pure competition p = mc chapter twenty-three copyright mcgraw-hill, inc. 1999

Pure CompetitionPure Competition

P = MCP = MC

CHAPTER TWENTY-THREECopyright McGraw-Hill, Inc. 1999

Market Structure ContinuumMarket Structure Continuum

PurePureCompetitionCompetition

PurePureMonopolyMonopoly

MonopolisticMonopolisticCompetitionCompetition OligopolyOligopoly

Copyright McGraw-Hill, Inc. 1999

Four Market ModelsFour Market ModelsPure Competition:Pure Competition:





• Very Large NumbersVery Large Numbers







• Very Large NumbersVery Large Numbers• Standardized ProductStandardized Product







• Very Large NumbersVery Large Numbers• Standardized ProductStandardized Product• “ “Price Taker”Price Taker”



Four Market ModelsFour Market Models





Pure Competition:Pure Competition:• Very Large NumbersVery Large Numbers• Standardized ProductStandardized Product• “ “Price Taker”Price Taker”• Free Entry and ExitFree Entry and Exit


Demand to a Competitive SellerDemand to a Competitive Seller

Perfectly Elastic DemandPerfectly Elastic Demand


In a perfectly competitive market, each individual firm does not have enough power to limit supply in order to raise price. If they charge a higher price no one will buy it from them.


Perfectly Elastic DemandPerfectly Elastic DemandPrice Taker RolePrice Taker Role




Total RevenueTotal Revenue




Total RevenueTotal RevenueAverage RevenueAverage Revenue




Total RevenueTotal RevenueAverage RevenueAverage RevenueMarginal RevenueMarginal Revenue

Graphically...Graphically...Copyright McGraw-Hill, Inc. 1999

Both of these equaldemand which equalsprice – MR. DARP

ProductProductPricePrice

(Average(AverageRevenue)Revenue)

TotalTotalRevenueRevenue

MarginalMarginalRevenueRevenue

$131$131 00 $ 0$ 0]

QuantityQuantityDemandedDemanded

(Sold)(Sold)


$131$131 131131

00 11

$ 0$ 0131131

$131$131]







(Sold)(Sold)

$131$131 131131131131

00 11 22

$ 0$ 0131131262262

] $131$131131131]







(Sold)(Sold)

$131$131 131131131131131131

00 11 2233

$ 0$ 0131131262262393393

] $131$131131131131131

]]







(Sold)(Sold)

$131$131 131131131131131131131131

00 11 223344

$ 0$ 0131131262262393393524524

] $131$131131131131131131131

]]]







(Sold)(Sold)

$131$131 131131131131131131131131131131131131131131131131131131131131

00 11 2233445566778899

1010

$ 0$ 0131131262262393393524524655655786786917917

104810481179117913101310

] $131$131131131131131131131131131131131131131131131131131131131

]]]]]]]]]







(Sold)(Sold)

Perfect CompetitionPerfect CompetitionDemand, Marginal Revenue, and Total RevenueP

rice

, ave

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d m

arg

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rev

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e,P

rice

, ave

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(do

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(do

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Quantity Demanded (sold)Quantity Demanded (sold)1 2 3 4 5 6 7 8 9 101 2 3 4 5 6 7 8 9 10

11791179

10481048

917917

786786

655655

524524

393393

262262

131131

00


Perfect CompetitionPerfect CompetitionDemand, Marginal Revenue, and Total Revenue

D = MRD = MR

PP

1 2 3 4 5 6 7 8 9 101 2 3 4 5 6 7 8 9 10

11791179

10481048

917917

786786

655655

524524

393393

262262

131131

00


Pri

ce, a

vera

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and

mar

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Pri

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and

mar

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tota

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rs)

Quantity Demanded (sold)Quantity Demanded (sold)

This is not market demand but demand forthe individual firm. Because there are so manyproducers of an identical product, the firm in a purely competitive industry must take the goingmarket price.

