Lecture Economics (18th edition): Chapter 9 - McConnell, Brue, Flynn''s

Chapter 9
Pure
Competition

McGraw­Hill/Irwin

        Copyright © 2009 by The McGraw­Hill Companies, Inc. All rights reserved.


Chapter Objectives
• The four basic market models
• Conditions for pure competition
• Profit maximization for
competitive firms
• The competitive firm supply
curve
• Industry entry and exit
• Industry cost structure
• Economic efficiency
9-2


Four Market Models
•
•
•
•

Pure competition
Pure monopoly
Monopolistic competition

Oligopoly
Imperfect Competition
Pure
Competition

Monopolistic
Competition

Oligopoly

Pure
Monopoly

Market Structure Continuum
9-3


Pure Competition
•
•
•
•
•

Very large numbers
Standardized product
“Price takers”
Free entry and exit
Perfectly elastic demand
– Average revenue

– Marginal revenue
– Price
9-4


Pure Competition
$1179

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

Firm’s
Demand
Schedule
(Average
Revenue)

786
655
524
393
262

D = MR = AR
131
2

4

6

8

10

Quantity Demanded (Sold)

12
9-5

Short Run Profit Maximization
• Market price is given
• Three questions:
– Should the product be produced?
– If so, in what amount?
– What economic profit (loss) will
be realized?
9-6


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
9-7


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)

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

(3)
(4)
(5)
(6)

Total Variable Total Cost Total Revenue Profit (+)
Cost (TVC)
(TC)
(TR)
or Loss (-)

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

$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…

9-8


Total Revenue Total Cost Approach

Total Economic
Profit

Total Revenue and Total Cost

$1800
1700
1600
1500
1400
1300
1200
1100
1000
900
800
700
600
500
400
300
200

100

$500
400
300
200
100

Break-Even Point
(Normal Profit)
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 1213 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)

9-9


Marginal Revenue Marginal Cost
Approach
(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

NoYou
Surprise

- Now
Let’s Graph Now?
It…
Do
See Profit
Maximization
9-10


Marginal Revenue Marginal Cost
Approach

Cost and Revenue

$200

MR = MC

150
P=$131

MC
MR = P
ATC

Economic Profit

100

AVC

A=$97.78

50

0

1

2

3

4

5

6

Output

7

8

9

10
9-11

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
9-12


Short Run Loss Minimizing Case

Cost and Revenue

$200

Lower the Price to $81 and
Observe the Results!

150

Loss

A=$91.67

ATC
AVC

100
P=$81

50

0

MC

MR = P
V = $75

1

2

3

4

5

6

Output

7

8

9

10
9-13


Short Run Shut Down Case

Cost and Revenue

$200

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

150

100

ATC

V = $74

AVC
MR = P

P=$71

Short-Run

Shut Down Point
P < Minimum AVC
$71 < $74

50

0

1

2

3

4

5

6

Output

7

8

9

10
9-14

Short-Run Supply Curve
Continuing the Same 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
9-15


Short-Run Supply Curve

Cost and Revenues (Dollars)

Firms produce where MR=MC

e

P5

d

P4
P3
P2
P1

MC
MR5
ATC

c

AVC

MR4

MR3
MR2
MR1

b
a

This Price is Below AVC
And Will Not Be Produced
0

Q2

Q3

Q4

Quantity Supplied

Q5
9-16


Short-Run Supply Curve
Firms produce where MR=MC
Cost and Revenues (Dollars)

Examine the MC for the Competitive Firm

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

e

P5

d

P4
P3
P2
P1

S
MC
MR5
ATC

c

AVC

MR4

MR3

MR2
MR1

b
a
Shut-Down Point
(If P is Below)

0

Q2

Q3

Q4

Quantity Supplied

Q5
9-17


Firm and Industry Supply
• Changes in firm supply
– Shifts in marginal cost
– Input price or technology

• The industry (total) supply curve
– Sum of individual supply

• Industry supply and demand
– Determine market price
9-18


Firm and Industry Supply
Single Firm

Industry

p

P
S = ∑ MC’s
s = MC

Economic
Profit

ATC
d

$111

$111

AVC
D

0

8

p

0

8000

P

Competitive firm must take the price that is
Established by industry supply and demand
9-19


Long Run Profit Maximization
• Assumptions
– Entry and exit only
– Identical costs
– Constant-cost industry

• Goal of the analysis
– In the long run, P = min ATC
– Entry eliminates profits
– Exit eliminates losses
9-20


Entry Eliminates Profits

Single Firm

Industry

p

P
S1
MC
ATC

$60

$60

50

50

MR

40

S2

D2

40

D1

0

100

p

0

80,000

90,000

100,000

P

An increase in demand temporarily raises price
Higher prices draw in new competitors
Increased supply returns price to equilibrium

9-21


Exit Eliminates Losses
Single Firm

Industry

p

P
S3
MC
ATC

$60

$60

50

50

MR

40

S1

D1

40

D3

0

100

p

0

80,000

90,000

100,000 P

A decrease in demand temporarily lowers price
Lower prices drive away some competitors
Decreased supply returns price to equilibrium

9-22


Long Run Supply
• Constant cost industry
– Entry/exit does not affect LR ATC
– Constant resource price
– Special case

• Increasing cost industry
– Most industries
– LR ATC increases with expansion
– Specialized resources

• Decreasing cost industry

9-23


Long-Run Supply Curve
Constant-Cost Industry
P

P1
P2

$50

Z3

Z1

Z2

S

P3
D3

0

Q3
90,000

D1
Q1

100,000

D2
Q2
110,000

Q

9-24


Long-Run Supply Curve
Increasing-Cost Industry
P

P2

$55

P1

$50

P3

$40

S
Y2
Y1

Y3
D2
D1

D3

0

Q3
90,000

Q1
100,000

Q2
110,000

Q

How would a decreasing-cost industry look?
9-25