Four market models (cont.

)
A. Pure competition entails a large number of firms, standardized product, and easy entry (or exit) by new (or existing) firms. B. At the opposite extreme, pure monopoly has one firm that is the sole seller of a product or service with no close substitutes; entry is blocked for other firms.

Four market models (cont.)
C.Monopolistic competition is close to pure competition, except that the product is differentiated among sellers rather than standardized, and there are fewer firms. D.An oligopoly is an industry in which only a few firms exist, so each is affected by the price‑output decisions of its rivals.

Four Market Models
Imperfect Competition
Pure Competition Pure Monopolistic Oligopoly Monopoly Competition

Market Structure Continuum

Pure Competition: Characteristics and Occurrence

A.The characteristics of pure competition.
1.Many sellers means that there are enough so that a single seller has no impact on price by its decisions alone. 2.The products in a purely competitive market are homogeneous or standardized; each seller’s product is identical to its competitor’s.

Pure Competition: Characteristics and Occurrence

A.The characteristics of pure competition.(cont.)

3.Individual firms must accept the market price; they are price takers and can exert no influence on price. 4.Freedom of entry and exit means that there are no significant obstacles preventing firms from entering or leaving the industry.

a. . but the model is important.) 5.Pure Competition: Characteristics and Occurrence (Cont. c. Pure competition provides a norm or standards against which to compare and evaluate the efficiency of the real world. The model helps analyze industries with characteristics similar to pure competition. The model provides a context in which to apply revenue and cost concepts developed in previous chapters. b. Pure competition is rare in the real world.

There are four major objectives in analyzing pure competition. To examine demand from the seller’s viewpoint 2.Pure Competition: Characteristics and Occurrence (Cont.) B. 1. To see how a competitive producer responds to market price in the short run 3. To evaluate the efficiency of competitive industries . To explore the nature of long‑run adjustments in a competitive industry 4.

Demand from the Viewpoint of a Competitive Sellerdemand as A. see slides for illustrations 2. since it must take the market price no matter what quantity it produces. 1. Note that a perfectly elastic demand curve is a horizontal line at the price. The demand curve is not perfectly elastic for the industry: It only appears that way to the individual firm.The individual firm will view its perfectly elastic. 3. .

) B. 3. Marginal revenue (MR) is the change in total revenue and will also equal the unit price in conditions of pure competition. total.Demand from the Viewpoint of a Competitive Seller (Cont. 2.Definitions of average. 1. and marginal revenue. . Average revenue (AR) is the price per unit for each firm in pure competition. Total revenue (TR) is the price multiplied by the quantity sold.

Table Representation Product Price Quantity ($) Demanded (Average Revenue) AR Total Marginal Revenue (TR) Revenue (MR) ($) ($) (PXQ) (Change in TR) 2 2 2 2 2 2 2 2 2 2 2 0 1 2 3 4 5 0 2 4 6 8 10 .

Graphical Representation .

Pure Competition Firm’s Demand Schedule (Average Revenue) Firm’s Revenue Data $1179 1048 917 TR Price and Revenue P QD TR $0 ] 131 ] 262 ] 393 ] 524 ] 655 ] 786 ] 917 ] 1048 ] 1179 ] 1310 MR $131 131 131 131 131 131 131 131 131 131 786 655 524 393 262 $131 0 131 1 131 2 131 3 131 4 131 5 131 6 131 7 131 8 131 9 131 10 D = MR = AR 131 2 4 6 8 10 12 Quantity Demanded (Sold) .

total‑revenue. c. b.” Explain verbally and graphically. What can you conclude about structure of the industry in which this firm is operating? Explain. and marginal‑revenue curves for this firm. Why do the demand and marginal‑revenue curves coincide? d. “Marginal revenue is the change in total revenue associated with additional units of output.Questions to Ponderthe a. Graph the demand. using the data in the table. .

Profit Maximization in the Short Run: Two Approaches A.In the short run the firm has a fixed plant and maximizes profits or minimizes losses by adjusting output. profits are defined as the difference between total costs and total revenue.Two ways to determine the level of output 1) Compare TR and TC Applicable to all firm in all 2) Compare MR and MC Market conditions . .

In What Amount? What Economic Profit (Loss) Will Be Realized? .Profit Maximization in the Short Run Total Revenue-Total Cost Approach Consider: Should Product Be Produced? If So.