Perfect CompetitionPerfect CompetitionDemand, Marginal Revenue, and Total Revenue

TRTR

D = MRD = MR

PP

1 2 3 4 5 6 7 8 9 101 2 3 4 5 6 7 8 9 10

11791179

10481048

917917

786786

655655

524524

393393

262262

131131

00


Pri

ce, a

vera

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Pri

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Quantity Demanded (sold)Quantity Demanded (sold)

Short Run Profit MaximizationShort Run Profit MaximizationTwo Approaches...Two Approaches...



Total-Revenue-Total Cost ApproachTotal-Revenue-Total Cost Approach




Should the firm produce?Should the firm produce?




Should the firm produce?Should the firm produce?What quantity should be produced?What quantity should be produced?




Should the firm produce?Should the firm produce?What quantity should be produced?What quantity should be produced?What profit or loss will be realized?What profit or loss will be realized?




Produce in the short-run if it can realizeProduce in the short-run if it can realize





Produce in the short-run if it can realize Produce in the short-run if it can realize 1- A profit (or)1- A profit (or)





Produce in the short-run if it can realize Produce in the short-run if it can realize 1- A profit (or)1- A profit (or)2- A loss less than its fixed costs 2- A loss less than its fixed costs




TotalTotalCostCost

TotalTotalProductProduct

TotalTotalFixedFixedCostCost

TotalTotalVariableVariable

CostCost


00 11 2233445566778899

1010Copyright McGraw-Hill, Inc. 1999

TotalTotalCostCost




CostCost


00 11 2233445566778899

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$ 100$ 100 100100 100100100100100100100100100100100100100100100100100100


TotalTotalCostCost




CostCost


00 11 2233445566778899

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$ 100$ 100 100100 100100100100100100100100100100100100100100100100100100

$ 0$ 09090

170170240240300300370370450450540540650650780780930930


TotalTotalCostCost




CostCost


00 11 2233445566778899

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$ 100$ 100 100100 100100100100100100100100100100100100100100100100100100

$ 0$ 09090

170170240240300300370370450450540540650650780780930930

$ 100$ 100190190270270340340400400470470550550640640750750880880

10301030Copyright McGraw-Hill, Inc. 1999

TotalTotalCostCost




CostCost


00 11 2233445566778899

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$ 100$ 100 100100 100100100100100100100100100100100100100100100100100100

$ 0$ 09090

170170240240300300370370450450540540650650780780930930

$ 100$ 100190190270270340340400400470470550550640640750750880880

10301030

Price: $71Price: $71


TotalTotalCostCost




CostCostTotalTotal

RevenueRevenue ProfitProfit


00 11 2233445566778899

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$ 0$ 07171

142142213213284284355355426426497497568568639639710710

$ 100$ 100 100100 100100100100100100100100100100100100100100100100100100

$ 0$ 09090

170170240240300300370370450450540540650650780780930930

$ 100$ 100190190270270340340400400470470550550640640750750880880

10301030



TotalTotalCostCost




CostCostTotalTotal



TotalTotalCostCost

00 11 2233445566778899

1010




CostCostTotalTotal


$ 100$ 100 100100 100100100100100100100100100100100100100100100100100100

$ 0$ 09090

170170240240300300370370450450540540650650780780930930

$ 100$ 100190190270270340340400400470470550550640640750750880880

10301030


- $100- $100- 119- 119- 128- 128- 127- 127- 116- 116- 115- 115- 124- 124- 143- 143- 182- 182- 241- 241- 320- 320


$ 0$ 07171

142142213213284284355355426426497497568568639639710710


TotalTotalCostCost

00 11 2233445566778899

1010




CostCostTotalTotal


$ 100$ 100 100100 100100100100100100100100100100100100100100100100100100

$ 0$ 09090

170170240240300300370370450450540540650650780780930930

$ 100$ 100190190270270340340400400470470550550640640750750880880

10301030


- $100- $100- 119- 119- 128- 128- 127- 127- 116- 116- 115- 115- 124- 124- 143- 143- 182- 182- 241- 241- 320- 320


$ 0$ 07171

142142213213284284355355426426497497568568639639710710


No profit and theNo profit and theloss is greater thanloss is greater than

its fixed costsits fixed costs

Shut Down!Shut Down!

