Chapter 10: Pure Competition in the Short Run

Announcements

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

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)
  • $TR =$
  • $MR =$

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:<ul> <li>A. 6</li> <li>B. 11</li> <li>C. 12</li> <li>D. 15</li></ul></li> <li><strong>116.</strong> 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….</li> <li>Should this firm shut down? Remember that we are in the short run and this firm cannot exit the industry.</li> <li>This is a loss-minimizing case</li> </ul> <h3 id="themeaningofshutdown">The Meaning of Shutdown</h3> <ul> <li>Short run: Firm cannot exit the industry. Why?</li> <li>If a firm makes a loss in the short run, there are two options:<ol> <li>Continue operating in the short run and exit in the long run.</li> <li>Shut down in the short run and exit in the long run.</li></ol></li> </ul> <h3 id="operatingprofit">Operating Profit</h3> <ul> <li>Operating profit = TR – TVC</li> <li>If economic profit is negative, can a firm still cover its operating expenses?</li> <li>Example: Wheat business<ul> <li>AFC =$2/lb. (cost of growing, harvesting wheat)
• AVC = $2/lb (cost of operating flour mill, etc.)</li> <li>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-year bank loan):$30,000/month or AFC = $40 per room per day</li> <li>AVC: electricity, water, cleaning costs, etc.: total$20 per room per day.
• ATC = AFC + AVC = $60</li> <li>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?</p> <p>*What is the shut down price?</p> <h3 id="bottomlineshortrun">Bottom Line: Short Run</h3> <p>If a firm earns:</p> <ul> <li>Economic profit: it should continue operating in the SR and expand in the LR.</li> <li>Economic Loss, then look at operating profit<ul> <li>If operating profit is positive, continue in the short run (to minimize loss) and exit in the long run.</li> <li>If operating profit is negative, shut down the business in the short run and exit in the long run.</li></ul></li> </ul> <h3 id="shutdowncase">Shutdown Case</h3> <p>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?</li> <li>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:<ul> <li>A. An economic loss of$8.
• B. An economic profit of $72.</li> <li>C. An economic profit of$16.
• D. Zero economic profit.