Powerpoint Chapter 10 - Pure Competition in the Short Run and Long Run

Four Market Models

• Pure competition

• Monopolistic competition

• Oligopoly

• Pure monopoly

Characteristics of Pure Competition

• Very large number of firms

• Standardized products

• No control over price (Price takers)

• Very easy entry and exit, no obstacles

• No nonprice competition

• Example: Agriculture

Characteristics of Monopolistic Competition

• Many firms

• Differentiated products

• Some control over price, but within rather narrow limits

• Relatively easy entry

• Nonprice Competition has considerable emphasis on advertising, brand names, and trademarks

• Examples: Retail trade, dresses, shoes

Characteristics of Oligopoly

• Few firms

• Standardized or differentiated products

• Control over price is limited by mutual inter-dependence; considerable with collusion

• Significant obstacles to entry

• Nonprice competition is typically a great deal, particularly with product differentiation

• Examples: Steel, auto, farm implements

Characteristics of Monopoly

• One firm

• Unique product; no close substitutes

• Considerable control over price

• Blocked entry

• Nonprice competition is mostly public relations and advertising

• Example: Local utilities

Purely Competitive Demand

• Perfectly elastic demand

  • Firm produces as much or as little as they wish at the market price

  • Demand graphs as horizontal line

Average Revenue

Revenue per unit

Total Revenue (TR) =

P x Q

Marginal Revenue

Extra revenue from 1 more unit

Marginal Revenue (MR) =

Change in TR / Change in Q

Average Revenue (AR) =

TR / Q = P

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

An output at which a firm makes a normal profit; Total Revenue = Total Costs

Profit Maximization: MR = MC Approach

• 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?

MR = MC Rule

Principal that a firm will maximize its profit or minimize its losses by producing the output at which marginal revenue and marginal cost are equal, provided product price is equal to or greater than average variable cost

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

Supply graph has upsloping line

Short Run Supply Curve

• As long as P exceeds minimum AVC

• Firm continues to produce using the MR (= P) = MC rule

A firm should produce 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.

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.

Production will result in economic profit if

Price exceeds average total cost (TR will exceed TC)

Production will NOT result in economic profit if

Average total cost exceeds price (TC will exceed TR)

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

In the long run

• Firms can expand or contract capacity

• Firms can enter or exit the industry

The Long Run in Pure Competition

Decisions are based on the incentives of profits or losses

Long Run Supply Curve

Defined as a curve showing the prices at which a purely competitive industry will make various quantities of the product available in the long run when all inputs are variable.

Profit Maximization in the Long Run

• Easy entry and exit

• Identical costs

  • All firms in the industry have identical costs

• Constant-Cost Industry

  • Entry and exit of firms does not affect resource prices

Long Run Adjustment Process in Pure Competition

• 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

• Entry eliminated profits

  • Firms enter

  • Supply increases

  • Price falls

Long Run Equilibrium - Exit

• Exit eliminates losses

  • Firms leave

  • Supply decreases

  • Price rises

Constant-Cost Industry

• Entry or exit does not affect Long Run ATC

• Constant resource prices

Increasing-Cost Industry

• Most Industries

• Long Run ATC increases with expansion

• Specialized resources

• Input costs have positive relationship with Entry and exit of firms

• Long run supply curve is upsloping

Decreasing-Cost Industry

• Input costs have inverse relationship with Entry and exit of firms

• Long run supply curve is down sloping

Productive Efficiency

Producing where P = Minimum ATC

Allocative Efficiency

Producing where P = MC

Triple Equality

P = MC = Minimum ATC

Pure Competition and Efficiency

• In the long run, efficiency is achieved

• Consumer Surplus and Producer Surplus are maximized

Purely competitive markets will automatically adjust to

• Changes in consumer tastes

• Resource supplies

• Technology

Technological Advance and Competition

• Entrepreneurs would like to increase profits beyond just a normal profit

  • Decrease costs by innovating

  • New product development

Creative Destruction

• Competition and innovation may lead to “Creative Destruction”

• Creation of new products and methods may destroy the old products and methods.

Patents

Give the inventor exclusive rights to market and sell their product for 20 years