Chapter 23 - Pure Competition
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Four Market Models Demand as seen by a Purely Competitive Seller Short-Run Profit Maximization Unit 3 Short-Run Competitive Equilibrium Long-Run Supply Long-Run Equilibrium for a Competitive Firm Pure Competition and Efficiency 9-1 Theory of the Firm ECONOMIC COSTS Four Market Models Demand as seen by a Purely Competitive Seller Short-Run Profit Maximization Short-Run Competitive Equilibrium Long-Run Supply Long-Run Equilibrium for a Competitive Firm Pure Competition and Efficiency 9-2 •Explicit + Implicit costs •Explicit costs •Monetary payments to others •Implicit costs •Opportunity costs of owner •Self-owned resources •Self-employed resources PROFITS Four Market Models Demand as seen by a Purely Competitive Seller Short-Run Profit Maximization Short-Run Competitive Equilibrium Long-Run Supply Long-Run Equilibrium for a Competitive Firm Pure Competition and Efficiency 9-3 • Accounting profit = Total revenue – Explicit cost • Economic profit = Total Revenue – Economic cost • Normal profit = Implicit cost SHORT RUN AND LONG RUN Four Market Models Demand as seen by a Purely Competitive Seller Short-Run Profit Maximization Short-Run Competitive Equilibrium Long-Run Supply Long-Run Equilibrium for a Competitive Firm Pure Competition and Efficiency 9-4 • The short run –Fixed plant capacity –Variable intensity of plant use –Variable output • The long run –Variable plant capacity –Firms enter and exit Four Market Models Demand as seen by a Purely Competitive Seller Short-Run Profit Maximization Short-Run Competitive Equilibrium SHORT-RUN PRODUCTION RELATIONSHIPS Total Product (TP) Marginal Product (MP) Change in Total Product Marginal Product = Change in Labor Input Long-Run Supply Long-Run Equilibrium for a Competitive Firm Pure Competition and Efficiency Average Product (AP) Average Product = Total Product Units of Labor 9-5 SHORT-RUN PRODUCTION COSTS Four Market Models Demand as seen by a Purely Competitive Seller Short-Run Profit Maximization Short-Run Competitive Equilibrium Summary Total Fixed Costs = TFC Total Variable Costs = TVC Total Costs = TC Average Fixed Costs = AFC Long-Run Supply Long-Run Equilibrium for a Competitive Firm Pure Competition and Efficiency Average Variable Costs = AVC Average Total Costs = ATC Marginal Cost = MC 9-6 Four Market Models Demand as seen by a Purely Competitive Seller Short-Run Profit Maximization Average product and marginal product PRODUCTIVITY AND COST CURVES Short-Run Competitive Equilibrium Long-Run Equilibrium for a Competitive Firm Pure Competition and Efficiency 9-7 Quantity of labor Costs (dollars) Long-Run Supply AP MP MC AVC Quantity of output Four Market Models Demand as seen by a Purely Competitive Seller Short-Run Profit Maximization Short-Run Competitive Equilibrium Long-Run Supply Long-Run Equilibrium for a Competitive Firm Pure Competition and Efficiency 9-8 Law of Diminishing Marginal Returns As more of a variable resource is added to a fixed resource, at some point, the MP of the variable resource will decline. Demand as seen by a Purely Competitive Seller Short-Run Profit Maximization Total Product TP Four Market Models SHORT-RUN PRODUCTION RELATIONSHIPS Law of Diminishing Returns Short-Run Competitive Equilibrium Long-Run Supply Pure Competition and Efficiency 9-9 AP and MP Long-Run Equilibrium for a Competitive Firm Quantity of Labor Quantity of Labor Negative Marginal Returns Average Product Marginal Product SHORT-RUN COSTS GRAPHICALLY Four Market Models Short-Run Profit Maximization Short-Run Competitive Equilibrium Long-Run Supply Long-Run Equilibrium for a Competitive Firm Pure Competition and Efficiency Costs (dollars) Demand as seen by a Purely Competitive Seller MC ATC AVC AFC Quantity 9 - 10 LONG-RUN PRODUCTION COSTS Demand as seen by a Purely Competitive Seller Short-Run Profit Maximization Short-Run Competitive Equilibrium Long-Run Supply Unit Costs Four Market Models LRATC Long-Run Equilibrium for a Competitive Firm Pure Competition and Efficiency Output 9 - 11 Four Market