08 and 09 Pure Competition in the Short Run & Long Run McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc All rights reserved Chapter Objectives Four Market Mode ls Pure Competition Profit Maximizati on in the Short-R un Marginal Cost an d Short-Run Supp ly Changes in Supp ly Profit Maximizati on in the Long Ru n Supply Readjust ment Pure Competition and Efficiency Long-Run Equilib rium Last Word Key Terms End Show 9-2 • Names and Main Characteristics of the Four Basic Market Models • Conditions for Perfect Competition • How Do Purely Competitive Firms Maximize Profits or Minimize Losses • Why the Marginal Cost and Supply Curves For Competitive Firms Are Identical • How Industry Entry and Exit Create Economic Efficiency • Differences Between Constant-Cost, Increasing-Cost, and DecreasingCost Industries Copyright 2008 The McGraw-Hill Companies Four Market Models Four Market Mode ls Pure Competition Profit Maximizati on in the Short-R un Marginal Cost an d Short-Run Supp ly Changes in Supp ly Profit Maximizati on in the Long Ru n Supply Readjust ment Pure Competition and Efficiency Long-Run Equilib rium Last Word • Pure Competition • Pure Monopoly • Monopolistic Competition • Oligopoly Imperfect Competition Pure Competition Monopolistic Competition Oligopoly Pure Monopoly Key Terms Market Structure Continuum End Show 9-3 Copyright 2008 The McGraw-Hill Companies Four Market Models Characteristics of the Four Basic Market Models Pure Characteristic Competition Monopolistic Competition Oligopoly Monopoly Number of firms A very large number Many Few One Type of product Standardized Differentiated Standardized or differentiated Unique; no close subs Control over price None Some, but within rather narrow limits Limited by mutual inter-dependence; considerable with collusion Considerable Conditions of entry Very easy, no obstacles Relatively easy Significant obstacles Blocked Nonprice Competition None Considerable emphasis on advertising, brand names, trademarks Typically a great deal, particularly with product differentiation Mostly public relation advertising Examples Agriculture Retail trade, dresses, shoes Steel, auto, farm implements Local utilities LO1 8-4 Pure Competition: Characteristics • Very large numbers of sellers • Standardized product • “Price takers” • Easy entry and exit • Perfectly elastic demand • Firm produces as much or little as they want at the price • Demand graphs as horizontal line LO2 8-5 Average, Total, and Marginal Revenue • Average Revenue • Revenue per unit • AR = TR/Q = P • Total Revenue • TR = P X Q • Marginal Revenue • Extra revenue from more unit • MR = ΔTR/ΔQ LO3 8-6 Pure Competition $1179 Key Terms Firm’s Demand Schedule (Average Revenue) P Firm’s Revenue Data 917 QD TR $131 131 131 131 131 131 131 131 131 131 131 10 TR 1048 $0 131 262 393 524 655 786 917 1048 1179 1310 MR ] $131 ] 131 ] 131 ] 131 ] 131 ] 131 ] 131 ] 131 ] 131 ] 131 Price and Revenue Four Market Mode ls Pure Competition Profit Maximizati on in the Short-R un Marginal Cost an d Short-Run Supp ly Changes in Supp ly Profit Maximizati on in the Long Ru n Supply Readjust ment Pure Competition and Efficiency Long-Run Equilib rium Last Word 786 655 524 393 262 D = MR = AR 131 10 Quantity Demanded (Sold) End Show 9-7 Copyright 2008 The McGraw-Hill Companies 12 Profit Maximization in the Short Run Four Market Mode ls Pure Competition Profit Maximizati on in the Short-R un Marginal Cost an d Short-Run Supp