Understanding Pure Competition Market Models in Short Run

1. Chapter 10 Pure Competition in the Short Run

2. Four Market Models • Market Structure • Pure competition • Imperfect competition • Monopolistic competition • Oligopoly • Pure monopoly LO1

3. Market Model Characteristics LO1

4. Pure Competition: Characteristics • Very large numbers of sellers • Standardized product • “Price takers” • Easy entry and exit LO2

5. Purely Competitive Demand • Perfectly elastic demand • Firm produces as much or little as they wish at the market price • Demand graphs as horizontal line LO3

6. Average, Total, and Marginal Revenue Formulas • Average revenue • Revenue per unit • AR = TR/Q = P • Total revenue • TR = P X Q • Marginal revenue • Extra revenue from 1 more unit • MR = ΔTR/ΔQ LO3

7. Firm’s Demand Schedule (Average Revenue) Firm’s Revenue Data ] ] ] ] ] ] ] ] ] ] Average, Total, and Marginal Revenue $1179 TR 1048 P TR MR QD 917 0 1 2 3 4 5 6 7 8 9 10 $131 131 131 131 131 131 131 131 131 131 131 $0 131 262 393 524 655 786 917 1048 1179 1310 786 $131 131 131 131 131 131 131 131 131 131 655 Price and revenue 524 393 262 D = MR = AR 131 2 4 6 8 10 12 Quantity demanded (sold) LO3

8. 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 LO4

9. Profit Maximization: TR - TC Table LO4

10. $1800 1700 1600 1500 1400 1300 1200 1100 1000 900 800 700 600 500 400 300 200 100 Break-even point (Normal profit) Total revenue, (TR) Maximum economic profit $299 Total cost, (TC) Total revenue and total cost P=$131 Break-even point (Normal profit) 0 0 1 1 2 2 3 3 4 4 5 5 6 6 7 7 8 8 9 9 10 10 11 11 12 12 13 13 14 14 Quantity demanded (sold) $500 400 300 200 100 Total economic profit $299 Total economic profit Quantity demanded (sold) Profit Maximization: TR - TC Graphs LO4

11. 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? LO5

12. Profit Maximization: MR = MC Table LO5

13. $200 150 100 50 0 1 2 3 4 5 6 7 8 9 10 Profit Maximization: MR = MC Graph MR = MC MC P=$131 Economic profit MR = P ATC Cost and revenue AVC A=$97.78 Output LO5

14. 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 LO5

15. $200 150 Cost and revenue 100 50 0 1 2 3 4 5 6 7 8 9 10 Output Loss Minimizing Case Graph MC Loss ATC A=$91.67 AVC MR = P P=$81 V = $75 LO5

16. $200 150 100 Cost and revenue 50 0 1 2 3 4 5 6 7 8 9 10 Output Shutdown Case MC ATC AVC V = $74 MR = P P=$71 Short-run shut down point P < minimum AVC $71 < $74 LO5

17. Short Run Supply • Short run supply curve • As long as P exceeds min. AVC • Firm continues to produce using the MR (= P) = MC rule • Supply graphs as upsloping line LO6

18. Marginal Cost and Short Run Supply LO6

19. Cost and revenues (dollars) Quantity supplied MC Curve and Short Run Supply MC e P5 MR5 d ATC P4 MR4 c AVC P3 MR3 b P2 MR2 a P1 MR1 Q2 Q3 Q4 Q5 0 LO6

20. Cost and revenues (dollars) Quantity supplied MC Becomes Short Run Supply Curve S MC e P5 MR5 d ATC P4 MR4 c AVC P3 MR3 b P2 MR2 a P1 MR1 Shut-down point (If P is below) Q2 Q3 Q4 Q5 0 LO6

21. Output Determination LO6

22. Firm and Industry: Equilibrium LO6

23. Firm versus Industry: Equilibrium S = ∑MCs s = MC Economic profit ATC d $111 $111 AVC D 8000 8 (a) Single firm (b) Industry LO6

24. Fixed Costs: Digging Out of a Hole • Shutting down in the short run does not mean shutting down forever • Low prices can be temporary • Some firms switch production on and off depending on the market price • Examples: oil producers, resorts, and firms that shut down during a recession