CHAPTER 10

Pure Competition in the Short Run

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 Chapter Contents
Four Market Models
Pure Competition: Characteristics and Occurrence
Demand as Seen by a Purely Competitive Seller
Profit Maximization in the Short Run: Total-Revenue-Total-Cost
Approach
Profit Maximization in the Short Run: Marginal-Revenue–
Marginal-Cost Approach
Marginal Cost and Short-Run Supply
10-2
FOUR MARKET MODELS
Market Structure
• Pure competition
Imperfect competition
• Monopolistic competition
• Oligopoly
• Pure monopoly

10-3
LO10.1
CHARACTERISTICS OF THE FOUR BASIC MARKET MODELS
Market Model
Characteristic Pure Competition Monopolistic Competition Oligopoly Pure Monopoly
Number of firms A very large number Many Few One
Type of product Standardized Differentiated Standardized or Unique; no close
differentiated substitutes
Control over price None Some, but within rather Limited by mutual inter- Considerable
narrow limits dependence;
considerable with
collusion
Conditions of entry Very easy, no Relatively easy Significant obstacles Blocked
obstacles
Nonprice Competition None Considerable emphasis on Typically a great deal, Mostly public relations
advertising, brand names, particularly with product advertising
trademarks differentiation

Examples Agriculture Retail trade, dresses, shoes Steel, automobiles, farm Local utilities
implements, many
household appliances
10-4
LO10.1
PURE COMPETITION: CHARACTERISTICS
Very large numbers of sellers
Standardized product
“Price takers”
Free entry and exit

10-5
LO10.2
PURELY COMPETITIVE DEMAND
Perfectly elastic demand:
• Firm produces as much or little as they wish at the
market price.
• Demand graphs as horizontal line.

10-6
LO10.3
AVERAGE, TOTAL, AND MARGINAL
REVENUE FORMULAS
Average revenue:
• Revenue per unit
• AR = TR/Q = P
Total revenue: TR = P × Q
Marginal revenue:
• Extra revenue from 1 more unit
• MR = ΔTR/ΔQ
10-7
LO10.3
A PURELY COMPETITIVE FIRM’S DEMAND AND REVENUE CURVES
_________Firm’s Revenue
_____Firm’s Demand Schedule_____
Data_________
(1) (2) (3) (4)
$1,179 TR
Product Price (P) Quantity Total Revenue Marginal Revenue
Average Revenue Demanded (Q) (TR), (1) x (2) (MR) 1,048
$131 0 $ 0
$131 917
131 1 131
131

Price and revenue

131 2 262 786
131
131 3 393
131 655
131 4 524
131
131 5 524
655
131
131 6 786 393
131
131 7 917
131 262
131 8 1,048
131
D = MR =
131 9 1,179 131 AR
131
131 10 1,310
0 2 4 6 8 10 12
Quantity demanded (sold) 10-8
LO10.3
PROFIT MAXIMIZATION: TR – TC APPROACH
The competitive producer will wish to produce at the
output level where total revenue exceeds total cost by
the greatest amount.
Break-even point

10-9
LO10.4
 PROFIT MAXIMIZATION: TR – TC TABLE
PRICE: $131

(1) (2) (3) (4) (5) (6)

Total Product Total Fixed Cost Total Variable Total Cost Total Revenue Profit (+)
(Output) (Q) (TFC) Costs (TVC) (TC) (TR) or Loss ()
0 $100 $ 0 $ 100 $ 0 $100

1 100 90 190 131 59

2 100 170 270 262 8

3 100 240 340 393 +53

4 100 300 400 524 +124
5 100 370 470 655 +185
6 100 450 550 786 +236
7 100 540 640 917 +277
8 100 650 750 1,048 +298
9 100 780 880 1,179 +299
10 100 930 1,030 1310 +280 10-10
LO10.4
TOTAL-REVENUE–TOTAL COST APPROACH TO PROFIT MAXIMIZATION
FOR A PURELY COMPETITIVE FIRM
(a) Profit maximizing case (b) Total economic profit

$1,800 Break-even point

1,700 (normal profit)
1,600
1,500 Total revenue, TR
1,400
Total revenue and total cost

1,300 $500
Maximum

Total economic profit

1,200
economic 400
1,100 $299
profit Total cost, TC Total economic
1,000 $299 300
profit
900
200
800
700 100
P=
600
$131
500 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14
400 Quantity demanded (sold)
300
200 Break-even point
100 (normal profit)

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14

Quantity demanded (sold)

10-11
LO10.4
PROFIT MAXIMIZATION: MR = MC APPROACH
Using the MR = MC rule
For a price taker, price = marginal revenue
The firm considers three questions:
• Should the firm produce?
• If so, what amount?
• What economic profit (loss) will be realized?

10-12
LO10.5
PROFIT MAXIMIZATION: MR = MC TABLE
Short-run profit maximization for a purely competitive firm: Table
(1) (2) (3) (4) (5) (6) (7)
Total Product Average Fixed Average Variable Average Total Marginal Cost Price = Marginal Total Economic
(Output) Cost (AFC) Costs (AVC) Cost (ATC) (MC) Revenue (MR) Profit (+) or Loss (-)
0 $ -100
1 $100.00 $90.00 $190.00 $ 90 $131 -59
2 50.00 85.00 135.00 80 131 -8
3 33.33 80.00 113.33 70 131 +53
4 25.00 75.00 100.00 60 131 +124
5 20.00 74.00 94.00 70 131 +185
6 16.67 75.00 91.67 80 131 +236
7 14.29 77.14 91.43 90 131 +277
8 12.50 81.25 93.75 110 131 +298
9 11.11 86.67 97.78 130 131 +299
10 10.00 93.00 103.00 150 131 +280
10-13
LO10.5
SHORT-RUN PROFIT MAXIMIZATION FOR A PURELY COMPETITIVE FIRM
Figure 10.3
$200

MR = MC
150 P = $131
MC
Cost and revenue

MR = P

Economic profit
ATC
100 AVC

A = $97.78
50

0 1 2 3 4 5 6 7 8 9 10
Output
10-14
LO10.5
LOSS MINIMIZING CASE
Loss minimization.
Still produce because MR > minimum AVC.
Losses at a minimum where MR = MC.
Producing adds more to revenue than to costs.