ly Changes in Supp ly Profit Maximizati on in the Long Ru n Supply Readjust ment Pure Competition and Efficiency Long-Run Equilib rium Last Word Total Revenue-Total Cost Approach Consider: –Should Product Be Produced? –If So, In What Amount? –What Economic Profit (Loss) Will Be Realized? Key Terms End Show 9-8 Copyright 2008 The McGraw-Hill Companies Production Questions Output Determination in Pure Competition in the Short Run LO3 Question Answer Should this firm produce? Yes, 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 Will production result in economic profit? Yes, if price exceeds average total cost (TR will exceed TC) No, if average total cost exceeds price (TC will exceed TR) 8-9 Profit Maximization in the Short Run Four Market Mode ls Pure Competition Profit Maximizati on in the Short-R un Marginal Cost an d Short-Run Supp ly Changes in Supp ly Profit Maximizati on in the Long Ru n Supply Readjust ment Pure Competition and Efficiency Long-Run Equilib rium Last Word Key Terms Total Revenue-Total Cost Approach Price = $131 (1) Total Product (Output) (Q) 10 (2) Total Fixed Cost (TFC) (3) Total Variable Cost (TVC) $100 100 100 100 100 100 100 100 100 100 100 $0 90 170 240 300 370 450 540 650 780 930 (4) (5) (6) Total Cost Total Revenue Profit (+) (TC) (TR) or Loss (-) $100 190 270 340 400 470 550 640 750 880 1030 $0 131 262 393 524 655 786 917 1048 1179 1310 $-100 -59 -8 +53 +124 +185 +236 +277 +298 +299 +280 Do You SeeGraph Profit The Maximization? Now Let’s Results… End Show 9-10 Copyright 2008 The McGraw-Hill Companies Marginal Cost and Short-Run Supply Four Market Mode ls Pure Competition Profit Maximizati on in the Short-R un Marginal Cost an d Short-Run Supp ly Changes in Supp ly Profit Maximizati on in the Long Ru n Supply Readjust ment Pure Competition and Efficiency Long-Run Equilib rium Last Word Key Terms End Show 9-18 Continuing the Same Numeric Example… Supply Schedule of a Competitive Firm Quantity Maximum Profit (+) Price Supplied or Minimum Loss (-) $151 10 $+480 131 +299 111 +138 91 -3 81 -64 71 -100 61 -100 The Schedule Shows the Quantity a Firm Will Produce at a Variety of Prices and Results Copyright 2008 The McGraw-Hill Companies Marginal Cost and Short-Run Supply Generalizing the MR=MC Relationship and its Use Cost and Revenues (Dollars) Four Market Mode ls Pure Competition Profit Maximizati on in the Short-R un Marginal Cost an d Short-Run Supp ly Changes in Supp ly Profit Maximizati on in the Long Ru n Supply Readjust ment Pure Competition and Efficiency Long-Run Equilib rium Last Word e P5 d P4 b a End Show AVC This Price is Below AVC And Will Not Be Produced Key Terms Q2 Q3 Q4 Quantity Supplied 9-19 Copyright 2008 The McGraw-Hill Companies MR5 ATC c P3 P2 P1 MC Q5 MR4 MR3 MR2 MR1 Marginal Cost and Short-Run Supply Generalizing the MR=MC Relationship and its Use Examine the MC for the Competitive Firm Cost and Revenues (Dollars) Four Market Mode ls Pure Competition Profit Maximizati on in the Short-R un Marginal Cost an d Short-Run Supp ly Changes in Supp ly Profit Maximizati on in the Long Ru n Supply Readjust ment Pure Competition and Efficiency Long-Run Equilib rium Last Word MC Above AVC Becomes the Short-Run Supply Curve Break-even (Normal Profit) Point P5 d P4 a Shut-Down Point (If P is Below) Q2 Q3 Q4 Quantity Supplied 9-20 Copyright 2008 The McGraw-Hill Companies MR5 AVC b This Price is Below AVC And Will Not Be Produced MC ATC c P3 P2 P1 Key Terms