Pure Competition

Four Market Models

Pure competition
Pure monopoly
Monopolistic competition
Oligopoly

Imperfect Competition
Pure Monopolistic Pure
Competition Competition Oligopoly Monopoly

Market Structure Continuum

9-2
Pure Competition
Very large numbers
Standardized product
“Price takers”
Free entry and exit
Perfectly elastic demand
 Average revenue
 Marginal revenue
 Price 9-3
Pure Competition
$1179
Firm’s Firm’s TR
Demand Revenue 1048
Schedule Data
(Average
Revenue) 917
P QD TR MR

Price and Revenue

786
$131 0 $0
] $131 655
131 1 131
] 131
131 2 262
] 131
131 3 393 524
] 131
131 4 524
] 131
131 5 655 393
] 131
131 6 786
] 131 262
131 7 917
] 131 D = MR = AR
131 8 1048
] 131 131
131 9 1179
131 10 1310
] 131
2 4 6 8 10 12
Quantity Demanded (Sold) 9-4
Short Run Profit Maximization

Market price is given

Three questions:
 Shouldthe product be
produced?
 If so, in what amount?
 What economic profit (loss)
will be realized?
9-5
Profit Maximization
Two approaches
Total revenue and total cost
approach
 Produce where TR-TC is
greatest
Marginal revenue and
marginal cost approach
 Produce where MR=MC 9-6
Total Revenue Total Cost Approach

Price = $131
(1) (2) (3) (4) (5) (6)
Total Product Total Fixed Total Variable Total Cost Total Revenue Profit (+)
(Output) (Q) Cost (TFC) Cost (TVC) (TC) (TR) or Loss (-)

0 $100 $0 $100 $0 $-100

1 100 90 190 131 -59
2 100 170 270 262 -8
3 100 240 340 393 +53
4 100 300 400 524 +124
5 100 370 470 655 +185
6 100 450 550 786 +236
7 100 540 640 917 +277
8 100 650 750 1048 +298
9 100 780 880 1179 +299
10 100 930 1030 1310 +280

9-7
Total Revenue Total Cost Approach
$1800
1700 Break-Even Point
1600 (Normal Profit)

Total Revenue and Total Cost

1500
1400 Total Revenue, (TR)
1300
1200
1100 Maximum
1000 Economic
Total Cost,
900 Profit
800 $299 (TC)
700
600
500 P=$131
400
300 Break-Even Point
200 (Normal Profit)
100
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14
Total Economic

Quantity Demanded (Sold)

$500
Total Economic $299
Profit

400
300 Profit
200
100
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14
Quantity Demanded (Sold)
9-8
Marginal Revenue Marginal Cost
Approach

(2) (3) (4)

(1) Average Average Average (5) (6)
Total Fixed Variable Total Marginal Marginal (7)
Product Cost Cost Cost Cost Revenue Profit (+)
(Output) (AFC) (AVC) (ATC) (MC) (MR) or Loss (-)

0 $-100
1 $100.00 $90.00 $190.00 $90 $131 -59
2 50.00 85.00 135.00 80 131 -8
3 33.33 80.00 113.33 70 131 +53
4 25.00 75.00 100.00 60 131 +124
5 20.00 74.00 94.00 70 131 +185
6 16.67 75.00 91.67 80 131 +236
7 14.29 77.14 91.43 90 131 +277
8 12.50 81.25 93.75 110 131 +298
9 11.11 86.67 97.78 130 131 +299
10 10.00 93.00 103.00 150 131 +280

9-9
Marginal Revenue Marginal Cost
Approach

$200

MR = MC MC
Cost and Revenue

150
P=$131
Economic Profit MR = P
ATC
100
AVC
A=$97.78

50

0
1 2 3 4 5 6 7 8 9 10
Output
9-10
Short Run Profit Maximization
Produce where MR (=P) = MC
Suffer loss, still produce?
Yes if loss is less than fixed cost
 Cover variable cost
Shut down if loss greater than
fixed cost
Produce if P > min AVC

9-11
Short Run Loss Minimizing Case
$200

Lower the Price to $81 and

Observe the Results! MC
Cost and Revenue

150

Loss
A=$91.67
ATC
100 AVC
P=$81
MR = P

V = $75
50

0
1 2 3 4 5 6 7 8 9 10
Output
9-12
Short Run Shut Down Case
$200

Lower the Price Further to

$71 and Observe the Results!
Cost and Revenue

150 MC

ATC
V = $74
100 AVC

MR = P
P=$71
50 Short-Run
Shut Down Point
P < Minimum AVC
$71 < $74
0
1 2 3 4 5 6 7 8 9 10
Output
9-13
Short-Run Supply Curve

Supply Schedule of a Competitive Firm

Quantity Maximum Profit (+)
Price Supplied or Minimum Loss (-)
$151 10 $+480
131 9 +299
111 8 +138
91 7 -3
81 6 -64
71 0 -100
61 0 -100
The schedule shows the quantity a firm
will produce at a variety of prices 9-14
Short-Run Supply Curve
Firms produce where MR=MC
Cost and Revenues (Dollars)

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

0 Q2 Q3 Q4 Q5
Quantity Supplied
9-15
Short-Run Supply Curve
Firms produce where MR=MC
Examine the MC for the Competitive Firm

MC Above AVC Becomes

Cost and Revenues (Dollars)

the Short-Run Supply Curve S

Break-even MC
(Normal Profit) Point e
P5 MR5
d
ATC
P4 MR4
c AVC
P3 MR3
b
P2 MR2
a
P1 MR1

Shut-Down Point
(If P is Below)

0 Q2 Q3 Q4 Q5
Quantity Supplied
9-16