TotalTotalCostCost

00 11 2233445566778899

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CostCostTotalTotal


$ 100$ 100 100100 100100100100100100100100100100100100100100100100100100

$ 0$ 09090

170170240240300300370370450450540540650650780780930930

$ 100$ 100190190270270340340400400470470550550640640750750880880

10301030


- $100- $100- 119- 119- 128- 128- 127- 127- 116- 116- 115- 115- 124- 124- 143- 143- 182- 182- 241- 241- 320- 320


$ 0$ 07171

142142213213284284355355426426497497568568639639710710


No profit and theNo profit and theloss is greater thanloss is greater than

its fixed costsits fixed costs

Shut Down!Shut Down!

How aboutHow abouta highera higherprice?price?

00 11 2233445566778899

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$ 0$ 08181

162162243243324324405405486486567567648648729729810810

$ 100$ 100 100100 100100100100100100100100100100100100100100100100100100

$ 0$ 09090

170170240240300300370370450450540540650650780780930930

$ 100$ 100190190270270340340400400470470550550640640750750880880

10301030


- $100- $100- 109- 109- 108- 108

- 97- 97- 76- 76- 65- 65- 64- 64- 73- 73

- 102- 102- 151- 151- 220- 220


TotalTotalCostCost




CostCostTotalTotal



00 11 2233445566778899

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$ 0$ 08181

162162243243324324405405486486567567648648729729810810

$ 100$ 100 100100 100100100100100100100100100100100100100100100100100100

$ 0$ 09090

170170240240300300370370450450540540650650780780930930

$ 100$ 100190190270270340340400400470470550550640640750750880880

10301030


- $100- $100- 109- 109- 108- 108

- 97- 97- 76- 76- 65- 65- 64- 64- 73- 73

- 102- 102- 151- 151- 220- 220

Still no profitStill no profitbut losses arebut losses areless than theless than the

firm’s fixed costsfirm’s fixed costs


TotalTotalCostCost




CostCostTotalTotal



TotalTotalCostCost




CostCostTotalTotal



00 11 2233445566778899

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$ 0$ 08181

162162243243324324405405486486567567648648729729810810

$ 100$ 100 100100 100100100100100100100100100100100100100100100100100100

$ 0$ 09090

170170240240300300370370450450540540650650780780930930

$ 100$ 100190190270270340340400400470470550550640640750750880880

10301030


- $100- $100- 109- 109- 108- 108

- 97- 97- 76- 76- 65- 65- 64- 64- 73- 73

- 102- 102- 151- 151- 220- 220

Keep producingKeep producingin the short-run:in the short-run:Look at a higherLook at a higher

priceprice


Still no profitStill no profitbut losses arebut losses areless than theless than the

firm’s fixed costsfirm’s fixed costs

TotalTotalCostCost




CostCostTotalTotal



00 11 2233445566778899

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$ 0$ 0131131262262393393524524655655786786917917

104810481179117913101310

$ 100$ 100 100100 100100100100100100100100100100100100100100100100100100

$ 0$ 09090

170170240240300300370370450450540540650650780780930930

$ 100$ 100190190270270340340400400470470550550640640750750880880

10301030


- $100- $100- 59- 59

- 8- 8+ 53+ 53

+ 124+ 124+ 185+ 185+ 236+ 236+ 277+ 277+ 298+ 298+ 299+ 299+ 280+ 280

Can you see the

Can you see the

profit maxim

ization?

profit maxim

ization?


00 11 2233445566778899

1010

$ 0$ 0131131262262393393524524655655786786917917

104810481179117913101310

$ 100$ 100 100100 100100100100100100100100100100100100100100100100100100

$ 0$ 09090

170170240240300300370370450450540540650650780780930930

$ 100$ 100190190270270340340400400470470550550640640750750880880

10301030


- $100- $100- 59- 59

- 8- 8+ 53+ 53

+ 124+ 124+ 185+ 185+ 236+ 236+ 277+ 277+ 298+ 298+ 299+ 299+ 280+ 280


TotalTotalCostCost




CostCostTotalTotal



TotalTotalCostCost




CostCostTotalTotal



00 11 2233445566778899

1010

$ 0$ 0131131262262393393524524655655786786917917

104810481179117913101310

$ 100$ 100 100100 100100100100100100100100100100100100100100100100100100

$ 0$ 09090

170170240240300300370370450450540540650650780780930930

$ 100$ 100190190270270340340400400470470550550640640750750880880

10301030


- $100- $100- 59- 59

- 8- 8+ 53+ 53

+ 124+ 124+ 185+ 185+ 236+ 236+ 277+ 277+ 298+ 298+ 299+ 299+ 280+ 280

Graphically...Graphically...