End Show e S Q5 MR4 MR3 MR2 MR1 Changes in Supply Four Market Mode ls Pure Competition Profit Maximizati on in the Short-R un Marginal Cost an d Short-Run Supp ly Changes in Supp ly Profit Maximizati on in the Long Ru n Supply Readjust ment Pure Competition and Efficiency Long-Run Equilib rium Last Word • Firm and Industry –Equilibrium Price –Market Price and Profits –Firm Versus Industry Graphically… Key Terms End Show 9-21 Copyright 2008 The McGraw-Hill Companies Changes in Supply Four Market Mode ls Pure Competition Profit Maximizati on in the Short-R un Marginal Cost an d Short-Run Supp ly Changes in Supp ly Profit Maximizati on in the Long Ru n Supply Readjust ment Pure Competition and Efficiency Long-Run Equilib rium Last Word Single Firm p W 9.3 P S = ∑ MC’s s = MC Economic Profit ATC d $111 $111 AVC D Key Terms Industry p 8000 Competitive Firm Must Take the Price that is Established By Industry Supply and Demand End Show 9-22 Copyright 2008 The McGraw-Hill Companies P 09 Pure Competition in the Long Run McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc All rights reserved Note to Students: • The following material will not be covered, nor is it required reading: – Long Run Supply: Constant-Cost Industry – Long Run Supply: Increasing-Cost Industry – Long Run Supply: Decreasing-Cost Industry Profit Maximization in the Long Run Four Market Mode ls Pure Competition Profit Maximizati on in the Short-R un Marginal Cost an d Short-Run Supp ly Changes in Supp ly Profit Maximizati on in the Long Ru n Supply Readjust ment Pure Competition and Efficiency Long-Run Equilib rium Last Word • Assumptions –Entry and Exit Only –Identical Costs –Constant-Cost Industry • Goal of the Analysis • Long-Run Equilibrium –Entry Eliminates Profits –Exit Eliminates Losses Key Terms End Show 9-25 Copyright 2008 The McGraw-Hill Companies Supply Readjustment Four Market Mode ls Pure Competition Profit Maximizati on in the Short-R un Marginal Cost an d Short-Run Supp ly Changes in Supp ly Profit Maximizati on in the Long Ru n Supply Readjust ment Pure Competition and Efficiency Long-Run Equilib rium Last Word Single Firm Industry p P S1 MC ATC $60 $60 50 50 MR 40 S2 D2 40 D1 100 p 80,000 90,000 100,000 P An Increase in Demand Temporarily Raises Price Higher Prices Draw in New Competitors Increased Supply Returns Price to Equilibrium Key Terms End Show 9-26 Copyright 2008 The McGraw-Hill Companies Supply Readjustment Four Market Mode ls Pure Competition Profit Maximizati on in the Short-R un Marginal Cost an d Short-Run Supp ly Changes in Supp ly Profit Maximizati on in the Long Ru n Supply Readjust ment Pure Competition and Efficiency Long-Run Equilib rium Last Word Single Firm Industry p P S3 MC ATC $60 $60 50 50 MR 40 S1 D1 40 D3 100 p 80,000 90,000 100,000 P A Decrease in Demand Temporarily Lowers Price Lower Prices Drive Away Some Competitors Decreased Supply Returns Price to Equilibrium Key Terms End Show 9-27 Copyright 2008 The McGraw-Hill Companies Pure Competition and Efficiency Four Market Mode ls Pure Competition Profit Maximizati on in the Short-R un Marginal Cost an d Short-Run Supp ly Changes in Supp ly Profit Maximizati on in the Long Ru n Supply Readjust ment Pure Competition and Efficiency Long-Run Equilib rium Last Word Key Terms End Show 9-30 • Productive Efficiency P = Minimum ATC • Allocative Efficiency P = MC • Maximum Consumer and Producer Surplus • Dynamic Adjustments • “Invisible