1. ©2004 Prentice Hall Publishing Ayers/Collinge, 1/e 1 Chapter 19 “Pure Competition”

2. ©2004 Prentice Hall Publishing Ayers/Collinge, 1/e 2 Learning Objectives 1.Name four market types and describe the characteristics of pure competition. 2.Illustrate how market demand and supply determine the competitive firm’s demand curve. 3.Identify the competitive firm’s short-run supply curve. 4.Describe the long-run equilibrium in pure competition. 1.Name four market types and describe the characteristics of pure competition. 2.Illustrate how market demand and supply determine the competitive firm’s demand curve. 3.Identify the competitive firm’s short-run supply curve. 4.Describe the long-run equilibrium in pure competition.

3. ©2004 Prentice Hall Publishing Ayers/Collinge, 1/e 3 Learning Objectives 5.Explain how efficiency is achieved in a purely competitive market. 6.Specify the difference between a constant- cost, increasing cost, and decreasing cost industry. 7.Show how competition can reduce discrimination in society. 5.Explain how efficiency is achieved in a purely competitive market. 6.Specify the difference between a constant- cost, increasing cost, and decreasing cost industry. 7.Show how competition can reduce discrimination in society.

4. ©2004 Prentice Hall Publishing Ayers/Collinge, 1/e 4 oThere are clearly different types of markets which are commonly called industries. oMarkets also differ according to whether the product is homogenous or differentiated. oHomogeneous products are identical no matter which firms produces them, and are often called commodities. oDifferentiated products will vary from one producer to the next. oThese differences lead to four different market structures, which are models of the way markets work. oThere are clearly different types of markets which are commonly called industries. oMarkets also differ according to whether the product is homogenous or differentiated. oHomogeneous products are identical no matter which firms produces them, and are often called commodities. oDifferentiated products will vary from one producer to the next. oThese differences lead to four different market structures, which are models of the way markets work. 19.1 TYPES OF MARKETS

5. ©2004 Prentice Hall Publishing Ayers/Collinge, 1/e 5 Types of Markets oMonopoly: Only one seller of a good with no close substitutes. oOligopoly: More than one seller, where at least one of the sellers can significantly influence price. oMonopolistic Competition: Numerous firms, each with slight ability to control price. oPure competition: a market in which there are many buyers and sellers of a homogeneous product. oMonopoly: Only one seller of a good with no close substitutes. oOligopoly: More than one seller, where at least one of the sellers can significantly influence price. oMonopolistic Competition: Numerous firms, each with slight ability to control price. oPure competition: a market in which there are many buyers and sellers of a homogeneous product.

6. ©2004 Prentice Hall Publishing Ayers/Collinge, 1/e 6 Types of Markets

7. ©2004 Prentice Hall Publishing Ayers/Collinge, 1/e 7 The Spectrum of Market Models 0 Pure Competition Monopolistic Competition OligopolyMonopoly Less Market Power More Market Power The term market power refers to the degree of influence over price by the individual firm.

8. ©2004 Prentice Hall Publishing Ayers/Collinge, 1/e 8 Characteristics of Pure Competition 4Numerous buyers and sellers 4Homogeneous product 4Firms do not advertise in pure competition 4Costless entry and exit of all firms. 4Firms are price takers with a perfectly elastic demand! A price taker always sells at the market price. 4Numerous buyers and sellers 4Homogeneous product 4Firms do not advertise in pure competition 4Costless entry and exit of all firms. 4Firms are price takers with a perfectly elastic demand! A price taker always sells at the market price.

