Chapter 23

Chapter 23 – Pure Competition

Group Industries into

Pure Monopoly – One firm is the sole seller of a product/supplier of a service

Monopolistic competition -  A large number of sellers sell differentiated products, this protects them from competition

Pure competition – A large number of firms producing similar goods

Oligopoly – Only a few sellers of similar or differentiated products such that they are affected by the actions of their rivals

Pure  Competition – Very large numbers of providers offered in markets,  standardized product – if the price is the same, buyers are indifferent to supplier, Price Takers – individual firms exert little or no control over product price, cannot change supply significantly so they have to accept the price given by the market, Free entry and exit – No significant legal, technological, financial or other attributes can stop them

Relevance – Although relatively rare, apparent in agricultural products etc and as a relative model to analyze efficiency

Demand as seen by a purely Competitive seller

Perfectly elastic demand – for each competitive firm

Average, total and Marginal Revenue – Demand Schedule is also its average revenue schedule

                Total revenue – price*quantity

                Marginal Revenue – the extra revenue generated by selling one more of an object

Graphical Portrayl – D is horizontal, TR is a straight slope up increasing by Marginal revenue

Profit maximization in the short run – Can only adjust its output, only through changes in the amount of variable resources (materials, labor) it uses

Total-revenue – Total cost approach – Profit maximization case – The producer will react to the market price by asking If they should produce the good and if so in what amount and what profit they will realize

Total revenue and total cost are equal where the total cost and total revenue curves intersect, here total revenue covers all costs but no profit is realized, this is the break-even point

Marginal-Revenue, Marginal-Cost technique

Should produce any unit who’s Marginal Revenue is greater then its marginal cost

At lower end of production, MC < style="mso-spacerun:yes">  There is a point where MC = MR, <= That is the point where you want to be as long as producing is preferable to shutting down

Three Characteristics of the MR = MC rule – 1) Only applies if producing is preferable to shutting down 2) The rule is accurate for any of the industry types 3) The rule can be restated as P = MC when applied to a purely competitive firm because demand is pretty much perfectly elastic at the market price

If you are going to sustain losses, if the marginal revenue per item is greater then the AVC, then you should produce

If the AVC is greater than the price always then you should shut down

Marginal Cost and Short-run Supply – Quantity supplied increases as price goes up

Very Important – know what should happen at every price on 23.6

Generalized depiction – Graph 23.6 – It helps to think that Price is the independent variable (price takers) and that ATC, AVC and MC curves are dictated by production techniques/demand.  MC = MR =  P because the market is perfectly competitive

At P1 – the firm should not produce because P1 <>

At P2 – P2 = the minimum AVC so the firm should produce that quantity such that MR = MC, it will lose its fixed cost

At P3 – P3 is on the MC cost curve such that MR = P = MC, this would minimize its short term loses

At P4 – where MC = ATC, the firm will just break even, Normal, but no Economic profit

Above P4, the firm will have an economic profit because MC is greater than ATC, Should be where MC = P = MR

Points along the MC graph are the optimal upsloping supply curve of the firm.  At any point below where AVC intersects MC, the company should shut down

Diminishing returns, production costs and product supply – b/c of the law of diminishing returns, marginal costs rise with output (and thus a higher price must be provided)

Changes in supply – costs go up, supply goes down

Firm and Industry: equilibrium price – In a purely competitive market – equilibrium price is determined by total suplly and demand, must sum supply curves then calculate the market supply schedule which determines product price