Total-Revenue-Total Cost ApproachTotal-Revenue-Total Cost Approach1,7001,7001,6001,6001,5001,5001,4001,4001,3001,3001,2001,2001,1001,1001,0001,000 900900 800800 700700 600600 500500 400400 300300 200200 100100 00

PPT

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Copyright McGraw-Hill, Inc. 1999 1 2 3 4 5 6 7 8 9 10 11 12 13 141 2 3 4 5 6 7 8 9 10 11 12 13 14 QQ


PPT

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and

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PPT

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TotalTotalCostCost



PPT

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TotalTotalCostCost

{

MaximumMaximumEconomicEconomic

ProfitsProfits$299$299

Break-Even Point(Normal Profit)

TR(P=$131)TR(P=$131)

Break-Even Point(Normal Profit)


Marginal Revenue - Marginal Revenue - Marginal Cost ApproachMarginal Cost Approach





MR = MC RuleMR = MC RuleFeatures:Features:






• MR = MC profit maximization in all marketsMR = MC profit maximization in all markets






• MR = MC profit maximization in all markets MR = MC profit maximization in all markets • Competitive markets maximize atCompetitive markets maximize at P = MCP = MC






• MR = MC profit maximization in all markets MR = MC profit maximization in all markets • Competitive markets maximize atCompetitive markets maximize at P = MCP = MC• Firms should produce MR=MC provided Firms should produce MR=MC provided MR (P) > AVC, if not then shut down.MR (P) > AVC, if not then shut down.




00 11 2233445566778899

1010

100.00100.00 50.0050.00 33.3333.3325.0025.0020.0020.0016.6716.6714.2914.2912.5012.5011.1111.1110.0010.00

90.0090.0085.0085.0080.0080.0075.0075.0074.0074.0075.0075.0077.1477.1481.2581.2586.6786.6793.0093.00

190.00190.00135.00135.00113.33113.33100.00100.00

94.0094.0091.6791.6791.4391.4393.7593.7594.7894.78

103.00103.00

Marginal-Revenue-Marginal Cost ApproachMarginal-Revenue-Marginal Cost Approach

]]]]]]]]]]


AverageAverageTotalTotalCostCost


AverageAverageFixedFixedCostCost

AverageAverageVariableVariable

CostCostMarginalMarginal

CostCost

TotalTotalEconomicEconomicProf./LossProf./Loss

Price =Price =MarginalMarginalRevenueRevenue

00 11 2233445566778899

1010

9090808070706060707080809090

110110130130150150

100.00100.00 50.0050.00 33.3333.3325.0025.0020.0020.0016.6716.6714.2914.2912.5012.5011.1111.1110.0010.00

90.0090.0085.0085.0080.0080.0075.0075.0074.0074.0075.0075.0077.1477.1481.2581.2586.6786.6793.0093.00

190.00190.00135.00135.00113.33113.33100.00100.00

94.0094.0091.6791.6791.4391.4393.7593.7594.7894.78

103.00103.00


]]]]]]]]]]







CostCost



00 11 2233445566778899

1010

9090808070706060707080809090

110110130130150150

100.00100.00 50.0050.00 33.3333.3325.0025.0020.0020.0016.6716.6714.2914.2912.5012.5011.1111.1110.0010.00

90.0090.0085.0085.0080.0080.0075.0075.0074.0074.0075.0075.0077.1477.1481.2581.2586.6786.6793.0093.00

