Pure Competition

Pure Competition By: Catherine Castañeda & Ana Logan

FOUR MARKET MODELS Pure Competition Monopolistic Competition Oligopoly Pure Monopoly

FOUR MARKET MODELS Pure Competition: • Very Large Numbers • Standardized Product • “Price Takers” • Free Entry and Exit

DEMAND AS SEEN BY APURELY COMPETITIVE SELLER • Perfectly Elastic Demand Price Taker Role • Total Revenue • Average Revenue • Marginal Revenue

DEMAND AS SEEN BY APURELY COMPETITIVE SELLER Total Revenue (TR) P x Q Marginal Revenue (MR) ▲TR Product Price (P) (Average Revenue) Quantity Demanded (Q) $131 0 $ 0

DEMAND AS SEEN BY APURELY COMPETITIVE SELLER ] Total Revenue (TR) P x Q Marginal Revenue (MR) ▲TR Product Price (P) (Average Revenue) Quantity Demanded (Q) $131 131 0 1 $ 0 131 $131

DEMAND AS SEEN BY APURELY COMPETITIVE SELLER ] ] Total Revenue (TR) P x Q Marginal Revenue (MR) ▲TR Product Price (P) (Average Revenue) Quantity Demanded (Q) $131 131 131 0 1 2 $ 0 131 262 $131 131

DEMAND AS SEEN BY APURELY COMPETITIVE SELLER ] ] ] Total Revenue (TR) P x Q Marginal Revenue (MR) ▲TR Product Price (P) (Average Revenue) Quantity Demanded (Q) $131 131 131 131 0 1 2 3 $ 0 131 262 393 $131 131 131

DEMAND AS SEEN BY APURELY COMPETITIVE SELLER ] ] ] ] Total Revenue (TR) P x Q Marginal Revenue (MR) ▲TR Product Price (P) (Average Revenue) Quantity Demanded (Q) $131 131 131 131 131 0 1 2 3 4 $ 0 131 262 393 524 $131 131 131 131

] ] ] ] ] ] ] ] ] ] DEMAND AS SEEN BY APURELY COMPETITIVE SELLER Total Revenue (TR) P x Q Marginal Revenue (MR) ▲TR Product Price (P) (Average Revenue) Quantity Demanded (Q) 0 1 2 3 4 5 6 7 8 9 10 $131 131 131 131 131 131 131 131 131 131 131 $ 0 131 262 393 524 655 786 917 1048 1179 1310 $131 131 131 131 131 131 131 131 131 131

DEMAND, MARGINAL REVENUE, AND TOTAL REVENUE IN PURE COMPETITION TR 1179 1048 917 786 655 524 393 262 131 0 Price and revenue D = MR 1 2 3 4 5 6 7 8 9 10 Quantity Demanded (sold)

SHORT-RUN PROFIT MAXIMIZATION Two Approaches First: Total-Revenue -Total Cost Approach • The Decision Process: • Should the firm produce? • What quantity should be produced? • What profit or loss will be realized? The Decision Rule: Produce in the short-run if it can realize 1- A profit (or) 2- A loss less than its fixed costs

TOTAL REVENUE-TOTAL COST APPROACH Total Fixed Cost Total Variable Cost Total Cost TFC+TVC Price: $131 Total Product Total Revenue Profit TR-TC $ 100 100 100 100 100 100 100 100 100 100 100 0 1 2 3 4 5 6 7 8 9 10 $ 0 131 262 393 524 655 786 917 1048 1179 1310 $ 0 90 170 240 300 370 450 540 650 780 930 - $100 - 59 - 8 + 53 + 124 + 185 + 236 + 277 + 298 + 299 + 280 $ 100 190 270 340 400 470 550 640 750 880 1030

TOTAL REVENUE-TOTAL COST APPROACH Total Fixed Cost Total Variable Cost Price: $131 Total Cost Total Product Total Revenue Profit TR-TC $ 100 100 100 100 100 100 100 100 100 100 100 0 1 2 3 4 5 6 7 8 9 10 $ 0 131 262 393 524 655 786 917 1048 1179 1310 $ 0 90 170 240 300 370 450 540 650 780 930 - $100 - 59 - 8 + 53 + 124 + 185 + 236 + 277 + 298 + 299 + 280 $ 100 190 270 340 400 470 550 640 750 880 1030

TOTAL REVENUE-TOTAL COST APPROACH Break-Even Point (Normal Profit) $1,800 1,700 1,600 1,500 1,400 1,300 1,200 1,100 1,000 900 800 700 600 500 400 300 200 100 0 Total Revenue Maximum Economic Profits $299 Total revenue and total cost Total Cost Break-Even Point (Normal Profit) 1 2 3 4 5 6 7 8 9 10 11 12 13 14

SHORT-RUN PROFIT MAXIMIZATION Two Approaches Second: Marginal-Revenue -Marginal Cost Approach MR = MC Rule • Three Characteristics of MR=MC Rule: • The rule applies only if producing is preferred to shutting down • Rule applies to all markets • Rule can be restated P=MC

MARGINAL REVENUE-MARGINAL COST APPROACH Average Fixed Cost Average Variable Cost Average Total Cost Price = Marginal Revenue Total Economic Profit/Loss Total Product Marginal Cost 0 1 2 3 4 5 6 7 8 9 10 $100.00 50.00 33.33 25.00 20.00 16.67 14.29 12.50 11.11 10.00 $90.00 85.00 80.00 75.00 74.00 75.00 77.14 81.25 86.67 93.00 $190.00 135.00 113.33 100.00 94.00 91.67 91.43 93.75 97.78 103.00 90 80 70 60 70 80 90 110 130 150 $ 131 131 131 131 131 131 131 131 131 131 - $100 - 59 - 8 + 53 + 124 + 185 + 236 + 277 + 298 + 299 + 280

MR-MC APPROACH Profit Maximization Position $200 150 100 50 0 Economic Profit MC MR $131.00 Cost and Revenue ATC AVC $97.78 1 2 3 4 5 6 7 8 9 10

MR-MC APPROACH Loss Minimization Position If the price is lowered from $131 to $81… the MR=MC rule still applies …but the MR = MC point changes.

