Pure
Competitio
n
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 A
PURELY COMPETITIVE SELLER
Perfectly Elastic Demand
Price Taker Role
Total Revenue
Average Revenue
Marginal Revenue
DEMAND AS SEEN BY A
PURELY COMPETITIVE SELLER
Total
Marginal
Product Price (P)
Quantity
Revenue (TR) Revenue (MR)
(Average Revenue) Demanded (Q)
PxQ
▲TR
$131
0
$
0
DEMAND AS SEEN BY A
PURELY COMPETITIVE SELLER
Total
Marginal
Product Price (P)
Quantity
Revenue (TR) Revenue (MR)
(Average Revenue) Demanded (Q)
PxQ
▲TR
$131
131
$
0
1
0]
131
$131
DEMAND AS SEEN BY A
PURELY COMPETITIVE SELLER
Total
Marginal
Product Price (P)
Quantity
Revenue (TR) Revenue (MR)
(Average Revenue) Demanded (Q)
PxQ
▲TR
$131
131
131
0
1
2
$
0]
131
]
262
$131
131
DEMAND AS SEEN BY A
PURELY COMPETITIVE SELLER
Total
Marginal
Product Price (P)
Quantity
Revenue (TR) Revenue (MR)
(Average Revenue) Demanded (Q)
PxQ
▲TR
$131
131
131
131
0
1
2
3
$
0
131
262
393
]
]
]
$131
131
131
DEMAND AS SEEN BY A
PURELY COMPETITIVE SELLER
Total
Marginal
Product Price (P)
Quantity
Revenue (TR) Revenue (MR)
(Average Revenue) Demanded (Q)
PxQ
▲TR
$131
131
131
131
131
0
1
2
3
4
$
0]
131 ]
262 ]
393 ]
524
$131
131
131
131
DEMAND AS SEEN BY A
PURELY COMPETITIVE SELLER
Total
Marginal
Product Price (P)
Quantity
Revenue (TR) Revenue (MR)
(Average Revenue) Demanded (Q)
PxQ
▲TR
$131
131
131
131
131
131
131
131
131
131
131
0
1
2
3
4
5
6
7
8
9
10
$
0]
131 ]
262 ]
393
]
524 ]
655 ]
786 ]
917 ]
1048 ]
1179 ]
1310
$13
1
131
131
131
131
131
131
131
131
DEMAND, MARGINAL REVENUE, AND TOTAL
REVENUE IN PURE COMPETITION
1179
TR
Price and revenue
1048
917
786
655
524
393
262
D = MR
131
0
1
2
3
4
5
6
7
8
Quantity Demanded (sold)
9
10
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 Total Total Price: $131
Total Fixed Variable Cost
Total Profit
Product Cost Cost TFC+TVC Revenue TR-TC
0
1
2
3
4
5
6
7
8
9
10
$ 100 $ 0 $ 100
100
90
190
100
170
270
100
240
340
100
300
400
100
370
470
100
450
550
100
540
640
100
650
750
100
780
880
100
930 1030
$
0
131
262
393
524
655
786
917
1048
1179
1310
- $100
- 59
-8
+ 53
+ 124
+ 185
+ 236
+ 277
+ 298
+ 299
+ 280
TOTAL REVENUE-TOTAL COST APPROACH
Total Total
Total Fixed Variable Total
Product Cost Cost Cost
0
1
2
3
4
5
6
7
8
9
10
$ 100 $ 0 $ 100
100
90
190
100
170
270
100
240
340
100
300
400
100
370
470
100
450
550
100
540
640
100
650
750
100
780
880
100
930 1030
Price: $131
Total
Profit
Revenue TR-TC
$
0
131
262
393
524
655
786
917
1048
1179
1310
- $100
- 59
-8
+ 53
+ 124
+ 185
+ 236
+ 277
+ 298
+ 299
+ 280
Total revenue and total cost
TOTAL REVENUE-TOTAL COST APPROACH
$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
Break-Even Point
(Normal Profit)
Total
Revenue
Maximum
Economic
Profits
$299
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 Average Average
Price = Total
Total Fixed Variable Total Marginal Marginal Economic
Cost
Cost
Product Cost
Cost Revenue Profit/Loss
0
1
2
3
4
5
6
7
8
9
10
$100.00 $90.00 $190.00 90
50.00 85.00 135.00 80
33.33 80.00 113.33 70
25.00 75.00 100.00 60
20.00 74.00
94.00 70
16.67 75.00
91.67 80
14.29 77.14
91.43 90
12.50 81.25
93.75 110
11.11 86.67
97.78 130
