macroeconomic mcgrowhill micro ch 8 and 9 19e use this one

08 and 09
Pure Competition in the Short Run &
Long Run

McGraw-Hill/Irwin

Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.


Chapter Objectives

Four Market Mode
ls
Pure Competition
Profit Maximizati
on in the Short-R
un
Marginal Cost an
d Short-Run Supp
ly
Changes in Supp
ly
Profit Maximizati
on in the Long Ru
n
Supply Readjust
ment
Pure Competition
and Efficiency
Long-Run Equilib
rium

Last Word

Key Terms
End Show
9-2

• Names and Main Characteristics of
the Four Basic Market Models
• Conditions for Perfect Competition
• How Do Purely Competitive Firms
Maximize Profits or Minimize
Losses
• Why the Marginal Cost and Supply
Curves For Competitive Firms Are
Identical
• How Industry Entry and Exit Create
Economic Efficiency
• Differences Between Constant-Cost,
Increasing-Cost, and DecreasingCost Industries
Copyright 2008 The McGraw-Hill Companies


Four Market Models
Four Market Mode
ls
Pure Competition
Profit Maximizati
on in the Short-R
un
Marginal Cost an

d Short-Run Supp
ly
Changes in Supp
ly
Profit Maximizati
on in the Long Ru
n
Supply Readjust
ment
Pure Competition
and Efficiency
Long-Run Equilib
rium
Last Word

• Pure Competition
• Pure Monopoly
• Monopolistic Competition
• Oligopoly
Imperfect Competition
Pure
Competition

Monopolistic
Competition

Oligopoly

Pure
Monopoly

Key Terms

Market Structure Continuum

End Show
9-3

Copyright 2008 The McGraw-Hill Companies


Four Market Models
Characteristics of the Four Basic Market Models
Pure
Characteristic Competition

Monopolistic
Competition

Oligopoly

Monopoly

Number of firms

A very large
number

Many

Few

One

Type of product

Standardized

Differentiated

Standardized or
differentiated

Unique; no
close subs.

Control over
price

None

Some, but within rather
narrow limits

Limited by mutual
inter-dependence;
considerable with
collusion

Considerable

Conditions of
entry

Very easy, no
obstacles

Relatively easy

Significant
obstacles

Blocked

Nonprice
Competition

None

Considerable emphasis
on advertising, brand
names, trademarks

Typically a great
deal, particularly
with product
differentiation

Mostly public
relation

advertising

Examples

Agriculture

Retail trade, dresses,
shoes

Steel, auto, farm
implements

Local utilities

LO1

8-4


Pure Competition: Characteristics

• Very large numbers of sellers
• Standardized product
• “Price takers”
• Easy entry and exit
• Perfectly elastic demand
• Firm produces as much or little as
they want at the price
• Demand graphs as horizontal line
LO2

8-5


Average, Total, and Marginal
Revenue
• Average Revenue
• Revenue per unit
• AR = TR/Q = P
• Total Revenue
• TR = P X Q
• Marginal Revenue
• Extra revenue from 1 more unit
• MR = ΔTR/ΔQ
LO3

8-6


Pure Competition
$1179

Key Terms

Firm’s
Demand
Schedule
(Average
Revenue)

P

Firm’s
Revenue
Data

917

QD TR

$131 0
131 1
131 2
131 3
131 4
131 5
131 6
131 7
131 8
131 9
131 10

TR

1048

$0
131
262
393

524
655
786
917
1048
1179
1310

MR
] $131
] 131
] 131
] 131
] 131
] 131
] 131
] 131
] 131
] 131

Price and Revenue

Four Market Mode
ls
Pure Competition
Profit Maximizati
on in the Short-R
un
Marginal Cost an
d Short-Run Supp

ly
Changes in Supp
ly
Profit Maximizati
on in the Long Ru
n
Supply Readjust
ment
Pure Competition
and Efficiency
Long-Run Equilib
rium
Last Word

786
655
524
393
262

D = MR = AR
131
2

4

6

8

10

Quantity Demanded (Sold)

End Show
9-7

Copyright 2008 The McGraw-Hill Companies

12


Profit Maximization in the
Short Run

Four Market Mode
ls
Pure Competition
Profit Maximizati
on in the Short-R
un
Marginal Cost an
d Short-Run Supp
ly
Changes in Supp
ly
Profit Maximizati
on in the Long Ru
n
Supply Readjust

ment
Pure Competition
and Efficiency
Long-Run Equilib
rium
Last Word

Total Revenue-Total Cost Approach

Consider:
–Should Product Be
Produced?
–If So, In What Amount?
–What Economic Profit
(Loss) Will Be Realized?