MR-MC APPROACH Loss Minimization Position $200 150 100 50 0 Economic Loss MC ATC Cost and Revenue AVC $91.67 MR $81.00 1 2 3 4 5 6 7 8 9 10

MR-MC APPROACH Short-Run Shut Down Point $200 150 100 50 0 MC ATC Cost and Revenue AVC MR $71.00 Minimum AVC is the Shut-Down Point 1 2 3 4 5 6 7 8 9 10

MR-MC APPROACH Marginal Cost & Short-Run Supply Observe the impact upon profitability as price is changed… Quantity Supplied Maximum Profit (+) Or Minimum Loss (-) Price $151 131 111 91 81 71 61 10 9 8 7 6 0 0 $+480 +299 +138 -3 -64 -100 -100

MR-MC APPROACH Marginal Cost & Short-Run Supply Break-even (Normal Profit) Point MC MR5 P5 ATC MR4 P4 Cost and Revenue, (dollars) AVC MR3 P3 MR2 P2 MR1 P1 Do not Produce – Below AVC Q2 Q3 Q4 Q5 Quantity Supplied

MR-MC APPROACH Marginal Cost & Short-Run Supply Yields the Short-Run Supply Curve Supply MC MR5 P5 MR4 P4 Cost and Revenue, (dollars) MR3 P3 MR2 P2 MR1 P1 No Production Below AVC Q2 Q3 Q4 Q5 Quantity Supplied

MR-MC APPROACH MC1 S1 Cost and Revenue, (dollars) AVC1 Quantity Supplied Marginal Cost & Short-Run Supply MC2 S2 AVC2 Higher Costs Move the Supply Curve to the Left

MR-MC APPROACH MC1 S1 Cost and Revenue, (dollars) AVC1 Quantity Supplied Marginal Cost & Short-Run Supply Lower Costs Move the Supply Curve to the Right MC2 S2 AVC2

SHORT-RUN COMPETITIVE EQUILIBRIUM The Competitive Firm “Takes” its Price from the Industry Equilibrium S= MCs P P Economic Profit ATC S=MC D $111 $111 AVC D Q Q 8 8000 Firm (price taker) Industry

PROFIT MAXIMIZATION IN THE LONG RUN Assumptions... • Entry and Exit Only • Identical Costs • Constant-Cost Industry Goal of the Analysis P= Minimum ATC Long-Run Equilibrium - The Zero Economic Profit Model

PROFIT MAXIMIZATION IN THE LONG RUN P P $60 50 40 $60 50 40 Q Q 100 100,000 Firm (price taker) Industry Temporary profits and the reestablishment of long-run equilibrium S1 MC ATC MR D1

P P $60 50 40 $60 50 40 Q Q 100 100,000 Firm (price taker) Industry PROFIT MAXIMIZATION IN THE LONG RUN An increase in demand increases profits Economic Profits S1 MC ATC MR D2 D1

PROFIT MAXIMIZATION IN THE LONG RUN P P $60 50 40 $60 50 40 Q Q 100 100,000 Firm (price taker) Industry New competitors increase supply, and lower prices decrease economic profits Zero Economic Profits S1 S2 MC ATC MR D2 D1

PROFIT MAXIMIZATION IN THE LONG RUN P P $60 50 40 $60 50 40 Q Q 100 100,000 Firm (price taker) Industry Decreases in demand, losses, and the reestablishment of long-run equilibrium S1 MC ATC MR D1

PROFIT MAXIMIZATION IN THE LONG RUN P P $60 50 40 $60 50 40 Q Q 100 100,000 Firm (price taker) Industry A decrease in demand creates losses Economic Losses S1 MC ATC MR D1 D2

PROFIT MAXIMIZATION IN THE LONG RUN P P $60 50 40 $60 50 40 Q Q 100 100,000 Firm (price taker) Industry Competitors with losses decrease supply, and prices return to zero economic profits S3 Return to Zero Economic Profits S1 MC ATC MR D1 D2

LONG-RUN SUPPLY IN A CONSTANT COST INDUSTRY Constant Cost Industry Perfectly Elastic Long-Run Supply Graphically...

LONG-RUN SUPPLY IN A CONSTANT COST INDUSTRY P P1 P2 P3 Z3 Z1 Z2 S =$50 D3 D1 D2 Q Q3 Q1 Q2 90,000 100,000 110,000

LONG-RUN SUPPLY IN AN INCREASING COST INDUSTRY P S P1 P2 P3 $55 50 45 Y2 Y1 Y3 D1 D2 D3 Q Q3 Q1 Q2 90,000 100,000 110,000

LONG-RUN EQUILIBRIUM FOR A COMPETITIVE FIRM MC ATC Price MR P P = MC = Minimum ATC (normal profit) Q Quantity

PURE COMPETITION & EFFICIENCY • Productive Efficiency P = Minimum ATC • Allocative Efficiency P = MC Underallocation: P > MC Overallocation: P < MC

Work Cited McConnell, R. Campbell and Stanley L. Brue. Economics. New York: McGraw-Hill, 2005: 413-33

Pure Competition