10-15
LO10.5
SHORT-RUN LOSS MINIMIZATION TABLE
Loss-Minimizing Case Shutdown Case
(6) (8)
(9)
(2) (3) $81 Price (7) $71 Price
Profit (+)
(1) Average Average (4) (5) = Total =
or Loss (-
Total Fixed Variable Average Marginal Marginal Economic Marginal
), $71
Product Cost Cost Total Cost Cost Revenue Profit (+) Revenue
Price
(Output) (AFC) (AVC) (ATC) (MC) (MR) or Loss (-) (MR)
0 $-100 $-100
1 $100.00 $90.00 $190.00 $ 90 $81 -109 $71 -119
2 50.00 85.00 135.00 80 81 -108 71 -128
3 33.33 80.00 113.33 70 81 -97 71 -127
4 25.00 75.00 100.00 60 81 -76 71 -116
5 20.00 74.00 94.00 70 81 -65 71 -115
6 16.67 75.00 91.67 80 81 -64 71 -124
7 14.29 77.14 91.43 90 81 -73 71 -143
8 12.50 81.25 93.75 110 81 -102 71 -182
9 11.11 86.67 97.78 130 81 -151 71 -241
10 10.00 93.00 103.00 150 81 -220 71 -320 10-16
LO10.5
SHORT-RUN LOSS MINIMIZATION FOR A PURELY COMPETITIVE FIRM

$200

MC
150
Cost and revenue

A = $91.67
100 ATC
Loss AVC
MR = P

P = $81
50
V = $75

0
1 2 3 4 5 6 7 8 9 10
Output
10-17
LO10.5
THE SHORT-RUN SHUTDOWN CASE FOR A PURELY COMPETITIVE FIRM

$200

MC
150
Cost and revenue

ATC
100
AVC
MR = P
P = $71
50

0
1 2 3 4 5 6 7 8 9 10
Output
10-18
LO10.5
SHORT-RUN SUPPLY
Short-run supply curve: As long as P exceeds minimum
AVC, the firm continues to produce using the rule:
MR (= P) = MC
Supply graphs as upsloping line.

10-19
LO10.6
MARGINAL COST AND SHORT-RUN SUPPLY
The Supply Schedule of a Competitive Firm Confronted with the Cost Data in the Table in Figure 10.3

Quantity Maximum Profit (+)

Price Supplied Minimum Loss (-)
$151 10 $+480
131 9 +299
111 8 +138
91 7 -3
81 6 -64
71 0 -100
61 0 -100

10-20
LO10.6
MC CURVE AND SHORT RUN SUPPLY
MC

e ATC
Cost and revenues (dollars)

P5 MR5

AVC
d
P4 MR4
c
P3 MR3
b
P2 MR2
a
P1 MR1

0 Q2 Q3 Q4 Q5

Quantity supplied
10-21
LO10.6
MC BECOMES SHORT-RUN SUPPLY CURVE
MC

e ATC
P5 MR5
Break-even point
(normal profit)
Cost and revenues (dollars)

AVC
d
P4 MR4
c
P3 MR3
b
P2 MR2
Shut-down point
a (if P is below)
P1 MR1

0 Q2 Q3 Q4 Q5

Quantity supplied
10-22
LO10.6
OUTPUT DETERMINATION
Output Determination in Pure Competition in the Short Run

Question
Should this firm produce?
What quantity should this firm produce?
Will production result in economic profit?
Answer
Yes, if price is equal to, or greater than,
minimum average variable cost. This means
that the firm is profitable or that its losses are
less than its fixed cost.
Produce where MR (= P) = MC; there, profit is
maximized (TR exceeds TC by a maximum
amount) or loss is minimized.
Yes, if price exceeds average total cost (TR will
exceed TC). No, if average total cost exceeds
price (so that TC exceeds TR).

10-23
LO10.6
FIRM AND INDUSTRY: EQUILIBRIUM PRICE
Firm and Market Supply and Market Demand

(1) (2) (4)

Quantity Supplied, Total (3) Total
Single Quantity Product Quantity
Firm Supplied, 1,000 Firms Price Demanded
10 10,000 $151 4,000
9 9,000 131 6,000
8 8,000 111 8,000
7 7,000 91 9,000
6 6,000 81 11,000
0 0 71 13,000
0 0 61 16,000

10-24
LO10.6
SHORT-RUN COMPETITIVE EQUILIBRIUM
P P

s = MC S = ∑MCs

ATC

$111 d $111
AVC
Economic
profit
D

0 8 q 0 8,000 Q

(a) Single firm (b) Industry 10-25

LO10.6
FIRM VERSUS INDUSTRY
Fallacy of composition:
• Atoms are not alive, but things made of atoms are.
• If everyone stands, no one can see.
• If everyone sells, prices will fall.

LO10.6 10-26