Profit Maximization in the Short Run 1 Compare TR and TC Approach Total Revenue-Total Cost Approach Price = $131 MR-MC TABLE (1) Total Product (Output) (Q) (2) (3) (4) (5) (6) Total Fixed Total Variable Total Cost Total Revenue Profit (+) Cost (TFC) Cost (TVC) (TC) (TR) or Loss (-) 0 1 2 3 4 5 Do You 6 See Profit Maximization? 7 8 9 10 $100 100 100 100 100 100 100 100 100 100 100 Muhammad Hasib Difari $0 90 170 240 300 370 450 540 650 780 930 $100 190 270 340 400 470 550 640 750 880 1030 $0 131 262 393 524 655 786 917 1048 1179 1310 $-100 -59 -8 +53 +124 +185 +236 +277 +298 +299 +280 Now Let’s Graph The Results… .

(TC) P=$131 Break-Even Point (Normal Profit) 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 Quantity Demanded (Sold) Total Economic Profit $500 400 300 200 100 Total Economic Profit $299 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 Quantity Demanded (Sold) Muhammad Hasib Difari .Profit Maximization in the Short Run Total Revenue-Total Cost Approach $1800 1700 1600 1500 1400 1300 1200 1100 1000 900 800 700 600 500 400 300 200 100 Total Revenue and Total Cost Break-Even Point (Normal Profit) Total Revenue. (TR) Maximum Economic Profit $299 Total Cost.

2. the firm should produce that output at which it maximizes its profit or minimizes its loss. The firm should not produce.Profit Maximization in the Short Run: Two Approaches (Cont.Compare TR and TC 1. 5. 4. but should shut down in the short run if its loss exceeds its fixed costs. 3.) Approach 1 . or if the loss is less than the fixed cost. . The profit or loss can be established by subtracting total cost from total revenue at each output level. In the short run. A graphical representation is shown Note: The firm has no control over the market price. The firm should produce if the difference between total revenue and total cost is profitable. by shutting down its loss will just equal those fixed costs. Then.

The rule assumes that marginal revenue must be equal to or exceed minimum-average-variable cost or firm will shut down. not just pure competition.Profit Maximization in the Short Run: Two Approaches (Cont. In pure competition. Three features of this MR = MC rule are important. The rule works for firms in any type of industry. . price = marginal revenue. because P = MR. c. so in purely competitive industries the rule can be restated as the firm should produce that output where P = MC. b. The MR = MC rule states that the firm will maximize profits or minimize losses by producing at the point at which marginal revenue equals marginal cost in the short run.) Approach 2 . 2.Compare MR and MC 1. a.

Profit Maximization in the Short Run Marginal Revenue-Marginal Cost Approach MR = MC Rule Important Features: • Firm Will Shut Down Unless MR at Least Meets MC • Profit Maximization in All Market Structures • Can Be Restated P = MC .

00 $71 80 91.00 2 33.00 1 50.00 4 See Profit 20.00 10 $90.78 $71150 103.11 9 10.00 $71 mr1 $81 $131 $81 131 $81 131 $81 131 $81 131 $81 131 $81 131 $81 131 $81 131 $81 131 $-100 -59 -8 +53 +124 +185 +236 64.14 81.00 74.00 mr2 $90 $190.00 $71 70 94.00 $71 80 135.00 $71 70 113. 14.33 $71 60 100.75 $71130 97.00 80.25 86.02 +277 +298 +299 +280 No Surprise .Now Let’s Graph It… .67 Now? 7 Min.43 $71110 93.29 12.67 93.50 8 11.00 77.67 $71 90 91.00 5 Maximization 6 Loss 16.00 85.Profit Maximization in the Short Run Marginal Revenue-Marginal Cost Approach MR = MC Rule TR-TR TABLE (2) Average Fixed Cost (AFC) (3) Average Variable Cost (AVC) (4) Average Total Cost (ATC) (6) Marginal Revenue (MR) (P) (1) Total Product (Output) (5) Marginal Cost (MC) (7) Profit (+) or Loss (-) Shut down 0 $100.00 75.33 3 Do You 25.00 75.

At the tenth unit MC exceeds MR. Therefore. . the firm should produce only nine (not the tenth) units to maximize profits.Compare MR and MC (cont.) Approach 2 .) 3. See slide as an illustration Compare MC and MR at each level of output.Profit Maximization in the Short Run: Two Approaches (Cont.

