ECONOMICS:
EXPLORE & APPLY
by Ayers and Collinge
Chapter 19
“Pure Competition”
©2004 Prentice Hall Publishing
Ayers/Collinge, 1/e
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Learning Objectives
1. Name four market types and describe the
characteristics of pure competition.
2. Illustrate how market demand and supply
determine the competitive firm’s demand
curve.
3. Identify the competitive firm’s short-run
supply curve.
4. Describe the long-run equilibrium in pure
competition.
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Learning Objectives
5. Explain how efficiency is achieved in a purely
competitive market.
6. Specify the difference between a constantcost, increasing cost, and decreasing cost
industry.
7. Show how competition can reduce
discrimination in society.
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19.1
TYPES OF MARKETS
o There are clearly different types of markets
which are commonly called industries.
o Markets also differ according to whether the
product is homogenous or differentiated.
o Homogeneous products are identical no matter
which firms produces them, and are often called
commodities.
o Differentiated products will vary from one producer
to the next.
o These differences lead to four different market
structures, which are models of the way
markets work.
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Types of Markets
o Monopoly: Only one seller of a good with no
close substitutes.
o Oligopoly: More than one seller, where at least
one of the sellers can significantly influence
price.
o Monopolistic Competition: Numerous firms,
each with slight ability to control price.
o Pure competition: a market in which there are
many buyers and sellers of a homogeneous
product.
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Types of Markets
One firm
Homogeneous product
Differentiated product
Monopoly
(example: city drinking water)
Not applicable
Oligopoly
Oligopoly
Few firms (example: gasoline refineries) (example: automakers)
Many firms
Pure competition
(example: farmers)
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Monopolistic competition
(example: restaurants)
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The Spectrum of Market Models
Less Market Power
0
Pure
Competition
Monopolistic
Competition
More Market Power
Oligopoly
Monopoly
The term market power
refers to the degree of
influence over price by
the individual firm.
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Characteristics of
Pure Competition
Numerous buyers and sellers
Homogeneous product
Firms do not advertise in pure
competition
Costless entry and exit of all firms.
Firms are price takers with a perfectly
elastic demand! A price taker always sells at
the market price.
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19.2
THE FIRM AND THE MARKET IN
PURE COMPETITION
Firm
Market
Market
Supply
Market
Price
Firm’s
Supply
Firm’s
Demand
Market
Demand
Market
Quantity
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Firm’s
Output
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Short-Run Supply
o At any price above the shutdown price, the
profit-maximizing firm equates marginal
revenue and marginal cost.
o Because the price taking firm’s marginal
revenue equals the market price, the firm
produces the quantity associated with its
marginal cost curve at that price.
o The price taking firm’s short-run supply curve is
that part of its marginal cost curve that lies above
average variable cost.
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Supply in Pure Competition
Market
Firm
Marginal Cost
Firm’s
supply
$250
Market
supply
$160
Shutdown
price
Average
variable
cost
6
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Supply in Pure Competition
Market
$250
Firms supply is its
marginal cost
curve above its
shutdown price.
Firm
Marginal Cost
Firm’s
supply
Market
supply
$160
Shutdown
price
Average
variable
cost
6
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For each price,
the market supply
adds up the
Quantities supplied
by each firm.
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19.3
THE LONG-RUN - Entry, Exit, and Efficiency
In the short-run, the market price could be
sufficiently high that the firm earns profits, or
it could be so low that the firm loses money.
Short-run profits attract new firms to enter the
market.
Short-run losses cause existing firms to leave the
industry.
The long-run equilibrium market price results
in the expectation of zero profit for a firm that
is considering entry into the industry.
Zero profit means the firm is breaking even, that is,
earning a normal profit.
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Profit Attracts New Entrants
Losses Cause Firms to Leave
Supply after Exit
Initial Supply
Supply after
Entry
Higher Price
after Exit
Initial Price
Lower Price
after Entry
Demand
Quantity
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Long-Run Equilibrium in
Pure Competition
Firm
Market
Market
Supply
Market
Price
Adjusts until price
leaves firms with
only a normal profit.
Marginal
cost
Average
cost
Firm’s
Demand
Market
Demand
= price
= marginal
revenue
The long-run equilibrium
the last firm to
Market in pure competition occurs when
Firm’s
enter the market
earns zero profits, as shown by the firm’s
average cost
Quantity
Output
curve just tangent to its demand. There would be no reason for a new firm
15
©2004
Prentice
Publishingfor an existing firm to exit.
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to enter
and
noHall
reason
The Efficiency of Pure Competition
The competitive market equilibrium
produces an allocatively efficient amount of
output.
