Pure Competition

Chapter 9
Four Market Models
Pure Competition: Characteristics
and Occurrences
• Presence of a large number of independently acting sellers, often
offering their products in large national or international markets.
• Selling standardized (homogeneous) products, making no attempt to
differentiate their products, and not engaging in other forms of
nonprime competition.
• Individual firms do not exert control over product price but it is a
price taker.
• Free entry and exit.
Demand as Seen by a Purely
Competitive Seller
• Because each purely competitive firm offers only negligible fraction of
total market supply, it must accept the price determined by the
market. In pure competition, marginal revenue and price are equal.
Demand as Seen by a Purely
Competitive Seller
• The demand schedule faced by the individual firm in a purely
competitive industry is perfectly elastic at the market price. For the
individual competitive firm, the market price is a fixed value at which
it can sell as many or as few units it cares to. However, market
demand graphs as a down sloping curve. An entire industry can affect
price by changing industry output.
• For example, all firms, acting independently but simultaneously, can increase
price by reducing output.
Demand as Seen by a Purely
Competitive Seller
• The firm's demand schedule is also its average-revenue schedule.
Price per unit to the purchaser is also revenue per unit, or average
revenue, to the seller.
• The total revenue for each sales level is found by multiplying price by
the corresponding quantity the firm can sell. Each unit sold adds
exactly its constant price to total revenue.
• Marginal revenue is the change in total revenue that results from
selling one more unit of output.
• NOTE: In pure competition, marginal revenue and price are equal.
A purely competitive firm’s demand
and revenue curves.
Profit Maximization in the Short Run: Total Revenue -
Total-Cost Approach

• Because the purely competitive firm is a price taker, it attempts to

maximize its economic profit by adjusting its output (i.e. variable
resources in the short run).
• Two ways to determine the level of output at which a competitive
firm will realize maximum profit or minimum loss:
• Comparing total revenue and total cost.
• Comparing marginal revenue and marginal cost.
Profit Maximization in the Short Run:
Total Revenue - Total-Cost Approach
• In total-revenue-total-cost approach to profit maximization, the firm
achieves maximum profit where the vertical distance between the
total-revenue and total-cost curves is the greatest.
• Total cost increases with output because more production requires
more resources. But the rate of increase in total cost varies with the
efficiency of the firm, which in turn varies with the amount of variable
inputs that are being combined with the firm's current amount of
capital.
• Total revenue and total cost are equal where the two curves intersect.
• This output is called a break-even point.
The Profit-Maximizing Output for a Purely Competitive
Firm: Total-Revenue–Total-Cost
Approach
Total-revenue–total-cost approach
to profit maximization for a purely competitive
firm.
Profit Maximization in the Short Run: Marginal-Revenue -
Marginal-Cost Approach

• Assuming that producing is preferable to shutting down, the firm

should produce any unit of output whose marginal revenue exceeds
its marginal cost because the firm would gain more in revenue from
selling that unit than it would add to its costs by producing it.
• MR = MC rule: In the short run, the firm will maximize profit or
minimize loss by producing the output at which marginal revenue
equals marginal cost (as long as producing is preferable to shutting
down).
• The firm should produce the last complete unit of output for which MR
exceeds MC.
• The rule can be restated as P = MC when applied to a purely competitive
market.
• NOTE: The firm wants to maximize its total profit, not its per-unit
profit.
Profit Maximizing Case
Loss Minimizing Case
Shutdown Case
Marginal Cost and Short Run Supply
Marginal Cost and Short Run Supply
• Each of the MR (= P) = MC intersection points indicates a possible
product price (on the vertical axis) and the corresponding quantity
that the firm would supply at that price (on the horizontal axis). We
can conclude that the portion of the firm's MC curve lying above its
AVC curve is its short-run supply curve.
• Higher product prices and marginal revenue encourage purely
competitive firm to expand output. As its output increases, the firm's
marginal costs rise as a result of the law of diminishing returns. Thus
MR=MC and profit is maximized at some now greater output.
Marginal Cost and Short Run Supply
• Changes in prices of variable inputs or in technology alter costs and
shift short-run supply curve:
• A wage increase would increase MC and shift the supply curve upward.
• Technological progress that increases labor productivity would reduce MC
and shift the supply curve downward.
• To determine the equilibrium price and output, total-supply data must
be compared with total-demand data.
• We find the total supply schedule by assuming a particular number of firms in
the industry and supposing that each firm has the same individual supply
schedule as the rest. Then we sum the quantities supplied at each price level
to obtain the total (or market) supply schedule.
Short Run competitive equilibrium