Pure Competition Pure Monopoly Monopolistic Competition Oligopoly

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2 Pure Competition Pure Monopoly Monopolistic Competition Oligopoly

3 Characteristics: Rare in the real world But helps analyze industries which are similar to pure competition Many sellers means that no one seller has an impact on price by its decisions alone Products are standardized Firms are price-takers must accept the market price Firms can freely enter and exit the market

4 Individual firm will view its demand as perfectly elastic BUT the demand curve is not perfectly elastic for the industry WHY the difference?? IMPORTANT: When you graph this for a quiz/test, you want to put the industry first and then the firm!!! Individual Firm s Demand Curve Firm is a PRICE TAKER Industry s Demand Curve Industry s Supply Curve

5 Total Revenue (TR) = Price multiplied by quantity sold (TR = P x Q) Average Revenue (AR)= price per unit for each firm in pure competition Marginal Revenue (MR) = in TR for each additional quantity sold AND will equal the unit price in conditions of pure competition

6 Assumptions of the Firm Fixed plant By adjusting output: Will maximize profits OR Will minimize losses Profits = TR-TC 3 Questions each firm must answer: 1. Should the firm produce 2. If so, how much? 3. What will be the profit or loss?

7 Total Cost vs. Total Revenue Firms should produce if the difference between TR and TC results in a profit (TR > TC) Firms should produce that output which maximizes its profit or minimizes its loss Profit (or loss) = TR TC So where do firms maximize profit?

8 Marginal Revenue vs. Marginal Cost The firm will keep producing if MR > MC (the firm is still seeking profits) The firm will stop producing at the point where MR < MC (i.e. the firm does not want to incur losses) The Profit Maximization/Loss Minimization Rule =

9 In the short run, the firm may keep producing even if Total Cost is higher than Total Revenue However, the firm may choose to SHUT DOWN if increases in Total Revenue does not cover Average Variable Costs at the production output The Shut Down Rule: For ALL Firms: If MR < AVC (average variable cost) at the production output, the firm will shut down In perfect competition then P < AVC

10 Equilibrium price is where total QS = total QD Sum of individual firms production = industry (or total) QS Individual firms must take equilibrium price ( price takers ) Supply plans of all competitive producers is a major determinant of product price

11 Assumptions: 1. Entry and exit of firms are the only longrun adjustments 2. Firms in the industry have identical cost curves 3. The industry is a constant-cost industry (i.e. entry and exit of firms doesn t affect costs of the individual firms)

12 Product price = Each firm s point of minimum long run average total cost (LRATC) i.e. NORMAL PROFITS In the Short Run though: If short term losses occur, firms leave the industry Qs decreases, P increases, profits increase If short term economic profits occur, firms will enter the industry Qs increases, P decreases, profits decrease or losses occur/increase

13 Long run Supply: Constant cost industry Perfectly elastic supply curve (HORIZONTAL) Level of output will not affect the price in the long run Expansion or contraction does not affect resource prices or production costs Entry/exit will affect quantity of output but price will always revert to equilibrium price

14 Long run Supply: Increasing cost industry Average cost curves shift upward as industry expands and downwards when it contracts If D increases, ATC increase as firms enter the industry, and P increases to maintain normal profit If D decreases, ATC decreases as firms exit the industry, P decreases, firms cannot attain above-normal profit

15 Long-run Supply Decreasing cost industry Supply will be downward sloping ATC falls as the industry expands Firms will enter until price is driven down to maintain normal profits

16 Regardless of cost model, long run equilibrium will have the same characteristics: The firm will make only NORMAL PROFITS Productive efficiency occurs when P = minimum LRATC Allocative efficiency occurs when P = MC If P > MC, then society values more units of good X and resources are underallocated to the production of good X If P < MC, then society values other goods more highly than good X and resources are overallocated to good X

17 Allocative efficiency implies maximum consumer and supplier surplus Combined consumer and supplier surplus is maximized at the equilibrium price

18 On a piece of paper, draw the following graphs The perfectly competitive market The perfectly competitive firm Show the relationship between the market price and the firm s price Include on the firm s graph the following: The Demand and Marginal Revenue Curve (D/MR) The LONG RUN Avg Total Cost Curve (LRATC) The LONG RUN Avg Varible Cost Curve (LRATC) The LONG RUN Avg Fixed Cost Curve (LRAFC) The Marginal Cost Curve (MC)

19 On a piece of paper, draw the following graphs The perfectly competitive market The perfectly competitive firm Show the relationship between the market price and the firm s price Include on the firm s graph the following: The Demand and Marginal Revenue Curve (D/MR) Show the firm making economic profits by drawing: The SHORT RUN Avg Total Cost Curve (SRATC) The SHORT RUN Avg Varible Cost Curve (SRATC) The SHORT RUN Avg Fixed Cost Curve (SRAFC) The Marginal Cost Curve (MC)

20 On a piece of paper, draw the following graphs The perfectly competitive market The perfectly competitive firm Show the relationship between the market price and the firm s price Include on the firm s graph the following: The Demand and Marginal Revenue Curve (D/MR) Show the firm making economic losses by drawing: The SHORT RUN Avg Total Cost Curve (SRATC) The SHORT RUN Avg Varible Cost Curve (SRATC) The SHORT RUN Avg Fixed Cost Curve (SRAFC) The Marginal Cost Curve (MC)

21 On a piece of paper, draw the following graphs The perfectly competitive market The perfectly competitive firm Show the relationship between the market price and the firm s price Include on the firm s graph the following: The Demand and Marginal Revenue Curve Show the firm making following the SHUT DOWN RULE by drawing: The SHORT RUN Avg Total Cost Curve (SRATC) The SHORT RUN Avg Varible Cost Curve (SRATC) The SHORT RUN Avg Fixed Cost Curve (SRAFC) The Marginal Cost Curve (MC)

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