10.00 93.00 103.00 150
$ 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
Cost and Revenue
$200
150
Economic
Profit
MC
MR
ATC
AVC
$131.00
100
$97.78
50
0
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
Cost and Revenue
$200
150
Economic
Loss
MC
ATC
AVC
MR
100
$91.67
$81.00
50
0
1 2 3 4 5 6 7 8 9 10
MR-MC APPROACH
Short-Run Shut Down Point
Cost and Revenue
$200
MC
150
ATC
AVC
100
$71.00
50
0
MR
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…
Price
Quantity
Supplied
$151
131
111
91
81
71
61
10
9
8
7
6
0
0
Maximum Profit (+)
Or Minimum Loss (-)
$+480
+299
+138
-3
-64
-100
-100
MR-MC APPROACH
Cost and Revenue, (dollars)
Marginal Cost & Short-Run Supply
Break-even
(Normal Profit)
Point
MC
MR5
P5
ATC
MR4
P4
AVC
P3
P2
P1
MR3
MR2
MR1
Do not
Produce –
Below AVC
Q2 Q3 Q4
Q5
Quantity Supplied
MR-MC APPROACH
Cost and Revenue, (dollars)
Marginal Cost & Short-Run Supply
P5
Yields the
Short-Run
Supply Curve
Supply
MC
MR5
P4
MR4
P3
MR3
MR2
MR1
P2
P1
No
Production
Below AVC
Q2 Q3 Q4
Q5
Quantity Supplied
MR-MC APPROACH
Cost and Revenue, (dollars)
Marginal Cost & Short-Run Supply
MC2
S2
MC1
S1
AVC2
AVC1
Higher Costs Move the
Supply Curve to the Left
Quantity Supplied
MR-MC APPROACH
Cost and Revenue, (dollars)
Marginal Cost & Short-Run Supply
Lower Costs Move
the Supply Curve
to the Right
MC1
S1
MC2
S2
AVC1
AVC2
Quantity Supplied
SHORT-RUN COMPETITIVE EQUILIBRIUM
The Competitive Firm “Takes” its
Price from the Industry Equilibrium
P
S= MCs
P
Economic
ATC Profit S=MC
D
$111
$111
AVC
D
8
Firm
(price taker)
Q
8000
Industry
Q
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
Temporary profits and the reestablishment
of long-run equilibrium
P
S1
P
MC
ATC
$60
50
40
MR
$60
50
40
D1
100
Firm
(price taker)
Q
100,000
Industry
Q
PROFIT MAXIMIZATION IN THE LONG RUN
An increase in demand increases profits
P
Economic
Profits
S1
P
MC
ATC
$60
50
40
MR
$60
50
40
D2
D1
100
Firm
(price taker)
Q
100,000
Industry
Q
PROFIT MAXIMIZATION IN THE LONG RUN
New competitors increase supply, and
lower prices decrease economic profits
P Zero Economic
Profits
S1
P
S2
MC
ATC
$60
50
40
MR
$60
50
40
D2
D1
100
Firm
(price taker)
Q
100,000
Industry
Q
PROFIT MAXIMIZATION IN THE LONG RUN
Decreases in demand, losses, and the
reestablishment of long-run equilibrium
P
S1
P
MC
ATC
$60
50
40
MR $60
50
40
D1
100
Firm
(price taker)
Q
100,000
Industry
Q
PROFIT MAXIMIZATION IN THE LONG RUN
A decrease in demand creates losses
P
Economic
Losses
S1
P
MC
ATC
$60
50
40
MR $60
50
40
D1
D2
100
Firm
(price taker)
Q
100,000
Industry
Q
PROFIT MAXIMIZATION IN THE LONG RUN
Competitors with losses decrease supply, and
prices return to zero economic profits
Return to Zero
P Economic Profits
S3
S1
P
MC
ATC
$60
50
40
MR $60
50
40
D1
D2
100
Firm
(price taker)
Q
100,000
Industry
Q
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 =$50
P3
Z3
Z1
Z2
S
D3 D1 D2
Q3
Q1
Q2
90,000 100,000 110,000
Q
LONG-RUN SUPPLY IN AN
INCREASING COST INDUSTRY
P
S
P1 $55
P2 50
P3 45
Y1
Y2
Y3
D3
Q3
Q1
Q2
90,000 100,000 110,000
D1
D2
Q
LONG-RUN EQUILIBRIUM
FOR A COMPETITIVE FIRM
MC
Price
ATC
P
MR
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