$97.78 x 9 = $880.)  Profit-maximizing case: The level of profit = $1179 .02 Economic Profit = $299 Step 1 ATC x Qty 97. Economic profit = (P – ATC) Q = ($131 .78 MR=MC MC ATC MR = P Alternatively.02 Step 2 TR = P x Q = $131 x 9 = $1179 P=$131 Cost & Revenue $97.$880.Compare MR and MC (cont.Profit Maximization in the Short Run: Two Approaches (Cont.)  Approach 2 .78) 9 = $299 23022011 (TOPIC5) Muhammad Hasib Difari output 9 .

Profit Maximization in the Short Run Marginal Revenue-Marginal Cost Approach MR = MC Rule $200 Cost and Revenue 150 P=$131 MR = MC MC MR = P ATC AVC Economic Profit 100 A=$97.78 50 0 1 2 3 4 Output 5 6 7 8 9 10 .

02$100 = $64.)  Approach 2 .Profit Maximization in the Short Run: Two Approaches (Cont.67 Cost & Revenue P=$81 V=$75 Economic loss MC=MR MC ATC AVC Step 1 ATC x Qty 91.Compare MR and MC (cont.67 x 6 = $550.02 Step 2 TR = P x Q = $81x6 = $486 MR=P output 6 .$486 The level of Loss = $550.) FC  Loss-minimising case: < .02 A=$91.

67 x 6 .02 -$486 =$64.Profit Maximization in the Short Run Marginal Revenue-Marginal Cost Approach MR = MC Rule $200 Loss Minimizing Case Cost and Revenue Loss = $91.$81x6 = $550.02 150 Lower the Price to $81 and Observe the Results! A=$91.67 MC Loss ATC AVC MR = P 100 P=$81 50 V = $75 0 1 2 3 4 Output 5 6 7 8 9 10 .

Hence in the SR it is best to shut down if the P<AVC P=$71 output 6 MR=P .Profit Maximization in the Short Run: Two Approaches (Cont.)  Approach 2 . the Cost & firm will lose at a total Revenue loss of $115.Compare MR and MC (cont.) Shut-down case The smallest loss = $100 : FC it will lose MC=MR MC ATC AVC Even at MC=MR.

Profit Maximization in the Short Run Marginal Revenue-Marginal Cost Approach MR = MC Rule Short-Run Shut Down Case $200 Cost and Revenue 150 Lower the Price Further to $71 and Observe the Results! MC V = $74 ATC AVC MR = P 100 50 P=$71 Short-Run Shut Down Point P < Minimum AVC $71 < $74 2 3 4 0 1 Output 5 6 7 8 9 10 .

.01. at $91 the loss will be $3. At a price of $151 profit will be $480.) MC and SR Supply Marginal cost and the short‑run supply curve can be illustrated by hypothetical prices such as those in Table of the next slide. at $61 the loss will be $100 because the latter represents the close-down case.Profit Maximization in the Short Run: Two Approaches (Cont. at $111 the profit will be $138 ($888‑$750).

Marginal Cost and Short-Run Supply Continuing the Same Numeric Example… Supply Schedule of a Competitive Firm Price Quantity Supplied Maximum Profit (+) or Minimum Loss (-) $151 10 $+480 131 9 +299 111 8 +138 91 7 -3 81 6 -64 71 0 -100 61 0 -100 The Schedule Shows the Quantity a Firm Will Produce at a Variety of Prices and Results .

Since a short‑run supply schedule tells how much quantity will be offered at various prices. 2. Note that the Table from the previous slide gives us the quantities that will be supplied at several different price levels in the short-run.Profit Maximization in the Short Run: Two Approaches (Cont. this identity of marginal revenue with the marginal cost tells us that the marginal cost above AVC will be the short‑run supply for this firm .) MC and SR Supply 1.

Marginal Cost and Short-Run Supply Generalizing the MR=MC Relationship and its Use Cost and Revenues (Dollars) P5 P4 P3 P2 P1 b a c e d MC MR5 ATC AVC MR3 MR2 MR1 MR4 This Price is Below AVC And Will Not Be Produced 0 Q2 Q3 Q4 Q5 Quantity Supplied .

Marginal Cost and Short-Run Supply Generalizing the MR=MC Relationship and its Use Examine the MC for the Competitive Firm Cost and Revenues (Dollars) MC Above AVC Becomes the Short-Run Supply Curve Break-even (Normal Profit) Point P5 P4 P3 P2 P1 b a Shut-Down Point (If P is Below) Q2 Q3 Q4 Q5 c d e S MC MR5 ATC AVC MR3 MR2 MR1 MR4 This Price is Below AVC And Will Not Be Produced 0 Quantity Supplied .

a specific tax would cause a decrease in the supply curve (upward shift in MC). .Profit Maximization in the Short Run: Two Approaches (Cont. A wage increase would shift the supply curve upward.) MC and SR Supply F. Using this logic. Technological progress would shift the marginal cost curve downward. Changes in prices of variable inputs or in technology will shift the marginal cost or short-run supply curve in 1. and a unit subsidy would cause an increase in the supply curve (downward shift in MC). 3. 2.