Models ECONOMIES AND DISECONOMIES OF SCALE Demand as seen by a Purely Competitive Seller Short-Run Competitive Equilibrium Long-Run Supply Long-Run Equilibrium for a Competitive Firm Constant returns to scale LRATC Pure Competition and Efficiency 9 - 12 Diseconomies of scale Unit Costs Short-Run Profit Maximization Economies of scale Output Four Market Models Demand as seen by a Purely Competitive Seller Short-Run Profit Maximization Short-Run Competitive Equilibrium FOUR MARKET MODELS Perfect Competition: • Very Large Numbers • Standardized Product • “Price Takers” • Free Entry and Exit Long-Run Supply Long-Run Equilibrium for a Competitive Firm Perfect Competition Monopolistic Competition Oligopoly Pure Monopoly Pure Competition and Efficiency Efficient 9 - 13 Inefficient SHORT-RUN PROFIT MAXIMIZATION Four Market Models Demand as seen by a Purely Competitive Seller Short-Run Profit Maximization Short-Run Competitive Equilibrium Long-Run Supply Long-Run Equilibrium for a Competitive Firm Pure Competition and Efficiency 9 - 14 Two Approaches... First: Total Revenue – Total Cost Approach 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 (PC, M, MC, & O) • Rule can be restated P=MC MARGINAL REVENUE-MARGINAL COST APPROACH Four Market Models Demand as seen by a Purely Competitive Seller Short-Run Profit Maximization Short-Run Competitive Equilibrium Long-Run Supply Long-Run Equilibrium for a Competitive Firm Pure Competition and Efficiency 9 - 15 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 The $100.00 $90.00 $190.00 same profit 50.00 85.00 135.00 33.33 80.00 113.33 maximizing 25.00 75.00 100.00 20.00 74.00 94.00 result! 16.67 75.00 91.67 14.29 12.50 11.11 10.00 77.14 81.25 86.67 93.00 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 MARGINAL REVENUE-MARGINAL COST APPROACH Demand as seen by a Purely Competitive Seller Short-Run Profit Maximization Short-Run Competitive Equilibrium Long-Run Supply Long-Run Equilibrium for a Competitive Firm $200 Cost and Revenue Four Market Models Profit Maximization Position Economic Profit 150 $131.00 MRDARP ATC AVC 100 $97.78 50 Pure Competition and Efficiency 0 9 - 16 MC 1 2 3 4 5 6 7 8 9 10 MARGINAL REVENUE-MARGINAL COST APPROACH Marginal Cost & Short-Run Supply Demand as seen by a Purely Competitive Seller Short-Run Profit Maximization Short-Run Competitive Equilibrium Long-Run Supply Long-Run Equilibrium for a Competitive Firm Pure Competition and Efficiency Cost and Revenue, (dollars) Four Market Models Break-even (Normal Profit) Point MR5 P5 ATC MR4 P4 AVC MR3 MR2 MR1 P3 P2 P1 Do not Produce – Below AVC Q2 Q3 Q4 9 - 17 MC Q5 Quantity Supplied MARGINAL REVENUE-MARGINAL COST APPROACH Marginal Cost & Short-Run Supply Demand as seen by a Purely Competitive Seller Short-Run Profit Maximization Short-Run Competitive Equilibrium Long-Run Supply Long-Run Equilibrium for a Competitive Firm Pure Competition and Efficiency Cost and Revenue, (dollars) Four Market Models Yields the Short-Run Supply Curve MC P5 MR5 P4 MR4 P3 MR3 MR2 MR1 P2 P1 MC Above AVC Q2 Q3 Q4 9 - 18 Supply Q5 Quantity Supplied MARGINAL REVENUE-MARGINAL COST APPROACH Four Market Models Demand as seen by a Purely Competitive Seller Short-Run Profit Maximization Short-Run Competitive Equilibrium Long-Run Supply Long-Run Equilibrium for a Competitive Firm Pure Competition and Efficiency 9 - 19 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 TAXES & SUBSIDIES Four Market Models Demand as seen by a Purely Competitive Seller Short-Run Profit Maximization Short-Run Competitive Equilibrium Long-Run Supply Long-Run Equilibrium for a Competitive Firm Pure Competition and Efficiency 9 - 20 Per Unit Tax • AVC • AFC No ∆ • ATC • MC Per Unit Subsidy • AVC No ∆ • AFC • ATC • MC Lump Sum Tax No ∆ • AVC • AFC • ATC No ∆ • MC Lump Sum Subsidy No ∆ • AVC • AFC • ATC • MC No ∆ SHORT-RUN COMPETITIVE EQUILIBRIUM The Competitive Firm “Takes” its Price from the Industry Equilibrium Four Market Models Demand as seen by a Purely Competitive Seller P S= MCs P Economic ATC Profit S=MC Short-Run Profit Maximization Short-Run Competitive