9. ©2004 Prentice Hall Publishing Ayers/Collinge, 1/e 9 19.2 THE FIRM AND THE MARKET IN PURE COMPETITION Market Supply Market Demand Market Price Market Quantity Dollars Quantity (millions) Firm’s Supply Firm’s Demand Firm’s Output Quantity (thousands) Market Firm

10. ©2004 Prentice Hall Publishing Ayers/Collinge, 1/e 10 Short-Run Supply oAt any price above the shutdown price, the profit-maximizing firm equates marginal revenue and marginal cost. oBecause the price taking firm’s marginal revenue equals the market price, the firm produces the quantity associated with its marginal cost curve at that price. oThe price taking firm’s short-run supply curve is that part of its marginal cost curve that lies above average variable cost. oAt any price above the shutdown price, the profit-maximizing firm equates marginal revenue and marginal cost. oBecause the price taking firm’s marginal revenue equals the market price, the firm produces the quantity associated with its marginal cost curve at that price. oThe price taking firm’s short-run supply curve is that part of its marginal cost curve that lies above average variable cost.

11. ©2004 Prentice Hall Publishing Ayers/Collinge, 1/e 11 Supply in Pure Competition Dollars Quantity Market Firm Marginal Cost Averagevariablecost Shutdown price $160 6 $250 7 60007000 Firm’ssupplyMarketsupply

12. ©2004 Prentice Hall Publishing Ayers/Collinge, 1/e 12 Supply in Pure Competition Dollars Quantity Market Firm Marginal Cost Averagevariablecost Shutdown price $160 6 $250 7 60007000 Firm’ssupplyMarketsupply Firms supply is its marginal cost curve above its shutdown price. For each price, the market supply adds up the Quantities supplied by each firm.

13. ©2004 Prentice Hall Publishing Ayers/Collinge, 1/e 13 19.3 THE LONG-RUN - Entry, Exit, and Efficiency In the short-run, the market price could be sufficiently high that the firm earns profits, or it could be so low that the firm loses money. Short-run profits attract new firms to enter the market. Short-run losses cause existing firms to leave the industry. The long-run equilibrium market price results in the expectation of zero profit for a firm that is considering entry into the industry. Zero profit means the firm is breaking even, that is, earning a normal profit. In the short-run, the market price could be sufficiently high that the firm earns profits, or it could be so low that the firm loses money. Short-run profits attract new firms to enter the market. Short-run losses cause existing firms to leave the industry. The long-run equilibrium market price results in the expectation of zero profit for a firm that is considering entry into the industry. Zero profit means the firm is breaking even, that is, earning a normal profit.

14. ©2004 Prentice Hall Publishing Ayers/Collinge, 1/e 14 Profit Attracts New Entrants Losses Cause Firms to Leave Dollars Quantity Initial Supply Demand Initial Price Supply after Exit Supply after Entry Higher Price after Exit Lower Price after Entry

15. ©2004 Prentice Hall Publishing Ayers/Collinge, 1/e 15 Long-Run Equilibrium in Pure Competition Market Supply Market Demand Market Price Market Quantity Dollars Quantity (millions) Marginal cost Firm’s Demand Firm’s Output Quantity (thousands) Market Firm Averagecost Adjusts until price leaves firms with only a normal profit. = price = marginal revenue The long-run equilibrium in pure competition occurs when the last firm to enter the market earns zero profits, as shown by the firm’s average cost curve just tangent to its demand. There would be no reason for a new firm to enter and no reason for an existing firm to exit.

16. ©2004 Prentice Hall Publishing Ayers/Collinge, 1/e 16 The Efficiency of Pure Competition  The competitive market equilibrium produces an allocatively efficient amount of output.  Competition also forces firms to keep cost in check, thus inducing technological efficiency as well.  For these reasons the model of pure competition is often used as the standard of efficiency by which other market structures are judged.  The competitive market equilibrium produces an allocatively efficient amount of output.  Competition also forces firms to keep cost in check, thus inducing technological efficiency as well.  For these reasons the model of pure competition is often used as the standard of efficiency by which other market structures are judged.