Key Terms
End Show
9-8

Copyright 2008 The McGraw-Hill Companies


3 Production Questions
Output Determination in Pure Competition in the Short Run

LO3

Question

Answer

Should this firm produce?

Yes, if price is equal to, or greater than,
minimum average variable cost. This
means that the firm is profitable or that
its losses are less than its fixed cost.

What quantity should this firm produce?

Produce where MR (=P) = MC; there,
profit is maximized (TR exceeds TC by
a maximum amount) or loss is
minimized.

Will production result in economic
profit?

Yes, if price exceeds average total cost
(TR will exceed TC). No, if average total
cost exceeds price (TC will exceed TR).

8-9


Profit Maximization in the
Short Run

Four Market Mode

ls
Pure Competition
Profit Maximizati
on in the Short-R
un
Marginal Cost an
d Short-Run Supp
ly
Changes in Supp
ly
Profit Maximizati
on in the Long Ru
n
Supply Readjust
ment
Pure Competition
and Efficiency
Long-Run Equilib
rium
Last Word

Key Terms

Total Revenue-Total Cost Approach
Price = $131
(1)
Total Product
(Output) (Q)

0

1
2
3
4
5
6
7
8
9
10

(2)
Total Fixed
Cost (TFC)

(3)
Total Variable
Cost (TVC)

$100
100
100
100
100
100
100
100
100
100
100

$0
90
170
240
300
370
450
540
650
780
930

(4)
(5)
(6)
Total Cost Total Revenue Profit (+)
(TC)
(TR)
or Loss (-)

$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
SeeGraph

Profit The
Maximization?
Now
Let’s
Results…

End Show
9-10

Copyright 2008 The McGraw-Hill Companies


Profit Maximization in the
Short Run

Total Revenue-Total Cost Approach
Total Revenue and Total Cost

$1800
1700
1600
1500
1400
1300
1200
1100
1000
900
800
700

600
500
400
300
200
100

Total Economic
Profit

Four Market Mode
ls
Pure Competition
Profit Maximizati
on in the Short-R
un
Marginal Cost an
d Short-Run Supp
ly
Changes in Supp
ly
Profit Maximizati
on in the Long Ru
n
Supply Readjust
ment
Pure Competition
and Efficiency
Long-Run Equilib
rium

Last Word

Key Terms
End Show
9-11

$500
400
300
200
100

Break-Even Point
(Normal Profit)
W 9.1

Total Revenue, (TR)
Maximum
Economic
Profit
$299

Total Cost,
(TC)

P=$131
Break-Even Point
(Normal Profit)
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14
Quantity Demanded (Sold)

Total Economic
Profit

$299

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14
Quantity Demanded (Sold)

Copyright 2008 The McGraw-Hill Companies

G 9.1


Profit Maximization in the
Short Run

Four Market Mode
ls
Pure Competition
Profit Maximizati
on in the Short-R
un
Marginal Cost an
d Short-Run Supp
ly
Changes in Supp
ly
Profit Maximizati
on in the Long Ru

n
Supply Readjust
ment
Pure Competition
and Efficiency
Long-Run Equilib
rium
Last Word

Key Terms

Marginal Revenue-Marginal Cost Approach
MR = MC Rule

Important Features:
• Firm Will max profits or
min loss where MR = MC
• Profit Maximization in All
Market Structures
• Can Be Restated P = MC

End Show
9-12

Copyright 2008 The McGraw-Hill Companies


Profit Maximization in the
Short Run

Four Market Mode
ls
Pure Competition
Profit Maximizati
on in the Short-R
un
Marginal Cost an
d Short-Run Supp
ly
Changes in Supp
ly
Profit Maximizati
on in the Long Ru
n
Supply Readjust
ment
Pure Competition
and Efficiency
Long-Run Equilib
rium
Last Word

