Chapter 23
Pure Competition
http://www.youtube.com/watch?v=aFBGsad_qE0
FOUR MARKET MODELS:
Industries typically operate within one of four distinct
market structures:
1. Pure Competition
large number of sellers, standardized product,
no/low barriers to entry
e.g. wheat, corn, gold, foreign currency, NYSE
2.
Monopolistic Competition
larger # of sellers, differentiated product, low entry
barriers, non-price competition
e.g. restaurants, casual clothing, some retail stores
3.
Oligopoly
few sellers of similar products, significant entry
barriers, price competition
e.g. Maytag/GE/Whirlpool refrigerator, Coke/Pepsi, airlines
4.
Pure Monopoly
one firm as sole seller, complete barriers to entry
e.g. certain electricity, water, phone, cable providers
the Four Market Models
A firms control over Price?
•
•
•
•
Pure Competition (e.g. wheat)
– none; market sets the price; “price takers”
Monopolistic Competition (e.g. restauraunts)
– some but within limits … market forces apply
Oligopoly (automobiles or airlines)
– significant but limited by mutual interdependence
Pure Monopoly (a town’s cable TV or electricity provider)
– considerable (… but must consider demand & elasticity of demand)
the Four Market Models
An industry’s non-price competition?
(e.g. advertising, product differentiation)
•
•
•
Pure Competition (e.g. corn for ethanol production)
– none
Monopolistic Competition (e.g. fiction books)
– considerable; emphasis on “branding”, trademarks, advertising
Oligopoly (automobiles or airlines)
– considerable; to differentiate relatively standard product (FF miles)
•
Pure Monopoly (a town’s electricity provider)
– an attempt to increase demand (consumer tastes/preferences)
– enough to create/maintain barriers to entry
p460 #1. Briefly indicate the basic characteristics of pure competition, pure monopoly,
monopolistic competition, and oligopoly. Under which of these market classifications does
each of the following most accurately fit? In each case justify your classification.
(a) a supermarket in your home town;
Oligopoly
- few in number, relatively standard products, price is interdependent w/ competition
(b) the steel industry;
Oligopoly
- few in number, relatively standard products, significant obstacles to entry
(c) a Kansas wheat farm;
Pure Competition
- Large number of firms, standardized product, no control over price
(d) the commercial bank in which you or your family has an account;
Monopolistic Competition (or maybe Oligopoly)
- Monopolistic: Relatively large #, some control over price (fees, interest, etc.), branding
- Oligopoly: Products fairly standardized, price interdependent, branding/advertising
(e) the automobile industry.
Oligopoly
- few in number, relatively standard products, attempts to differentiate, high entry barriers
Introduction to Pure Competition
•
•
•
•
Very large numbers
Standardized Product
“Price Takers”
-- the competitive firm cannot set market price,
but will adjust to it
Free entry and exit (i.e. low barriers to entry)
Relevance of Pure Competition
• a benchmark for evaluating the efficiency of the real-world economy
•
pure competition would result in long-run productive efficiency,
where price equals minimum LRATC
•
pure competition would result in long-run allocative efficiency,
where price equals MC
PURE COMPETITION
Questions to answer when analyzing pure competition:
1. What is demand from the seller’s viewpoint?
2. How does a competitive firm respond to market price (in the short run)?
3. In the long run, what adjustments are made in a competitive industry? Why?
4. How efficient are perfectly competitive industries? Why/how?
1. Demand
in aofcompetitive
industry
downward
sloping.
(Law When
of demand.)
3.
Entry/exit
firms. When
profitsisexist,
new firms
will enter.
losses occur,
The
demand
curve
for an individual firm is perfectly elastic. (Price-taker.)
some
firms will
exit.
2. ItPerfectly
“accepts”competitive
the price (but
will change
quantity
response to aand
change
in price).
4.
markets
are the
mostsupplied
efficientin(productive
allocative
efficiency) and preferred whenever possible by economists.
p460 #3. Use the following demand schedule to determine total and marginal
revenues for each possible level of sales:
a. What can you conclude about the
structure of the industry in which this
firm is operating? Explain.
Purely competitive market; the firm is a
price-taker; as the “quantity demanded”
of the supplier increases, there is no
change in price paid by the buyer.
Product
Quantity
Total
Price ($) Demanded Revenue
($)
2
2
2
2
2
2
0
1
2
3
4
5
Marginal
Revenue
($)
$ 0
2
4
6
8
10
-2
2
2
2
2
b. Graph the demand, total revenue, and marginal revenue curves for this firm.
c. Why do the demand and marginal revenue curves coincide?