17. ©2004 Prentice Hall Publishing Ayers/Collinge, 1/e 17 The Efficiency of Pure Competition SupplyDemand Competitive Output Quantity Too Much Output QuantitySupply Competitive Output Too Little Output Demand Maximum social surplus Surplus lost from producing too much Surplus foregone from producing too little

18. ©2004 Prentice Hall Publishing Ayers/Collinge, 1/e 18 19.4 LONG RUN SUPPLY The expansion or contraction of industries over time sometimes affects the cost of production in that industry. In response to entry, input prices might remain unchanged, rise, or fall, which gives rise to three industry types…. Constant-cost industry Increasing-cost industry Decreasing-cost industry The expansion or contraction of industries over time sometimes affects the cost of production in that industry. In response to entry, input prices might remain unchanged, rise, or fall, which gives rise to three industry types…. Constant-cost industry Increasing-cost industry Decreasing-cost industry

19. ©2004 Prentice Hall Publishing Ayers/Collinge, 1/e 19 Constant-cost industry; an increase in the industry’s output does not affect the cost of production. Increasing-cost industry; an increase in the industry’s output causes input prices to rise. Decreasing-cost industry; an increase in the industry’s output causes input prices to fall. Constant-cost industry; an increase in the industry’s output does not affect the cost of production. Increasing-cost industry; an increase in the industry’s output causes input prices to rise. Decreasing-cost industry; an increase in the industry’s output causes input prices to fall. Long-Run Characteristics of Industries

20. ©2004 Prentice Hall Publishing Ayers/Collinge, 1/e 20 Perfect Competition and Long-Run Supply  Perfect competition is a variant of pure competition.  Perfect competition adds to the model of pure competition a further assumption that all firms are identical, with access to resources and technology, with all information fully and freely available.  In a constant-cost industry, the entry of new firms would have no effect on the production cost of other firm’s, and with perfect competition, expansion of the industry would lead to the same equilibrium output price.  Perfect competition is a variant of pure competition.  Perfect competition adds to the model of pure competition a further assumption that all firms are identical, with access to resources and technology, with all information fully and freely available.  In a constant-cost industry, the entry of new firms would have no effect on the production cost of other firm’s, and with perfect competition, expansion of the industry would lead to the same equilibrium output price.

21. ©2004 Prentice Hall Publishing Ayers/Collinge, 1/e 21 Perfect Competition and Long-Run Supply  In an increasing -cost industry, the entry of new firms would not only increase industry output, but would shift up the cost curves of each firm in the industry.  Thus, an expansion of the industry would lead to a higher equilibrium price of the industry’s output.  Conversely, in a decreasing-cost industry, the entry of new firms would lower production cost for all firms and thus lead to a lower equilibrium price of output.  In an increasing -cost industry, the entry of new firms would not only increase industry output, but would shift up the cost curves of each firm in the industry.  Thus, an expansion of the industry would lead to a higher equilibrium price of the industry’s output.  Conversely, in a decreasing-cost industry, the entry of new firms would lower production cost for all firms and thus lead to a lower equilibrium price of output.

22. ©2004 Prentice Hall Publishing Ayers/Collinge, 1/e 22 Perfect Competition and Long-Run Supply Supply Demand Price Average cost Industry’s quantity Firm’s quantity $ Long-run supply Constant average cost curve as industry size grows Constant-cost industry

23. ©2004 Prentice Hall Publishing Ayers/Collinge, 1/e 23 Perfect Competition and Long-Run Supply Supply Demand Price Industry’s quantity Firm’s quantity $ Long-run supply Higher average cost curve as industry size grows Average cost Increasing-cost industry

24. ©2004 Prentice Hall Publishing Ayers/Collinge, 1/e 24 Perfect Competition and Long-Run Supply Supply Demand Price Average cost Industry’s quantity Firm’s quantity $ Long-run supply Lower average cost curve as industry size grows Decreasing-cost industry

25. ©2004 Prentice Hall Publishing Ayers/Collinge, 1/e 25 19.5 Discrimination – What a Difference Market Structure Makes  Two features of purely competitive firm’s prevents racial discrimination.  One feature is the homogeneous product, which means that the firm has no opportunity to vary the product in discriminatory ways.  Pure competition gives firms a strong profit incentive to avoid discrimination.  In pure competition a firm that inflicts higher input cost on itself can find itself going from profit to loss.  Two features of purely competitive firm’s prevents racial discrimination.  One feature is the homogeneous product, which means that the firm has no opportunity to vary the product in discriminatory ways.  Pure competition gives firms a strong profit incentive to avoid discrimination.  In pure competition a firm that inflicts higher input cost on itself can find itself going from profit to loss.

