Ch. 10 - Pure Competition

Pure Competition

Large # of firms

standardized products

no control over price, “price takers”

Easy entry

Financial markets, agricultural products, raw materials

Purely Competitive Demand

perfectly elastic demand: firm produces as much or little as they wish at market price (horizontal line)

Monopolistic Competition

Many # of firms

Differentiated products

some control over price, with narrow limits

relatively easy entry

restaurants, gyms, gas stations, retail trade

Oligopoly

Few # of firms

standardized or differentiated

Limited control over price

significant obstacles for entry

airlines, automoblies, wireless services providers, space travel , waste disposal

Pure Monopoly

One firm

unique product; no close substitutes

considerable control over price

blocked entry

local utilities, patented pharmaceuticals

Profit Maximization: TR – TC Approach

competitive producer will wish to produce at the
output level where total revenue exceeds total cost by
the greatest amount

Break-Even

where cost = price (no profit)

Profit Maximization: MR = MC Approach

MR = MC rule
For a price taker, P = MR

Loss Minimizing Case

Still produce because MR > minimum AVC

Losses at a minimum where MR = MC.
Producing adds more to revenue than to costs

Short-run supply curve

as long as P exceeds
minimum AVC, firm continues to produce using MR (= P) = MC rule

supply graph upsloping

Should this firm produce?

Yes, if price is equal to, or greater than, min. AVC cost. firm is profitable or that its losses are
less than its fixed cost

What quantity should this firm produce?

Produce where MR (= P) = MC; there, profit is
maximized (TR exceeds TC by a maximum
amount) or loss is minimized

Will production result in economic profit?

Yes, if price exceeds average total cost (TR will
exceed TC). No, if average total cost exceeds
price (so that TC exceeds TR)

The Long Run in Pure Competition

Firms can enter/exit industry + expand/contract capacity

Constant-cost industry

Entry and exit of firms does not affect resource prices

Long-Run Adjustment Process

• Firms seek profits and shun losses.
• Firms are free to enter or to exit.
• Production will occur at firm’s minimum average
total cost.
• Price will equal minimum average total cost.

Long-Run Equilibrium: Entry eliminates profits

• Firms enter
• Supply increases
• Price falls

Long-Run Equilibrium: Exit eliminates losses

• Firms leave
• Supply decreases
• Price rises

In the long run

efficiency is achieved

Productive efficiency

Producing where P = minimum
ATC

Allocative efficiency

Producing where P = MC

Entrepreneurs would like to increase profits beyond just a normal profit

• Decrease costs by innovating
• New product development