190.00190.00135.00135.00113.33113.33100.00100.00

94.0094.0091.6791.6791.4391.4393.7593.7594.7894.78

103.00103.00


$ 131$ 131131131131131131131131131131131131131131131131131131131

]]]]]]]]]]







CostCost



00 11 2233445566778899

1010

9090808070706060707080809090

110110130130150150

100.00100.00 50.0050.00 33.3333.3325.0025.0020.0020.0016.6716.6714.2914.2912.5012.5011.1111.1110.0010.00

90.0090.0085.0085.0080.0080.0075.0075.0074.0074.0075.0075.0077.1477.1481.2581.2586.6786.6793.0093.00

190.00190.00135.00135.00113.33113.33100.00100.00

94.0094.0091.6791.6791.4391.4393.7593.7594.7894.78

103.00103.00

- $100- $100- 59- 59

- 8- 8+ 53+ 53

+ 124+ 124+ 185+ 185+ 236+ 236+ 277+ 277+ 298+ 298+ 299+ 299+ 280+ 280


$ 131$ 131131131131131131131131131131131131131131131131131131131

]]]]]]]]]]







CostCost








CostCost



00 11 2233445566778899

1010

9090808070706060707080809090

110110130130150150

100.00100.00 50.0050.00 33.3333.3325.0025.0020.0020.0016.6716.6714.2914.2912.5012.5011.1111.1110.0010.00

90.0090.0085.0085.0080.0080.0075.0075.0074.0074.0075.0075.0077.1477.1481.2581.2586.6786.6793.0093.00

190.00190.00135.00135.00113.33113.33100.00100.00

94.0094.0091.6791.6791.4391.4393.7593.7594.7894.78

103.00103.00

- $100- $100- 59- 59

- 8- 8+ 53+ 53

+ 124+ 124+ 185+ 185+ 236+ 236+ 277+ 277+ 298+ 298+ 299+ 299+ 280+ 280


$ 131$ 131131131131131131131131131131131131131131131131131131131

]]]]]]]]]]

TheThesame profitsame profitmaximizingmaximizing

result!result!







CostCost



00 11 2233445566778899

1010

9090808070706060707080809090

110110130130150150

100.00100.00 50.0050.00 33.3333.3325.0025.0020.0020.0016.6716.6714.2914.2912.5012.5011.1111.1110.0010.00

90.0090.0085.0085.0080.0080.0075.0075.0074.0074.0075.0075.0077.1477.1481.2581.2586.6786.6793.0093.00

190.00190.00135.00135.00113.33113.33100.00100.00

94.0094.0091.6791.6791.4391.4393.7593.7594.7894.78

103.00103.00

- $100- $100- 59- 59

- 8- 8+ 53+ 53

+ 124+ 124+ 185+ 185+ 236+ 236+ 277+ 277+ 298+ 298+ 299+ 299+ 280+ 280


$ 131$ 131131131131131131131131131131131131131131131131131131131

]]]]]]]]]]


TheThesame profitsame profitmaximizingmaximizing

result!result!

Graphically...

Graphically...

Graphically...

Graphically...

To

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1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10

PP

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200200

150150

100100

5050

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To

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1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10

PP

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MRMR

200200

150150

100100

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131131


To

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1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10

PP

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MRMR

AVCAVC

200200

150150

100100

5050

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131131


To

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1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10

PP

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MRMR

AVCAVCATCATC

200200

150150

100100

5050

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131131


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1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10

PP

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MCMC

MRMR

AVCAVCATCATC

200200

150150

100100

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131131


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1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10

PP

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200200

150150

100100

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131131

MCMC

MRMR

AVCAVCATCATC

Economic ProfitEconomic Profit

97.7897.78


To

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1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10

PP

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MCMC

MRMR

AVCAVCATCATC

200200

150150

100100

5050

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131131

97.7897.78

MR = MCMR = MCOptimumOptimumSolutionSolution


Economic ProfitEconomic Profit

Marginal Revenue -Marginal Revenue -Marginal Cost Approach...Marginal Cost Approach...

to Short-run loss minimizationto Short-run loss minimization




If the price is lowered from $131 to $81If the price is lowered from $131 to $81




If the price is lowered from $131 to $81If the price is lowered from $131 to $81

The MR = MC point changes...The MR = MC point changes...