26. ©2004 Prentice Hall Publishing Ayers/Collinge, 1/e 26 Discrimination – What a Difference Market Structure Makes Quantity Price Marginal Cost Average cost $ Firm’s quantity Profit Loss Discrimination can turn a profit into a loss By increasing costs…

27. ©2004 Prentice Hall Publishing Ayers/Collinge, 1/e 27 Terms Along the Way  homogenous product  differentiated product  market structure  monopoly  oligopoly  monopolistic competition  pure competition  homogenous product  differentiated product  market structure  monopoly  oligopoly  monopolistic competition  pure competition  market power  constant-cost industry  increasing-cost industry  decreasing-cost industry  perfect competition  long-run supply  market power  constant-cost industry  increasing-cost industry  decreasing-cost industry  perfect competition  long-run supply

28. ©2004 Prentice Hall Publishing Ayers/Collinge, 1/e 28 Test Yourself 1.Price takers are found in a.pure competition. b.monopolistic competition. c.oligopoly. d.all of the above. 1.Price takers are found in a.pure competition. b.monopolistic competition. c.oligopoly. d.all of the above.

29. ©2004 Prentice Hall Publishing Ayers/Collinge, 1/e 29 Test Yourself 2. In pure competition the firm’s demand curve will be a.upward sloping. b.downward sloping. c.hump shaped. d.horizontal. 2. In pure competition the firm’s demand curve will be a.upward sloping. b.downward sloping. c.hump shaped. d.horizontal.

30. ©2004 Prentice Hall Publishing Ayers/Collinge, 1/e 30 Test Yourself 3.For a price taking firm, demand is a.equal to price. b.less than price. c.greater than price. d.unrelated to price. 3.For a price taking firm, demand is a.equal to price. b.less than price. c.greater than price. d.unrelated to price.

31. ©2004 Prentice Hall Publishing Ayers/Collinge, 1/e 31 Test Yourself 4. A price taking firm’s short-run supply curve is associated with its a.total revenue curve. b.average cost curve. c.marginal revenue curve. d.marginal cost curve. 4. A price taking firm’s short-run supply curve is associated with its a.total revenue curve. b.average cost curve. c.marginal revenue curve. d.marginal cost curve.

32. ©2004 Prentice Hall Publishing Ayers/Collinge, 1/e 32 Test Yourself 5.Profit maximization calls for the purely competitive firm to produce at the point where its demand curve intersects its a.total revenue curve. b.average cost curve. c.marginal revenue curve. d.marginal cost curve. 5.Profit maximization calls for the purely competitive firm to produce at the point where its demand curve intersects its a.total revenue curve. b.average cost curve. c.marginal revenue curve. d.marginal cost curve.

33. ©2004 Prentice Hall Publishing Ayers/Collinge, 1/e 33 Test Yourself 6.Which statement best describes the long run in a purely competitive market? a.The firm’s demand curve is downward sloping. b.The market will shrink as firms exit. c.The number of firms will be stable because there no incentive for entry or exit. d.In the long run, the market will slowly become a monopoly. 6.Which statement best describes the long run in a purely competitive market? a.The firm’s demand curve is downward sloping. b.The market will shrink as firms exit. c.The number of firms will be stable because there no incentive for entry or exit. d.In the long run, the market will slowly become a monopoly.

34. ©2004 Prentice Hall Publishing Ayers/Collinge, 1/e 34 The End! Next Chapter 20 “Monopoly and Antitrust"