Marginal Cost and Short-Run Supply Cost and Revenues (Dollars) Decrease S2 S S1 Increase Changes in the Short-Run Supply Curve P1 Quantity Supplied .

3.) MC and SR Supply G.Figure 21-7a and b shows this analysis graphically.) see slide 35 2. industry supply will be 8000 units. .Profit Maximization in the Short Run: Two Approaches (Cont. individual firm supply curves are summed horizontally to get the total-supply curve S in Figure 21-7b.A loss situation similar to Figure 21-4 could result from weaker demand (lower price and MR) or higher marginal costs. since that is the quantity demanded and supplied at $111. (See Table 21-7. Determining equilibrium price for a firm and an industry 1. This will result in economic profits similar to those portrayed in Figure 21-3. If product price is $111.Total-supply and total-demand data must be compared to find the most profitable price and output levels for the industry.

but the supply plans of all competitive producers as a group are a major determinant of product price.Profit Maximization in the Short Run: Two Approaches (Cont.) MC and SR Supply H. industry: Individual firms must take price as given.Firm vs. .

Changes in Supply Firm and Industry Equilibrium Price Market Price and Profits Firm Versus Industry Graphically… .

3 S = ∑ MC’s Economic Profit $111 ATC d AVC D $111 0 8 p 0 8000 P Competitive Firm Must Take the Price that is Established By Industry Supply and Demand .Changes in Supply Single Firm p P s = MC Industry W 21.

1. The entry and exit of firms are the only long‑run adjustments. .Profit Maximization in the Long Run A. Firms in the industry have identical cost curves. The industry is a constant‑cost industry. which means that the entry and exit of firms will not affect resource prices or location of unit‑cost schedules for individual firms. 2. Several assumptions are made. 3.

1. and production will occur at.Profit Maximization in the Long Run (cont. The basic conclusion to be explained is that after long‑run equilibrium is achieved. if economic profits occur. the product price will be exactly equal to. 2. firms will enter the industry. Under competition. each firm’s point of minimum average total cost. firms will leave the industry. Firms seek profits and shun losses. . firms may enter and leave industries freely. 3. If short‑run losses occur.) B.

) C. If economic profits are being earned. . The model is one of zero economic profits. causing the product price to gravitate downward to the equilibrium price where zero economic profits are earned (Figure 21-8). which increases the market supply. 2. firms enter the industry.Profit Maximization in the Long Run (cont. causing the product price to rise until losses disappear and normal profits are earned (Figure 219). firms will leave the industry. but note that this allows for a normal profit to be made by each firm in the long run. If losses are incurred in the short run. this decreases the market supply. 1.

the curve will be horizontal. the level of output will not affect the price in the long run. . 1. In other words. expansion or contraction does not affect resource prices or production costs. In a constant‑cost industry.) D. 2. Long‑run supply for a constant cost industry will be perfectly elastic.Profit Maximization in the Long Run (cont. but will always bring the price back to the equilibrium price (Figure 21-10). The entry or exit of firms will affect quantity of output.

Average‑cost curves shift upward as the industry expands and downward as the industry contracts. Long‑run supply for an increasing cost industry will be upward sloping as the industry expands output. and competition will drive the price down so that individual firms do not realize above‑normal profits (see Figure 23-11). .) E. 1. A two‑way profit squeeze will occur as demand increases because costs will rise as firms enter. 2. because resource prices are affected. Note that the price will fall if the industry contracts as production costs fall. and the new equilibrium price must increase if the level of profit is to be maintained at its normal level.Profit Maximization in the Long Run (cont.

Long‑run supply for a decreasing-cost industry will be downward sloping as the industry expands output. Average‑cost curves fall as the industry expands and firms will enter until price is driven down to maintain only normal profits .) F.Profit Maximization in the Long Run (cont. This situation is the reverse of the increasing‑cost industry.

Profit Maximization in the Long Run Assumptions Entry and Exit Only Identical Costs Constant-Cost Industry Goal of the Analysis Long-Run Equilibrium Entry Eliminates Profits Exit Eliminates Losses .