00 11 2233445566778899

1010

9090808070706060707080809090

110110130130150150

100.00100.00 50.0050.00 33.3333.3325.0025.0020.0020.0016.6716.6714.2914.2912.5012.5011.1111.1110.0010.00

90.0090.0085.0085.0080.0080.0075.0075.0074.0074.0075.0075.0077.1477.1481.2581.2586.6786.6793.0093.00

190.00190.00135.00135.00113.33113.33100.00100.00

94.0094.0091.6791.6791.4391.4393.7593.7594.7894.78

103.00103.00


]]]]]]]]]]







CostCost



To

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ven

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and

to

tal

cost

s (d

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ars)


1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10

PP

QQ

200200

150150

100100

5050

00

MCMC

AVCAVCATCATC


To

tal

reve

nu

e an

d t

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(do

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and

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1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10

PP

QQ

200200

150150

100100

5050

00

8181

MCMC

MRMR

AVCAVCATCATC


To minimize losses always look at the place whereMR = MC in the increasing portion of the MC curve.

00 11 2233445566778899

1010

$ 0$ 08181

162162243243324324405405486486567567648648729729810810

$ 100$ 100 100100 100100100100100100100100100100100100100100100100100100

$ 0$ 09090

170170240240300300370370450450540540650650780780930930

$ 100$ 100190190270270340340400400470470550550640640750750880880

10301030


- $100- $100- 109- 109- 108- 108

- 97- 97- 76- 76- 65- 65- 64- 64- 73- 73

- 102- 102- 151- 151- 220- 220


TotalTotalCostCost




CostCostTotalTotal



To

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(do

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and

to

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1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10

PP

QQ

200200

150150

100100

5050

00

8181

MCMC

MRMR

AVCAVCATCATC

Economic LossEconomic Loss


To

tal

reve

nu

e an

d t

ota

l co

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(do

llar

s)T

ota

l re

ven

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and

to

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1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10

PP

QQ

200200

150150

100100

5050

00

8181

MCMC

MRMR

AVCAVCATCATC


Economic LossEconomic LossWith economic losses,With economic losses,at what point should theat what point should the

firm shut down operations?firm shut down operations?

To

tal

reve

nu

e an

d t

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(do

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s)T

ota

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and

to

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cost

s (d

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ars)


1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10

PP

QQ

200200

150150

100100

5050

00

7171

MCMC

MRMR

AVCAVCATCATC


When price is inadequateWhen price is inadequateto meet minimum AVC,to meet minimum AVC,the firm should shut downthe firm should shut down


00 11 2233445566778899

1010

9090808070706060707080809090

110110130130150150

100.00100.00 50.0050.00 33.3333.3325.0025.0020.0020.0016.6716.6714.2914.2912.5012.5011.1111.1110.0010.00

90.0090.0085.0085.0080.0080.0075.0075.0074.0074.0075.0075.0077.1477.1481.2581.2586.6786.6793.0093.00

190.00190.00135.00135.00113.33113.33100.00100.00

94.0094.0091.6791.6791.4391.4393.7593.7594.7894.78

103.00103.00


]]]]]]]]]]







CostCost



To

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(do

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l re

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and

to

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cost

s (d

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1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10

PP

QQ

200200

150150

100100

5050

00

7171

MCMC

MRMR

AVCAVCATCATC


When price is inadequateWhen price is inadequateto meet minimum AVC,to meet minimum AVC,the firm should shut downthe firm should shut down


Another use of th

e

Another use of th

e

marginal cost curve...

marginal cost curve...

P = MC Short - run Supply CurveP = MC Short - run Supply CurvePP

QQ

MCMC

AVCAVC

ATCATC

At every price, theAt every price, theMR = MC pointMR = MC point

changes the quantitychanges the quantitybeing exchanged...being exchanged...