Key Terms

Marginal Revenue-Marginal Cost Approach
MR = MC Rule
(1)
Total
Product
(Output)

0
1
2
3
4
5
6
7
8
9
10

(2)
Average
Fixed
Cost
(AFC)

$100.00
50.00
33.33
25.00
20.00
16.67
14.29
12.50
11.11
10.00

(3)
Average
Variable
Cost
(AVC)

(4)
Average
Total
Cost
(ATC)

$90.00 $190.00
85.00 135.00
80.00 113.33
75.00 100.00
74.00
94.00
75.00
91.67
77.14
91.43
81.25
93.75
86.67
97.78
93.00 103.00

(5)
Marginal

Cost
(MC)

$90
80
70
60
70
80
90
110
130
150

(6)
Marginal
Revenue
(MR)

(7)
Profit (+)
or Loss (-)

$131
131
131
131
131
131
131

131
131
131

$-100
-59
-8
+53
+124
+185
+236
+277
+298
+299
+280

Surprise
- Now
Let’s GraphNow?
It…
DoNo
You
See Profit
Maximization

End Show
9-13

Copyright 2008 The McGraw-Hill Companies

Profit Maximization in the
Short Run

W 9.2

$200

Cost and Revenue

Four Market Mode
ls
Pure Competition
Profit Maximizati
on in the Short-R
un
Marginal Cost an
d Short-Run Supp
ly
Changes in Supp
ly
Profit Maximizati
on in the Long Ru
n
Supply Readjust
ment
Pure Competition
and Efficiency
Long-Run Equilib
rium

Last Word

Marginal Revenue-Marginal Cost Approach
MR = MC Rule

150

MR = MC

P=$131

MC
MR = P
ATC

Economic Profit
100

AVC
A=$97.78

50

Key Terms

0
End Show
9-14

1

2

Copyright 2008 The McGraw-Hill Companies

3

4

5

6

Output

7

8

9

10


Profit Maximization in the
Short Run
Loss Minimizing Case

$200

Cost and Revenue

Four Market Mode
ls
Pure Competition
Profit Maximizati
on in the Short-R
un
Marginal Cost an
d Short-Run Supp
ly
Changes in Supp
ly
Profit Maximizati
on in the Long Ru
n
Supply Readjust
ment
Pure Competition
and Efficiency
Long-Run Equilib
rium
Last Word

Marginal Revenue-Marginal Cost Approach
MR = MC Rule

Lower the Price to $81 and
Observe the Results!

150

Loss

A=$91.67

ATC
AVC

100

MR = P

P=$81
50

MC

V = $75

Key Terms

0
End Show
9-15

1

2

Copyright 2008 The McGraw-Hill Companies

3

4

5

6

Output

7

8

9

10


Fixed Costs: Digging Out of a Hole

• Shutting down in the short run does not
•
•
•

mean shutting down forever
Low prices can be temporary

Some firms switch production on and
off depending on the market price
Examples: oil producers, resorts, and
firms that shut down during a recession

8-16


Profit Maximization in the
Short Run
Short-Run Shut Down Case

$200

Cost and Revenue

Four Market Mode
ls
Pure Competition
Profit Maximizati
on in the Short-R
un
Marginal Cost an
d Short-Run Supp
ly
Changes in Supp
ly
Profit Maximizati
on in the Long Ru
n

Supply Readjust
ment
Pure Competition
and Efficiency
Long-Run Equilib
rium
Last Word

Marginal Revenue-Marginal Cost Approach
MR = MC Rule

Lower the Price Further to
$71 and Observe the Results!
MC

150

100

ATC

V = $74

AVC
MR = P

50

P=$71

Short-Run
Shut Down Point
P < Minimum AVC
$71 < $74

Key Terms

0
End Show
9-17

1

2

Copyright 2008 The McGraw-Hill Companies

3

4

5

6

Output

7

8

9

10


Marginal Cost and
Short-Run Supply

Four Market Mode
ls
Pure Competition
Profit Maximizati
on in the Short-R
un
Marginal Cost an
d Short-Run Supp
ly
Changes in Supp
ly
Profit Maximizati
on in the Long Ru
n
Supply Readjust
ment
Pure Competition
and Efficiency
Long-Run Equilib
rium
Last Word