Supply Readjustment Single Firm p MC ATC $60 50 40 $60 50 Industry P S1 S2 MR 40 D2 D1 0 100 p 0 80.000 90.000 100.000 P An Increase in Demand Temporarily Raises Price Higher Prices Draw in New Competitors Increased Supply Returns Price to Equilibrium .

Supply Readjustment Single Firm p MC ATC $60 50 40 $60 50 Industry P S3 S1 MR 40 D1 D3 0 100 p 0 80.000 P A Decrease in Demand Temporarily Lowers Price Lower Prices Drive Away Some Competitors Decreased Supply Returns Price to Equilibrium .000 90.000 100.

Long-Run Supply Curve Constant-Cost Industry P P1 P2 P3 D3 D1 Q1 100.000 D2 $50 Z3 Z1 Z2 S 0 Q3 90.000 Q .000 Q2 110.

000 Q How Would a Decreasing-Cost Industry Look? .Long-Run Supply Curve Increasing-Cost Industry P P2 P1 P3 $55 $50 Y1 $40 Y3 Y2 S D2 D3 D1 Q1 100.000 Q2 110.000 0 Q3 90.

. 2. Allocative efficiency occurs where P = MC. because price is society’s measure of relative worth of a product at the margin or its marginal benefit. And the marginal cost of producing product X measures the relative worth of the other goods that the resources used in producing an extra unit of X could otherwise have produced. increasing.Pure Competition and Efficiency A. or decreasing costs. the final long‑run equilibrium will have the same basic characteristics (Figure 23-12). at this point firms must use the least‑cost technology or they won’t survive. Productive efficiency occurs where P = minimum AC. 1. In short. and the marginal cost of this unit of X measures the sacrifice or cost to society of other goods given up to produce more of X. price measures the benefit that society gets from additional units of good X. Whether the industry is one of constant.

4. . If price is less than marginal cost. then society values more units of good X more highly than alternative products the appropriate resources can otherwise produce.) 3. If price exceeds marginal cost. and resources are overallocated to the production of good X. Resources are underallocated to the production of good X. then society values the other goods more highly than good X.Pure Competition and Efficiency (Cont.

Under pure competition this outcome will be achieved. “The invisible hand” works in a competitive market system since no explicit orders are given to the industry to achieve the P = MC result . Disequilibrium will cause expansion or contraction of the industry until the new equilibrium at P = MC occurs. 6. Efficient allocation occurs when price and marginal cost are equal. Dynamic adjustments will occur automatically in pure competition when changes in demand or in resource supplies or in technology occur.Pure Competition and Efficiency (Cont.) 5. 7.

Pure Competition and Efficiency Productive Efficiency P = Minimum ATC Allocative Efficiency P = MC Maximum Consumer and Producer Surplus Dynamic Adjustments “Invisible Hand” Revisited .

Long-Run Equilibrium Competitive Firm and Market Single Firm P=MC=Minimum ATC (Normal Profit) Market S MC ATC Price P MR Price P D 0 Qf 0 Qe Quantity Quantity Productive Efficiency: Price = Minimum ATC Allocative Efficiency: Price = MC Pure Competition Has Both in Its Long-Run Equilibrium .

Since pure competition establishes the lowest price consistent with continued production. it yields the largest sustainable amount of consumer surpluses.LAST WORD: Pure Competition and Consumer Surplus A. consumers collectively obtain more utility (total satisfaction) from their purchases than the amount of their expenditures (product price x quantity). . B.In almost all markets.

LAST WORD: Pure Competition and Consumer Surplus (cont.) $20 $16 $12 $8 Consumer surplus S (ΣMC) Arises because some Consumers are willing to pay more Than the equil. P but need not do so At the lowest price (P=$8) Pure Competition yields the largest sustainable Amount of consumer surplus Q1 .

Efficiency Gains From Entry: st La ord W The Case of Generic Drugs Competitive Model Predicts Lower Price and Greater Output With Increased Efficiency When New Producers Enter Market Example is Patented Drugs Patents Enable Greater Profits in Support of R&D and Accelerated Cost Recovery After Patent Period Generics Enter Market Profits Decrease and Quantities Increase Combined Consumer and Producer Surpluses Increase .

b c P • Consumer Surplus abc d f P Increases to adf • Producer and Consumer Surplus is D Maximized Q Q Together as Quantity Shown by Results: Greater Quantity at Lower Prices the Gray as Predicted by the Competitive Model Triangle 1 Price 2 1 2 .Efficiency Gains From Entry: ast L ord W • The Case of Generic Drugs New Producers Enter Market a S As Price Initial Patent Price Decreases to f.