Co

sts

and

rev

enu

es (

do

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ost

s an

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even

ues

(d

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ars)


P = MC Short - run Supply CurveP = MC Short - run Supply CurvePP

QQ

MCMC

AVCAVC

ATCATC

PP33 MRMR33

QQ33

Record theRecord thequantity beingquantity being

supplied forsupplied foreach priceeach price

Co

sts

and

rev

enu

es (

do

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s)C

ost

s an

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(d

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Marginal-Revenue-Marginal Cost ApproachMarginal-Revenue-Marginal Cost ApproachPP

QQ

MCMC

AVCAVC

ATCATC

MRMR22

MRMR33PP22

PP33

QQ22 QQ33

At a lower priceAt a lower pricea lower quantitya lower quantitywill be suppliedwill be suppliedC

ost

s an

d r

even

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(d

oll

ars)

Co

sts

and

rev

enu

es (

do

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QQ

MCMC

AVCAVC

ATCATC

MRMR22

MRMR33

MRMR44

PP22

PP33

PP44

QQ33QQ44

At a higher priceAt a higher pricea greater quantitya greater quantitywill be suppliedwill be supplied

QQ22

Break-evenBreak-even(normal profit)(normal profit)

pointpointC

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(d

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ars)

Co

sts

and

rev

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es (

do

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s)



QQ

MCMC

AVCAVC

ATCATC

MRMR22

MRMR33

MRMR44

MRMR55

PP22

PP33

PP44

PP55

QQ22 QQ33QQ44 QQ55


pointpointC

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(d

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Co

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and

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QQ


PP11

MCMC

MRMR11

AVCAVC

ATCATC

MRMR22

MRMR33

MRMR44

MRMR55

PP22

PP33

PP44

PP55

QQ22 QQ33QQ44 QQ55


pointpointC

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Co

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and

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do

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Firm should notFirm should notproduce unlessproduce unless

revenue is at leastrevenue is at leastable to meet AVCable to meet AVC


QQ

PP11

MCMC

MRMR11

AVCAVC

ATCATC

MRMR22

MRMR33

MRMR44

MRMR55

PP22

PP33

PP44

PP55

QQ22 QQ33QQ44 QQ55


pointpointC

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(d

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Co

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and

rev

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The MarginalThe MarginalCost Curve at points aboveCost Curve at points aboveAVC represent the short-runAVC represent the short-run

supply curvesupply curve


QQ

PP11

MCMC

MRMR11

AVCAVC

ATCATC

MRMR22

MRMR33

MRMR44

MRMR55

PP22

PP33

PP44

PP55

QQ22 QQ33QQ44 QQ55

Short-runShort-runSupply CurveSupply Curve

(blue)(blue)C

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d r

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(d

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ars)

Co

sts

and

rev

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es (

do

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s)



QQ

MCMC11

AVCAVC11

If costs increase...If costs increase...the supply curvethe supply curveeffectively shiftseffectively shiftsto the leftto the left



QQ

MCMC11

AVCAVC11

If costs increase...If costs increase...the supply curvethe supply curveeffectively shiftseffectively shiftsto the leftto the left

MCMC22

AVCAVC22



QQ

MCMC11

AVCAVC11

If costs decrease...If costs decrease...the supply curvethe supply curveeffectively shiftseffectively shiftsto the rightto the right MCMC22

AVCAVC22


Short-run Competitive EquilibriumShort-run Competitive Equilibrium

PP

QQ

PP

QQ

DD

IndustryIndustryFirmFirm(price taker)(price taker)

TotalTotalIndustryIndustryDemandDemand



PP

QQ

PP

QQ80008000

DD

S= S= MC’s MC’s


$111$111

Include theInclude thefirm’s costs firm’s costs

MCMC



PP

QQ

MCMC

AVCAVC

ATCATC

PP

QQ80008000

DD

S= S= MC’s MC’s


The firm The firm “takes”“takes”the Industry Pricethe Industry Price

$111$111



PP

QQ

MCMC

AVCAVC

ATCATC

88

DD

PP

QQ80008000

DD

S= S= MC’s MC’s


$111$111$111$111



PP

QQ

MCMC

AVCAVC

ATCATC

88

DD

PP

QQ80008000

DD

S= S= MC’s MC’s


EconomicEconomicProfitProfit

$111$111$111$111



PP

QQ

MCMC

AVCAVC

ATCATC

88

DD

PP

QQ80008000

DD

S= S= MC’s MC’s


EconomicEconomicProfitProfit

$111$111$111$111


How about theHow about thelong-run?long-run?