Equilibrium $111 MRDARP $111 Long-Run Supply AVC Long-Run Equilibrium for a Competitive Firm Pure Competition and Efficiency D 8000 Industry 9 - 21 Q 8 Firm Q PROFIT MAXIMIZATION IN THE LONG RUN Four Market Models Demand as seen by a Purely Competitive Seller Temporary profits and the reestablishment of long-run equilibrium P P MC LRATC Short-Run Profit Maximization Short-Run Competitive Equilibrium S1 $60 50 40 MR Long-Run Supply $60 50 40 Long-Run Equilibrium for a Competitive Firm Pure Competition and Efficiency D1 100 Firm (price taker) 9 - 22 Q 100,000 Industry Q PROFIT MAXIMIZATION IN THE LONG RUN An increase in demand increases profits… Four Market Models Demand as seen by a Purely Competitive Seller P S1 P MC LRATC Short-Run Profit Maximization Short-Run Competitive Equilibrium Economic Profits $60 50 40 MR Long-Run Supply $60 50 40 D2 Long-Run Equilibrium for a Competitive Firm Pure Competition and Efficiency D1 100 Firm (price taker) 9 - 23 Q 100,000 Industry Q PROFIT MAXIMIZATION IN THE LONG RUN Four Market Models Demand as seen by a Purely Competitive Seller Short-Run Profit Maximization Short-Run Competitive Equilibrium New competitors increase supply, and lower prices decrease economic profits. Zero Economic P Profits MC LRATC $60 50 40 MR Long-Run Supply S1 P S2 $60 50 40 D2 Long-Run Equilibrium for a Competitive Firm Pure Competition and Efficiency D1 100 Firm (price taker) 9 - 24 Q 100,000 Industry Q PURE COMPETITION AND EFFICIENCY Four Market Models Demand as seen by a Purely Competitive Seller P LRATC Short-Run Profit Maximization Short-Run Competitive Equilibrium P Long-Run Supply Long-Run Equilibrium for a Competitive Firm Pure Competition and Efficiency 9 - 25 Q Underallocation P > MC MC Overallocation P < MC Productive MR Efficiency P = Min ATC Allocative Q Efficiency P = MC MONOPOLY EXAMPLES Four Market Models Demand as seen by a Purely Competitive Seller Short-Run Profit Maximization Short-Run Competitive Equilibrium Long-Run Supply Long-Run Equilibrium for a Competitive Firm Pure Competition and Efficiency 9 - 26 • Pure Monopoly • Near Monopoly • Natural Monopoly • Regulated Monopoly THE NATURAL MONOPOLY CASE Demand as seen by a Purely Competitive Seller Short-Run Profit Maximization Short-Run Competitive Equilibrium Long-Run Supply Long-Run Equilibrium for a Competitive Firm Average Total Cost Four Market Models $20 15 10 If LRATC declines over extended output, least-cost production is realized only if there is one producer - a natural monopoly. Pure Competition and Efficiency 0 9 - 27 LRATC 50 100 Quantity 200 MONOPOLY REVENUES & COSTS Revenue Data Four Market Models Quantity Price of (Average Total Marginal Demand as seen Output Revenue) Revenue Revenue by a Purely Cost Data Average Total Cost Profit + Total Marginalor Cost Cost loss - Can 0you $172see $ 0profit $100 90 - $100 ] $162 ]= MC MR > Short-Run Profit 1 162 162 - 28 $190.00 190 80 Maximizationmaximization? ] 142 ] Competitive Seller Short-Run Competitive Equilibrium Long-Run Supply Long-Run Equilibrium for a Competitive Firm Pure Competition and Efficiency 9 - 28 2 3 4 5 6 7 8 9 10 152 142 132 122 112 102 92 82 72 304 ] 122 426 ] 102 528 ] 82 610 ] 62 672 ] 42 714 ] 22 736 ] 2 738 ] - 18 720 135.00 270 ] 113.33 340 ] 100.00 400 ] 94.00 470 ] 91.67 550 ] 91.43 640 ] 93.73 750 ] 97.78 880 ] 103.00 1030 70 + 34 60 + 86 70 + 128 80 + 140 90 + 122 110 + 74 - 14 130 150 - 142 - 310 MONOPOLY REVENUES & COSTS Elastic $200 Short-Run Profit Maximization Short-Run Competitive Equilibrium Long-Run Supply Long-Run Equilibrium for a Competitive Firm Pure Competition and Efficiency 9 - 29 Dollars Four Market Models Demand as seen by a Purely Competitive Seller Inelastic 150 100 50 MR 0 1 2 3 4 5 6 7 8 9 10 11 DARP Q 12 13 14 15 16 17 18 • MR bisects DARP • When MR = 0 Total Revenue is Maximized • When MR is positive D is elastic • When MR is negative D is inelastic OUTPUT AND PRICE DETERMINATION Profit Maximization Under Monopoly Four Market Models Short-Run Profit Maximization Short-Run Competitive Equilibrium Long-Run Supply Long-Run Equilibrium for a