Demand is perfectly elastic; MR is constant and equals Price. MR = P
d. “Marginal revenue is the change in total revenue.” Explain verbally and graphically,
using the data in the table.
Given a price & the short-run cost structure:
a. will this firm produce in the short run?
b. Why, or why not?
c.
If it does produce, what will be the output?
d. What will be the economic profit or loss?
To solve:
• Is price greater than at least one level of AVC?
• If no, shut down. (zero production; loss = TFC)
• If yes, apply MR “=“ MC rule to find output.
• Find the difference between price and ATC to
determine per unit profit or loss.
• Multiply per unit profit or loss by output to
determine total profit/loss.
Potential prices:
1.
2.
3.
4.
product price of $38
product price of $45
product price of $50
product price of $68
TP
0
1
2
3
4
5
6
7
8
9
10
AFC
x
50.00
25.00
16.67
12.50
10.00
8.33
7.14
6.25
5.56
5.00
AVC
x
48.00
46.00
42.67
40.50
40.40
41.67
44.29
46.88
50.00
54.00
ATC
x
98.00
71.00
59.33
53.00
50.40
50.00
51.43
53.13
55.56
59.00
MC
x
48
44
36
34
40
48
60
65
75
90
Short Run Profit Maximization
1.
Total Revenue minus Total Cost Approach
2.
MR = MC.
Marginal Revenue equals Marginal Cost Approach
• Law of DR explains first decreasing then increasing marginal costs
• In lower stages of output, MR > MC; in higher stages of output, MC > MR
• To maximize profit, a firm will produce output at the point where MR = MC
(this allows a firm to earn the cumulative profit of all output where MR > MC)
The MR = MC rule:
• only applies when producing is preferred to shutting down
(a firm will shut down when its loss at all levels of output exceeds fixed costs)
• applies to pure competition (and oligopoly, monopoly, & monopolistic comp.)
Four scenarios after applying MR = MC:
1. Shut Down (P < AVC)
2. Minimize Losses (AVC < P < ATC)
3. Break Even (P = ATC)
4. Maximize Profits (P > ATC)
iii. If it does
produce, what will be the profit maximizing or loss minimizing output? iv. Explain. v. What
economic profit or loss will the firm realize per unit of output.
p460 #4.
i. will this firm produce in the short run? ii. Why, or why not?
a. product price of $56
P > AVC (not shutdown)
at $56, MR “=” MC at 8 units
MR > ATC (earning profit)
Profit per unit is ≈ $7.87 ($56.00 – $48.13)
(x 8 ≈ $63 total profit)
b. product price of $41
P > AVC (not shutdown)
at $41, MR “=” MC at 2 and 6 units
AC @ 2 units > AC @ 6 units
MR < ATC (loss minimization)
Loss per unit is ≈ $6.50 ($41.00 – $47.50)
(x 6 ≈ $39 total loss… < $60 fixed costs)
c. product price of $32
P < AVC at all levels of output
(shutdown!!!)
Loss equal to total fixed costs: loss of $60 incurred
P460 #4 d – g.
Part d.
Part f.
g.
is $46;
e. The
The equilibrium
firm will notprice
produce
if P < AVC.
equilibrium
output
= 10,500.
When P > AVC,
the firm
will produce in the short run at the quantity where P = MC.
Each
firmcurve
will produce
units.
The MC
– above 7the
AVC curve – shows the quantity of output the firm will supply at
Loss
per
unit
=
$1.14,
or
$8
per firm.
each price level. (That schedule
is the short run supply curve.)
The industry will contract in the long run.
LONG RUN PROFIT MAXIMIZATION
Assumptions (remember: Perfect Competition):
• The only long run change is the entry and exit of firms
• The “representative” firm; identical costs for all firms
Entry Eliminates Profits
• When short run economic profits are earned, new
firms enter (long run)
 increase in supply
Exit Eliminates Losses
• When short run economic losses exist, firms exit
the market (long run)
 decrease in supply
Long run equilibrium established by entry/exit of firms.
PURE COMPETITION AND EFFICIENCY
Productive Efficiency: P = Minimum ATC
-- market forces this behavior in the long run
-- entry eliminates profit; loss eliminates firms (i.e. causes exit)
Productive Efficiency is reached when price is equal to minimum average total costs.
Allocative Efficiency : P = MC
P = MB…why?
when P > MC, resources have been underallocated
and more resources should be used to produce that good
when P < MC, resources have been overallocated
and fewer resources should be used to produce that good
Allocative Efficiency is reached when price is equal to marginal cost.