Key Terms
End Show
9-18

Continuing the Same Numeric
Example…
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 and Results
Copyright 2008 The McGraw-Hill Companies


Marginal Cost and
Short-Run Supply

Generalizing the MR=MC
Relationship and its Use
Cost and Revenues (Dollars)

Four Market Mode
ls
Pure Competition
Profit Maximizati
on in the Short-R
un
Marginal Cost an
d Short-Run Supp
ly
Changes in Supp
ly
Profit Maximizati
on in the Long Ru
n

Supply Readjust
ment
Pure Competition
and Efficiency
Long-Run Equilib
rium
Last Word

e

P5

d

P4
b
a

0

End Show

AVC

This Price is Below AVC
And Will Not Be Produced

Key Terms

Q2

Q3

Q4

Quantity Supplied
9-19

Copyright 2008 The McGraw-Hill Companies

MR5
ATC

c

P3
P2
P1

MC

Q5

MR4
MR3
MR2
MR1


Marginal Cost and

Short-Run Supply

Generalizing the MR=MC
Relationship and its Use

Examine the MC for the Competitive Firm
Cost and Revenues (Dollars)

Four Market Mode
ls
Pure Competition
Profit Maximizati
on in the Short-R
un
Marginal Cost an
d Short-Run Supp
ly
Changes in Supp
ly
Profit Maximizati
on in the Long Ru
n
Supply Readjust
ment
Pure Competition
and Efficiency
Long-Run Equilib
rium
Last Word

MC Above AVC Becomes
the Short-Run Supply Curve
Break-even
(Normal Profit) Point

P5

d

P4
a

0

Shut-Down Point
(If P is Below)
Q2

Q3

Q4

Quantity Supplied
9-20

Copyright 2008 The McGraw-Hill Companies

MR5
AVC

b

This Price is Below AVC
And Will Not Be Produced

MC
ATC

c

P3
P2
P1

Key Terms
End Show

e

S

Q5

MR4
MR3
MR2
MR1


Changes in Supply

Four Market Mode
ls
Pure Competition
Profit Maximizati
on in the Short-R
un
Marginal Cost an
d Short-Run Supp
ly
Changes in Supp
ly
Profit Maximizati
on in the Long Ru
n
Supply Readjust
ment
Pure Competition
and Efficiency
Long-Run Equilib
rium
Last Word

• Firm and Industry
–Equilibrium Price
–Market Price and Profits
–Firm Versus Industry
Graphically…

Key Terms
End Show

9-21

Copyright 2008 The McGraw-Hill Companies


Changes in Supply
Four Market Mode
ls
Pure Competition
Profit Maximizati
on in the Short-R
un
Marginal Cost an
d Short-Run Supp
ly
Changes in Supp
ly
Profit Maximizati
on in the Long Ru
n
Supply Readjust
ment
Pure Competition
and Efficiency
Long-Run Equilib
rium
Last Word

Single Firm
p

W 9.3

P
S = ∑ MC’s
s = MC

Economic
Profit

ATC
d

$111

$111

AVC
D

0
Key Terms

Industry

8

p

0

8000

Competitive Firm Must Take the Price that is
Established By Industry Supply and Demand

End Show
9-22

Copyright 2008 The McGraw-Hill Companies

P


09
Pure Competition in the
Long Run

McGraw-Hill/Irwin

Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.


Note to Students:
• The following material will not be
covered, nor is it required reading:
– Long Run Supply: Constant-Cost Industry
– Long Run Supply: Increasing-Cost Industry
– Long Run Supply: Decreasing-Cost
Industry

Profit Maximization in
the Long Run
Four Market Mode
ls
Pure Competition
Profit Maximizati
on in the Short-R
un
Marginal Cost an
d Short-Run Supp
ly
Changes in Supp
ly
Profit Maximizati
on in the Long Ru
n
Supply Readjust
ment
Pure Competition
and Efficiency
Long-Run Equilib
rium
Last Word

• Assumptions
–Entry and Exit Only
–Identical Costs
–Constant-Cost Industry

• Goal of the Analysis
• Long-Run Equilibrium
–Entry Eliminates Profits
–Exit Eliminates Losses

Key Terms
End Show
9-25

Copyright 2008 The McGraw-Hill Companies