Chapter 10: Pure Competition in the Short Run

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Connect Chapter 10, Parts 1 and 2 are due on Monday, April 14.

Chapter 10: Pure Competition in the Short Run

Market Structures

The four market structures, ranked by level of competition, are:

  1. Perfect Competition
  2. Monopolistic Competition
  3. Oligopoly
  4. Monopoly

Characteristics of Market Structures

CharacteristicPure CompetitionMonopolistic CompetitionOligopolyPure Monopoly
# of firmsVery LargeManyFewOne
Type of productHomogeneousDifferentiatedHomogeneous or DifferentiatedUnique
Control over priceNoneSomeLimited but can be enhanced with collusionConsiderable
Condition of entryVery easyRelatively EasySignificant obstaclesBlocked
Nonprice CompetitionNoneConsiderableA great dealAdvertising, PR
ExamplesAgricultureWomen dresses, restaurantsAuto, SteelCable TV, Water, etc.

Bonus Points

  • Bonus Point 108: Which of the following industries is considered an oligopoly?
    • A. Soybean
    • B. Electricity
    • C. Handbags
    • D. Grocery stores
  • Bonus Point 109: Which of the following industries is considered a monopoly?
    • A. Gasoline
    • B. State Lottery
    • C. Drugstores
    • D. Book publishing

Pure Competition (PC)

  • Large number of sellers
  • Standardized product (identical or homogeneous)
  • Price takers: firms have no control over the market price.
  • Free entry and exit

Market Demand vs. Individual Demand

Marginal Revenue (MR)

  • Additional revenue when sales increases by 1 unit.
  • In perfect competition, Marginal Revenue = ?
  • Total Revenue (TR) and Marginal Revenue (MR)
    • TR=TR =
    • MR=MR =

Firm’s Decision

  • Should we produce this product?
  • If so, in what amount?
  • What economic profit will we realize?
  • What about the price?

Profit Maximization in the Short Run

The MR = MC profit max rule.

  • Firm should produce more output if MR > MC.
  • Once MR < MC, there is no gain from producing.
  • Then MR = MC rule becomes P = MC in pure competition. Why?

Problem 110

Refer to the above diagram. At the profit-maximizing output, total revenue will be:

  • A. 0AHE
  • B. 0BGE
  • C. 0CFE
  • D. ABGE

Problem 111

Refer to the above diagram. At the profit-maximizing output, total cost will be:

  • A. 0AHE
  • B. 0BGE
  • C. 0CFE
  • D. ABGE

Problem 112

Refer to the above diagram. At the profit-maximizing output, the firm will realize:

  • A. a loss equal to BCFG.
  • B. a loss equal to ACFH.
  • C. an economic profit of ACFH.
  • D. an economic profit of ABGH.

Problem 113

Refer to the above diagram. At the profit-maximizing output, total fixed cost is equal to:

  • A. 0AHE
  • B. 0BGE
  • C. 0CFE
  • D. BCFG.

Problem 114

Refer to the above diagram. At the profit-maximizing output, total variable cost is equal to:

  • A. 0AHE
  • B. 0CFE
  • C. 0BGE
  • D. ABGH.

Problems 115 and 116

  • 115. If the market price for wheat is 13 per bushel, profit maximizing level of output will be:
    • A. 6
    • B. 11
    • C. 12
    • D. 15
  • 116. If the market price for wheat is 11 per bushel, profit maximizing level of output will be:
    • A. 0
    • B. 6
    • C. 10
    • D. 12

What if the market price keeps falling…

  • If price falls to 3, economic profit is….
  • Should this firm shut down? Remember that we are in the short run and this firm cannot exit the industry.
  • This is a loss-minimizing case

The Meaning of Shutdown

  • Short run: Firm cannot exit the industry. Why?
  • If a firm makes a loss in the short run, there are two options:
    1. Continue operating in the short run and exit in the long run.
    2. Shut down in the short run and exit in the long run.

Operating Profit

  • Operating profit = TR – TVC
  • If economic profit is negative, can a firm still cover its operating expenses?
  • Example: Wheat business
    • AFC = 2/lb. (cost of growing, harvesting wheat)
    • AVC = 2/lb (cost of operating flour mill, etc.)
    • Q = 800 lbs, P = 3
    • Operating in the SR:
      • Operating Profit =
      • Economic Profit =
    • If Shutdown: Economic Profit =
    • If Operate: Economic Profit =

Example: Hotel Business (Not pure competition)

A 50-room hotel:

  • TFC: Construction cost = 3,000,000(15−yearbankloan):3,000,000 (15-year bank loan):30,000/month or AFC = 40 per room per day
  • AVC: electricity, water, cleaning costs, etc.: total 20 per room per day.
  • ATC = AFC + AVC = 60
  • Market Room rate in the area = 80/night
  • Economic Profit Per Room =
  • Economic profit = 0 when room rate is ?

The economy enters a recession, it’s hard to fill hotel rooms. A guest walks in and offers 50, should you let him stay? Should you exit the industry?

*What is the shut down price?

Bottom Line: Short Run

If a firm earns:

  • Economic profit: it should continue operating in the SR and expand in the LR.
  • Economic Loss, then look at operating profit
    • If operating profit is positive, continue in the short run (to minimize loss) and exit in the long run.
    • If operating profit is negative, shut down the business in the short run and exit in the long run.

Shutdown Case

What if price falls to below 1?

  • Shutdown case: when price falls below minimum AVC.

The Farmer’s Shutdown Point

  • The farmer’s shutdown point is at a price less than ___
  • If the market price is 10, what is the profit-maximizing level of output?
  • At P = 10, what are his economic and operating profits?
  • What is your recommendation for this farmer in the long run?

Problems 117 and 118

  • 117. If the market price for wheat is 9 per bushel, a profit-maximizing level of output, the firm will realize:
    • A. An economic loss of 8.
    • B. An economic profit of 72.
    • C. An economic profit of 16.
    • D. Zero economic profit.
  • 118. If the market price for wheat is 9 per bushel, operating profit will be:
    • A. -8.
    • B. 8.
    • C. -16.
    • D. $$16.