Long-run Profit MaximizationLong-run Profit Maximization

Assumptions...Assumptions...



Assumptions...Assumptions...• Entry and Exit OnlyEntry and Exit Only



Assumptions...Assumptions...• Entry and Exit OnlyEntry and Exit Only• Identical CostsIdentical Costs



Assumptions...Assumptions...• Entry and Exit OnlyEntry and Exit Only• Identical CostsIdentical Costs• Constant-Cost IndustryConstant-Cost Industry




Goal...Goal...




Goal...Goal...Price = Minimum ATCPrice = Minimum ATC




Goal...Goal...Price = Minimum ATCPrice = Minimum ATCZero Economic Profit Model...Zero Economic Profit Model...


PP

QQ

MCMCPP

QQ

DD11

SS11


ATCATC

MRMR$60$60$50 $50 $40$40

$100$100 $90,000$90,000

$60$60$50 $50 $40$40

$100,000$100,000

What happens if demand decreases...What happens if demand decreases...



PP

QQ

MCMCPP

QQ

DD11

SS11


ATCATC

MRMR$60$60$50 $50 $40$40

$100$100 $90,000$90,000

DD22

$60$60$50 $50 $40$40

$100,000$100,000

Short-run losses at lower prices...Short-run losses at lower prices...



PP

QQ

MCMCPP

QQ

DD11

SS11


ATCATC

MRMR$60$60$50 $50 $40$40

$100$100 $90,000$90,000

DD22

SS33

$100,000$100,000

...cause a reduction in supply and......cause a reduction in supply and...

$60$60$50 $50 $40$40



PP

QQ

MCMCPP

QQ

DD11

SS11


ATCATC

MRMR$60$60$50 $50 $40$40

$100$100 $90,000$90,000

DD22

SS33

$60$60$50 $50 $40$40

$100,000$100,000

...returns to a new equilibrium...returns to a new equilibrium



Pure Competition and EfficiencyPure Competition and Efficiency

Productive EfficiencyProductive Efficiency



Productive EfficiencyProductive EfficiencyPrice = Minimum ATCPrice = Minimum ATC


Goods produced in the least costly way. The firm is producing the greatest output consistent with its costs.



Allocative EfficiencyAllocative Efficiency


Requires that goods be produced according to that which is most valued by society.



Allocative EfficiencyAllocative EfficiencyPrice = MCPrice = MC





UnderallocationUnderallocation





UnderallocationUnderallocationPrice > MCPrice > MC


Society values that product more and firms will enter.





OverallocationOverallocation


Society values that product less and firms will leave.





OverallocationOverallocationPrice < MCPrice < MC


PP

QQ

MCMCPP

QQ

DD11

SS11


ATCATC

MRMR$60$60$50 $50 $40$40

$100$100 $90,000$90,000

$60$60$50 $50 $40$40

$100,000$100,000

What happens if demand decreases...What happens if demand decreases...







OverallocationOverallocationPrice < MCPrice < MC


Resources areResources areefficiently allocatedefficiently allocatedunder competitionunder competition

pure competitionpure competition pure monopolypure monopoly monopolistic monopolistic

competitioncompetition oligopolyoligopoly imperfect imperfect

competitioncompetition price takerprice taker average revenueaverage revenue total revenuetotal revenue marginal revenuemarginal revenue

break-even pointbreak-even point MR = MC ruleMR = MC rule short-run supply curveshort-run supply curve long-run supply curvelong-run supply curve constant-cost industryconstant-cost industry increasing-cost increasing-cost

industryindustry decreasing-cost decreasing-cost

industryindustry productive efficiencyproductive efficiency allocative efficiencyallocative efficiency


Coming Next...Coming Next...

Pure MonopolyPure Monopoly

Chapter 24Chapter 24


pure competition p = mc chapter twenty-three copyright mcgraw-hill, inc. 1999

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