Pure Competition

1
Monopolistic Competition
Pure Competition
Price Searchers with Low Entry Barriers
Price Takers
Oligopoly
Monopoly
Price Searchers with High Entry Barriers
2
Market Structures
Pure Competition
Monopolistic Competition
Oligopoly
Monopoly
Number of Firms
Many small
Many small
A few large
one
Considers action or reaction of other firms
Importance
Diff or Homog
Differentiated
Homogeneous
Product type
one
Need to stress differences?
Importance
Barriers to Entry
none
none
large
large
Long run profits possible?
Importance
Price Taker/Maker
taker
taker/seeker
maker
maker
Ability to influence market price?
Importance
Non-price Competition
no
yes
yes
yes
As important as price?
Importance
3
Price Takers (many small firms)

• Market supply demand determine price.
• The firms demand will be perfectly elastic.
• Firms can sell as much as they want at P
• Above P, they lose business
• Below P they lose revenue.

P
P
4
Long-run Equilibrium

• The two conditions necessary for long-run
  equilibrium in a price-taker market are
  depicted here.

• The quantity supplied and the quantity demanded
  must be equal in the market, as shown below at P1
  with output Q1.

• At the price established in the market, firms in
  the industry earn zero economic profit

Firm
Price
MC
ATC
P1
d1
Output
q1
5
Pure Competition
Equilibrium
Price
Operating at Minimum ATC
6
ATC
MC
5
4
3
Price Demand MR
2
1
0
10
20
30
40
50
60
Quantity
6
Short Run Profits
Earn economic profit MR gt ATC
MR
P3
Normal Profit
MR ATC
Short Run Losses
Firm covers AVC, but not AFC MR lt ATC, but MR gt
AVC
Shut Down
Firm cant cover AVC, minimize losses by shutting
down MR lt AVC
7
The Supply Curve

• The marginal cost curve (MC) is the firms
  supply curve.

• Below MC AVC, the firm will shut down
  Output 0 below P1,,

• At P2 MR MC at q2.

• At P3 MR MC at q3.

P3
P2
q2
q3
8
Profits and Losses
Entry and Exit
Case 1 Prices rise
Profits?
Entry or Exit?
Supply
9
An Increase in Market Demand

• Consider the market for toothpicks. A new candy
  that sticks to teeth causes the market demand
  for toothpicks to increase from D1 to D2

market price
increases to P2
shifting the firms demand curve upward. At
the higher price, firms expand output to q2 and
earn short-run profits.

• Economic profits will draw competitors into the
  industry, shifting the market supply curve
  from S1 to S2.

Market
Firm
S1
Price
Price
MC
ATC
P2
P2
P1
P1
d1
D1
Output
Output
q1
Q1
q2
Q2
10
The Adjustment

• After the increase in market supply, a new
  equilibrium is established at the original
  market price P1 and a larger rate of output
  (Q3).

• As the market price returns to P1, the demand
  curve facing the firm returns to its original
  level.

• In the long-run, economic profits are driven
  down to zero.

Market
Firm
S1
Price
Price
MC
S2
ATC
P2
P2
d2
P1
P1
D1
D2
Output
Output
q1
Q1
q2
Q2
Q3
11
SR Profits
1. Price goes up
2. Firms enter, Supply increases
Price
3. Price goes down
6
ATC
MC
5
4
SR Profits
3
Price Demand MR
2
4. No LR Profits
1
0
10
20
30
40
50
60
Quantity
12
Profits and Losses
Entry and Exit
Case 2 Prices fall
Profits?
Entry or Exit?
Supply
13
A Decrease in Demand

• If, instead, something causes market demand for
  toothpicks to decrease from D1 to D2

the market price falls to
P2
shifting the firms demand curve downward,
leading to a reduction in output to q2. The firm
is now making losses.

• Short-run losses cause some competitors to exit
  the market, and others to reduce the scale of
  their operation, shifting the market supply
  curve from S1 to S2.

Market
Firm
S1
Price
Price
MC
ATC
P1
P1
d1
P2
P2
D1
Output
Output
q1
Q1
q2
Q2
14
The Adjustment

• After the decrease in market supply, a new
  equilibrium is established at the original
  market price P1 and a smaller rate of output
  Q3.

• As the market price returns to P1, the demand
  curve facing the firm returns to its original
  level.

• In the long-run, economic profit returns to zero.

• Note the long-run market supply curve is flat
  Slr.

Market
Firm
S2
S1
Price
Price
MC
ATC
P1
P1
P2
P2
d2
D1
D2
Output
Output
q1
Q1
q2
Q2
Q3
15
SR Losses
1. Price goes down
2. Firms leave, Supply decreases
Price
3. Price goes up
6
ATC
MC
5
4
P D MR
3
SR Losses
2
4. No LR Losses
1
0
10
20
30
40
50
60
Quantity
16
Long Run Equilibrium
Short Run Profits
Cause firms to enter the market
Supply shifts out and price drops
Short Run Losses
Cause firms to leave the market
Supply shifts in and price rises
17
Increasing-Cost Industries
An increase in Market Demand will lead to higher
per-unit costs of production for all firms.
The long-run market supply curve in a
increasing-cost industry is upward-sloping.
18
21 Questions
19
In competitive price-taker markets, firms a. can
sell all of their output at the market
price. b. produce differentiated products. c. can
influence the market price by altering their
output level. d. are large relative to the total
market.

• When we say that a firm is a price taker, we are
  indicating that the
• firm takes the price established in the market
  then tries to increase that price through
  advertising.
• b. firm can change output levels without having
  any significant effect on price.
• c. demand curve faced by the firm is perfectly
  inelastic.
• d. firm will have to take a lower price if it
  wants to increase the number of units that it
  sells.

In price-taker markets, individual firms have no
control over price. Therefore, the firms
marginal revenue curve is a. a downward-sloping
curve. b. indeterminate. c. constant at the
market price of the product. d. precisely the
same as the firms total revenue curve.
20
If marginal revenue exceeds marginal cost, a
price-taker firm should a. expand output.
b. reduce output. c. lower its price.
d. do both a and c.
expand output

• When firms in a price-taker market are
  temporarily able to charge prices that exceed
  their production costs,
• a. the firms will earn long-run economic profit.
• b. additional firms will be attracted into the
  market until price falls to the level of per-unit
  production cost.
• c. the firms will earn short-run economic profits
  that will be offset by long-run economic losses.
• the existing firms must be colluding or rigging
  the market, otherwise, they would be unable to
  charge such high prices.

Suppose a restaurant that is highly profitable
during the summer months is unable to cover its
total cost during the winter months. If it wants
to maximize profits, the restaurant
should a. shut down during the winter, even if it
is able to cover its variable costs during that
period. b. continue operating during the winter
months if it is able to cover its variable
costs. c. go a out of business immediately
losses should never be tolerated. d. lower its
prices during the summer months.
21

• This graph illustrates a firm
• capable of earning economic profit.
• that is only able to break even when it maximizes
  profit.
• taking economic losses.
• that should shut down immediately

This graph depicts the cost curves of a firm in a
price-taker industry. At what output would the
firms per-unit cost be at a minimum? a. 100
c. 150 b. 125 d. an output gt 150
For the above graph, if the market price is 30,
what is the firms profit-maximizing output and
maximum profit. a. output, 125 economic profit,
zero b. output, 125 economic profit, between
1,000 and 1,250 c. output, 150 economic
profit, 1,500 d. output, 150 economic profit,
between 1,250 and 1,500