Competitive Firm Pure Competition and Efficiency Profit Per Unit 175 Price, costs, and revenue Demand as seen by a Purely Competitive Seller 200 150 $122 125 $94 100 Profit ATC DARP 75 50 MR = MC 25 0 9 - 30 MC 1 2 3 4 MR 5 6 7 8 9 10 Q INEFFICIENCY OF PURE MONOPOLY P An industry in pure competition S = MC sells where supply and Four Market Models demand are equal Demand as seen by a Purely Competitive Seller Long-Run Supply At MR=MC a monopolist will sell less units at a higher price than in competition Long-Run Equilibrium for a Competitive Firm DARP Short-Run Profit Maximization Pm Short-Run Competitive Equilibrium Pc Pure Competition and Efficiency 9 - 31 MR Qm Qc Q PRICE DISCRIMINATION Demand as seen by a Purely Competitive Seller Short-Run Profit Maximization Short-Run Competitive Equilibrium Long-Run Supply Long-Run Equilibrium for a Competitive Firm P Economic profits with price discrimination Price and Costs Four Market Models ATC MR=D DARP Pure Competition and Efficiency 9 - 32 MC Q1 Q2 Q REGULATED MONOPOLY P Demand as seen by a Purely Competitive Seller Short-Run Profit Maximization Short-Run Competitive Equilibrium Long-Run Supply Long-Run Equilibrium for a Competitive Firm MR = MC Fair-Return Price Price and Costs Four Market Models Pm Socially-Optimum Price ATC MC Pf Pr DARP Pure Competition and Efficiency MR Qm 9 - 33 Qf Qr Q PRICE AND OUTPUT IN MONOPOLISTIC COMPETITION Four Market Models Expect New Competitors Demand as seen by a Purely Competitive Seller Short-Run Competitive Equilibrium Long-Run Supply Long-Run Equilibrium for a Competitive Firm ATC Price and Costs Short-Run Profit Maximization P1 A1 Short-Run Economic Profits D Pure Competition and Efficiency 9 - 34 MC MR Q1 Quantity PRICE AND OUTPUT IN MONOPOLISTIC COMPETITION Four Market Models Expect New Competitors Demand as seen by a Purely Competitive Seller Short-Run Competitive Equilibrium Long-Run Supply Long-Run Equilibrium for a Competitive Firm ATC Price and Costs Short-Run Profit Maximization New competition provides P1 other goods in the market so demand for your good falls. A 1 Short-Run Economic Profits D Pure Competition and Efficiency 9 - 35 MC MR Q1 Quantity PRICE AND OUTPUT IN MONOPOLISTIC COMPETITION Four Market Models Long-Run Equilibrium Normal Profit Only Short-Run Profit Maximization Short-Run Competitive Equilibrium Long-Run Supply Long-Run Equilibrium for a Competitive Firm P3 = A3 D Pure Competition and Efficiency 9 - 36 ATC Price and Costs Demand as seen by a Purely Competitive Seller MC MR Q3 Quantity Four Market Models Demand as seen by a Purely Competitive Seller Short-Run Profit Maximization Short-Run Competitive Equilibrium Long-Run Supply Long-Run Equilibrium for a Competitive Firm Pure Competition and Efficiency MONOPOLISTIC COMPETITION AND EFFICIENCY • Not Productively Efficient P Minimum ATC • Not Allocatively Efficient P MC • Excess Capacity Graphically… 9 - 37 Four Market Models Demand as seen by a Purely Competitive Seller Short-Run Profit Maximization Short-Run Competitive Equilibrium Long-Run Supply FOUR MARKET MODELS Oligopoly: • Control Over Price •Mutual Interdependence •Strategic Behavior • Entry Barriers • Economies of Scale • Control of Resources Long-Run Equilibrium for a Competitive Firm Pure Competition and Efficiency 9 - 38 Pure Competition Monopolistic Competition Oligopoly Pure Monopoly Market Structure Continuum OLIGOPOLY AND EFFICIENCY Four Market Models Demand as seen by a Purely Competitive Seller Short-Run Profit Maximization Short-Run Competitive Equilibrium Long-Run Supply Long-Run Equilibrium for a Competitive Firm Pure Competition and Efficiency 9 - 39 • Not Productively Efficient P Minimum ATC • Not Allocatively Efficient P MC OLIGOPOLY BEHAVIOR Four Market Models A Game-Theory Overview RareAir’s Price Strategy Demand as seen by a Purely Competitive Seller Short-Run Competitive Equilibrium Long-Run Supply Long-Run Equilibrium for a Competitive Firm Pure Competition and Efficiency 9 - 40 Uptown’s Price Strategy Short-Run Profit Maximization High A $12 Low B $15 High $12 C $6 $6 D Low $15 $8 $8
