Lecture Economics (18th edition): Chapter 9 - McConnell, Brue, Flynn''s

Chapter 9 - Pure competition. After completing this unit, you should be able to: The four basic market models, conditions for pure competition, profit maximization for competitive firms, the competitive firm supply curve, industry entry and exit, industry cost structure, economic efficiency.

Chapter Pure Competition McGrawưHill/Irwin Copyrightâ2009byTheMcGrawưHillCompanies,Inc.Allrightsreserved Chapter Objectives The four basic market models • Conditions for pure competition • Profit maximization for competitive firms • The competitive firm supply curve • Industry entry and exit • Industry cost structure • Economic efficiency 9-2 Four Market Models • • • • Pure competition Pure monopoly Monopolistic competition Oligopoly Imperfect Competition Pure Competition Monopolistic Competition Oligopoly Pure Monopoly Market Structure Continuum 9-3 Pure Competition • • • • • Very large numbers Standardized product “Price takers” Free entry and exit Perfectly elastic demand – Average revenue – Marginal revenue – Price 9-4 Pure Competition $1179 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 Firm’s Demand Schedule (Average Revenue) 786 655 524 393 262 D = MR = AR 131 10 Quantity Demanded (Sold) 12 9-5 Short Run Profit Maximization • Market price is given • Three questions: – Should the product be produced? – If so, in what amount? – What economic profit (loss) will be realized? 9-6 Profit Maximization • Two approaches • Total revenue and total cost approach – Produce where TR-TC is greatest • Marginal revenue and marginal cost approach – Produce where MR=MC 9-7 Total Revenue Total Cost Approach Price = $131 (1) Total Product (Output) (Q) 10 (2) Total Fixed Cost (TFC) $100 100 100 100 100 100 100 100 100 100 100 (3) (4) (5) (6) Total Variable Total Cost Total Revenue Profit (+) Cost (TVC) (TC) (TR) or Loss (-) $0 90 170 240 300 370 450 540 650 780 930 $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… 9-8 Total Revenue Total Cost Approach Total Economic Profit Total Revenue and Total Cost $1800 1700 1600 1500 1400 1300 1200 1100 1000 900 800 700 600 500 400 300 200 100 $500 400 300 200 100 Break-Even Point (Normal Profit) Total Revenue, (TR) Maximum Economic Profit $299 Total Cost, (TC) P=$131 Break-Even Point (Normal Profit) 10 11 1213 14 Quantity Demanded (Sold) Total Economic Profit $299 10 11 12 13 14 Quantity Demanded (Sold) 9-9 Marginal Revenue Marginal Cost Approach (1) Total Product (Output) 10 (2) Average Fixed Cost (AFC) $100.00 50.00 33.33 25.00 20.00 16.67 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 93.00 103.00 (5) Marginal Cost (MC) $90 80 70 60 70 80 90 110 130 150 (6) Marginal Revenue (MR) (7) Profit (+) or Loss (-) $131 131 131 131 131 131 131 131 131 131 $-100 -59 -8 +53 +124 +185 +236 +277 +298 +299 +280 NoYou Surprise - Now Let’s Graph Now? It… Do See Profit Maximization 9-10 Short-Run Supply Curve Firms produce where MR=MC Cost and Revenues (Dollars) Examine the MC for the Competitive Firm MC Above AVC Becomes the Short-Run Supply Curve Break-even (Normal Profit) Point e P5 d P4 P3 P2 P1 S MC MR5 ATC c AVC MR4 MR3 MR2 MR1 b a Shut-Down Point (If P is Below) Q2 Q3 Q4 Quantity Supplied Q5 9-17 Firm and Industry Supply • Changes in firm supply – Shifts in marginal cost – Input price or technology • The industry (total) supply curve – Sum of individual supply • Industry supply and demand – Determine market price 9-18 Firm and Industry Supply Single Firm Industry p P S = ∑ MC’s s = MC Economic Profit ATC d $111 $111 AVC D p 8000 P Competitive firm must take the price that is Established by industry supply and demand 9-19 Long Run Profit Maximization • Assumptions – Entry and exit only – Identical costs – Constant-cost industry • Goal of the analysis – In the long run, P = ATC – Entry eliminates profits – Exit eliminates losses 9-20 Entry Eliminates Profits 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 9-21 Exit Eliminates Losses 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 9-22 Long Run Supply • Constant cost industry – Entry/exit does not affect LR ATC – Constant resource price – Special case • Increasing cost industry – Most industries – LR ATC increases with expansion – Specialized resources • Decreasing cost industry 9-23 Long-Run Supply Curve Constant-Cost Industry P P1 P2 $50 Z3 Z1 Z2 S P3 D3 Q3 90,000 D1 Q1 100,000 D2 Q2 110,000 Q 9-24 Long-Run Supply Curve Increasing-Cost Industry P P2 $55 P1 $50 P3 $40 S Y2 Y1 Y3 D2 D1 D3 Q3 90,000 Q1 100,000 Q2 110,000 Q How would a decreasing-cost industry look? 9-25 Pure Competition and Efficiency • Productive efficiency P = minimum ATC • Allocative efficiency P = MC • Maximum consumer and producer surplus • Dynamic adjustments • “Invisible Hand” revisited 9-26 Long-Run Equilibrium Single Firm P=MC=Minimum ATC (Normal Profit) Market MC S Price Price ATC MR P P D Qf Quantity Qe Quantity Productive Efficiency: Price = minimum ATC Allocative Efficiency: Price = MC Pure competition has both in its long-run equilibrium 9-27 The Case of Generic Drugs • Efficiency gains from entry – Lower price and greater output • Purpose of drug patent – Encourage R&D – Cost recovery • Expiration of patent on drugs – Generics enter – Profits decrease, output increase – Combined CS and PS increase 9-28 The Case of Generic Drugs New Producers Enter Market Initial Patent Price P1 Price • As price decreases to f, • Consumer surplus abc increases to adf • Producer and consumer surplus is maximized as shown by the gray triangle a P2 b S c d f D Q1 Q2 Quantity Result: Greater Quantity at Lower Prices as Predicted by the Competitive Model 9-29 Key Terms • pure competition • pure monopoly • monopolistic competition • oligopoly • imperfect competition • price taker • average revenue • total revenue • marginal revenue • break-even point • MR=MC rule • short-run supply curve • long-run supply curve • constant-cost industry • increasing-cost industry • decreasing-cost industry • productive efficiency • allocative efficiency • consumer surplus • producer surplus 9-30 Next Chapter Preview… Pure Monopoly 9-31 ... Loss (-) $0 90 170 240 300 370 450 540 650 780 93 0 $100 190 270 340 400 470 550 640 750 880 1030 $0 131 262 393 524 655 786 91 7 1048 11 79 1310 $-1 00 - 59 -8 +53 +124 +185 +236 +277 + 298 + 299 +280... (+) or Loss (-) $131 131 131 131 131 131 131 131 131 131 $-1 00 - 59 -8 +53 +124 +185 +236 +277 + 298 + 299 +280 NoYou Surprise - Now Let’s Graph Now? It… Do See Profit Maximization 9- 10 Marginal... Supplied or Minimum Loss (-) $151 10 $+480 131 + 299 111 +138 91 -3 81 -6 4 71 -1 00 61 -1 00 The schedule shows the quantity a firm will produce at a variety of prices 9- 15 Short-Run Supply Curve Cost