Competition also forces firms to keep cost in
check, thus inducing technological efficiency
as well.
For these reasons the model of pure
competition is often used as the standard of
efficiency by which other market structures
are judged.
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The Efficiency of Pure Competition
Supply
Supply
Maximum
social surplus
Surplus foregone
from producing
too little
Demand
Competitive
Output
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Surplus lost
from producing
too much
Demand
Competitive
Output
Too Much
Too Little
Output
Output
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19.4
LONG RUN SUPPLY
The expansion or contraction of
industries over time sometimes affects the
cost of production in that industry.
In response to entry, input prices might
remain unchanged, rise, or fall, which
gives rise to three industry types….
Constant-cost industry
Increasing-cost industry
Decreasing-cost industry
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Long-Run Characteristics
of Industries
Constant-cost industry; an increase in the
industry’s output does not affect the cost
of production.
Increasing-cost industry; an increase in
the industry’s output causes input prices
to rise.
Decreasing-cost industry; an increase in
the industry’s output causes input prices
to fall.
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Perfect Competition and
Long-Run Supply
 Perfect competition is a variant of pure competition.
 Perfect competition adds to the model of pure
competition a further assumption that all firms are
identical, with access to resources and technology,
with all information fully and freely available.
 In a constant-cost industry, the entry of new firms
would have no effect on the production cost of other
firm’s, and with perfect competition, expansion of
the industry would lead to the same equilibrium
output price.
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Perfect Competition and
Long-Run Supply
 In an increasing -cost industry, the entry of new
firms would not only increase industry output, but
would shift up the cost curves of each firm in the
industry.
 Thus, an expansion of the industry would lead to a
higher equilibrium price of the industry’s output.
 Conversely, in a decreasing-cost industry, the entry
of new firms would lower production cost for all
firms and thus lead to a lower equilibrium price of
output.
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Perfect Competition and
Long-Run Supply
Constant-cost industry
$
Supply
Long-run supply
Price
Constant average cost
curve as industry size
grows
•
Average
cost
Demand
Industry’s
quantity
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Firm’s
quantity
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Perfect Competition and
Long-Run Supply
Increasing-cost industry
$
Price
Supply Long-run
supply
•
•
Higher average cost
curve as industry size
grows
•
•
Average cost
Demand
Industry’s
quantity
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Firm’s
quantity
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Perfect Competition and
Long-Run Supply
Decreasing-cost industry
$
Lower average cost
curve as industry size
grows
Supply
Average cost
Price
•
•
•
•
Long-run
supply
Demand
Industry’s
quantity
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Firm’s
quantity
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19.5
Discrimination – What a Difference Market
Structure Makes
Two features of purely competitive firm’s prevents
racial discrimination.
One feature is the homogeneous product, which
means that the firm has no opportunity to vary the
product in discriminatory ways.
Pure competition gives firms a strong profit
incentive to avoid discrimination.
In pure competition a firm that inflicts higher
input cost on itself can find itself going from profit
to loss.
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Discrimination – What a Difference
Market Structure Makes
Marginal Cost
$
By increasing
costs…
Average cost
Price
Discrimination
can turn a profit
into a loss
Loss
Profit
•
•
Firm’s
quantity
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Terms Along the Way
homogenous product
differentiated
product
market structure
monopoly
oligopoly
monopolistic
competition
pure competition
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market power
constant-cost
industry
increasing-cost
industry
decreasing-cost
industry
perfect competition
long-run supply
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Test Yourself
1.
a.
b.
c.
d.
Price takers are found in
pure competition.
monopolistic competition.
oligopoly.
all of the above.
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Test Yourself
2. In pure competition the firm’s demand
a.
b.
c.
d.
curve will be
upward sloping.
downward sloping.
hump shaped.
horizontal.
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Test Yourself
3.
a.
b.
c.
d.
For a price taking firm, demand is
equal to price.
less than price.
greater than price.
unrelated to price.
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Test Yourself
4. A price taking firm’s short-run supply
curve is associated with its
a. total revenue curve.
b. average cost curve.
c. marginal revenue curve.
d. marginal cost curve.
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Test Yourself
5. Profit maximization calls for the purely
competitive firm to produce at the point
where its demand curve intersects its
a. total revenue curve.
b. average cost curve.
c. marginal revenue curve.
d. marginal cost curve.
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Test Yourself
6. Which statement best describes the long run
in a purely competitive market?
a. The firm’s demand curve is downward
sloping.
b. The market will shrink as firms exit.
c. The number of firms will be stable because
there no incentive for entry or exit.
d. In the long run, the market will slowly
become a monopoly.
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The End!
Next Chapter 20
“Monopoly and
Antitrust"
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