT COSTS
How much output should be produced?
How much is Total Revenue? How much is Total Cost?
Is there profit or loss? How much? P $9 8 7 6 5 4 3 2 1 MC
MR=D=AR=P
Profit = $18
ATC
AVC
Don’t forget that averages show PER UNIT COSTS
Total Cost=$45
Total Revenue =$63 Q

20. The profit maximizing rule is also the loss minimizing rule!!!
Suppose the market demand falls. What would happen if the price is lowered from $7 to $5?
The MR=MC rule still applies but now the firm will make an economic loss.
The profit maximizing rule is also the loss minimizing rule!!!

21. How much output should be produced?
How much is Total Revenue? How much is Total Cost?
Is there profit or loss? How much? MC $9 8 7 6 5 4 3 2 1
ATC
Cost and Revenue
AVC
Loss =$7
MR=D=AR=P
Total Cost = $42
Total Revenue=$35 Q

22. Assume the market demand falls even more
Assume the market demand falls even more. If the price is lowered from $5 to $4 the firm should stop producing.
Shut Down Rule:
A firm should continue to produce as long as the price is above the AVC
When the price falls below AVC then the firm should minimize its losses by shutting down
Why? If the price is below AVC the firm is losing more money by producing than they would have to pay to shut down.

23. Minimum AVC is shut down point
SHUT DOWN! Produce Zero MC $9 8 7 6 5 4 3 2 1
ATC
Cost and Revenue
AVC
Minimum AVC is shut down point Q

24. P<AVC. They should shut down
Producing nothing is cheaper than staying open. MC $9 8 7 6 5 4 3 2 1
ATC
Cost and Revenue
Fixed Costs=$10
AVC
TC=$35
MR=D=AR=P
TR=$20 Q

25. Profit Maximizing Rule
MR = MC
Three Characteristics of MR=MC Rule:
Rule applies to ALL markets structures (PC, Monopolies, etc.)
The rule applies only if price is above AVC
Rule can be restated P = MC for perfectly competitive firms (because MR = P)

26. Practice 26

27. #1 MC MR=D=AR= P ATC AVC Q $20 15 10 14 5 6 Should the firm produce?
What output should the firm produce?
What is TR at that output? What is TC?
How much profit or loss?
Yes 10
TR=$140
TC=$100
Profit=$40
$20 15 10 5 MC
MR=D=AR= P 14
ATC
Cost and Revenue
AVC 6 Q

28. #2 MC ATC AVC MR=D=AR=P Q $20 15 10 11 5 9
What output should the firm produce?
What is TR at MR=MC point?
What is TC at MR=MC point?
How much profit or loss?
Zero Shutdown
(Price below AVC)
$45
$55
Loss=Only Fixed Cost $5
$20 15 10 5 MC
ATC
AVC 11
Cost and Revenue 9
MR=D=AR=P Q
5 7

29. #3 MC ATC AVC MR=D=AR=P Q $40 30 20 10 19 15
What output should the firm produce?
What is TR at that output?
What is TC?
How much profit or loss? 6
$90
$120
Loss= $30
$40 30 20 10 MC
ATC
Cost and Revenue
AVC 19 15
MR=D=AR=P Q
6 8