Hand” Revisited O 9.1 Copyright 2008 The McGraw-Hill Companies Long-Run Equilibrium Single Firm P=MC=Minimum ATC (Normal Profit) Market MC S Price ATC Price Four Market Mode ls Pure Competition Profit Maximizati on in the Short-R un Marginal Cost an d Short-Run Supp ly Changes in Supp ly Profit Maximizati on in the Long Ru n Supply Readjust ment Pure Competition and Efficiency Long-Run Equilib rium Last Word Competitive Firm and Market MR P P D Qf Quantity Qe Quantity Productive Efficiency: Price = Minimum ATC Allocative Efficiency: Price = MC Key Terms Pure Competition Has Both in Its Long-Run Equilibrium End Show 9-31 Copyright 2008 The McGraw-Hill Companies Efficiency Gains From Entry: The Case of Generic Drugs Four Market Mode ls Pure Competition Profit Maximizati on in the Short-R un Marginal Cost an d Short-Run Supp ly Changes in Supp ly Profit Maximizati on in the Long Ru n Supply Readjust ment Pure Competition and Efficiency Long-Run Equilib rium Last Word Key Terms End Show 9-32 • Competitive Model Predicts Lower Price and Greater Output With Increased Efficiency When New Producers Enter Market • Example is Patented Drugs • Patents Enable Greater Profits in Support of R&D and Accelerated Cost Recovery • After Patent Period Generics Enter Market • Profits Decrease and Quantities Increase • Combined Consumer and Producer Surpluses Increase Copyright 2008 The McGraw-Hill Companies Efficiency Gains From Entry: The Case of Generic Drugs New Producers Enter Market a S • As Price Initial Patent Price Decreases to f, b c P • Consumer Surplus abc d f P Increases to adf • Producer and Consumer Surplus is D Maximized Q Q Together as Quantity Shown by the Gray Results: Greater Quantity at Lower Prices Triangle as Predicted by the Competitive Model Price Four Market Mode ls Pure Competition Profit Maximizati on in the Short-R un Marginal Cost an d Short-Run Supp ly Changes in Supp ly Profit Maximizati on in the Long Ru n Supply Readjust ment Pure Competition and Efficiency Long-Run Equilib rium Last Word Key Terms End Show 9-33 Copyright 2008 The McGraw-Hill Companies Key Terms Four Market Mode ls Pure Competition Profit Maximizati on in the Short-R un Marginal Cost an d Short-Run Supp ly Changes in Supp ly Profit Maximizati on in the Long Ru n Supply Readjust ment Pure Competition and Efficiency Long-Run Equilib rium Last Word Key Terms End Show 9-34 • pure competition • pure monopoly • monopolistic comp etition • oligopoly • imperfect competition • price taker • average revenue • total revenue • marginal revenue • break-even point • MR=MC • short-run supply curve Copyright 2008 The McGraw-Hill Companies • long-run supply curve • constant-cost industry • increasing-cost industry • decreasing-cost industry • productive efficiency • allocative efficiency • consumer surplus • producer surplus ... 14. 29 12.50 11.11 10.00 (3) Average Variable Cost (AVC) (4) Average Total Cost (ATC) $90 .00 $ 190 .00 85 .00 135.00 80 .00 113.33 75.00 100.00 74.00 94 .00 75.00 91 .67 77.14 91 .43 81 .25 93 .75 86 .67 97 . 78. .. 524 655 786 91 7 10 48 11 79 1310 $-100 - 59 -8 +53 +124 + 185 +236 +277 +2 98 + 299 + 280 Do You SeeGraph Profit The Maximization? Now Let’s Results… End Show 9- 10 Copyright 20 08 The McGraw-Hill Companies... $0 90 170 240 300 370 450 540 650 780 93 0 (4) (5) (6) Total Cost Total Revenue Profit (+) (TC) (TR) or Loss (-) $100 190 270 340 400 470 550 640 750 88 0 1030 $0 131 262 393 524 655 786 91 7 1048