Four market models (cont.)A. Pure competition entails a large number of firms, standardized product, and easy entry (or exit) by new (or existing) firms. B. At the opposite extreme, pure monopoly has one firm that is the sole seller of a product or service with no close substitutes; entry is blocked for other firms.

Four market models (cont.)C.Monopolistic competition is close to pure competition, except that the product is differentiated among sellers rather than standardized, and there are fewer firms. D.An oligopoly is an industry in which only a few firms exist, so each is affected by the priceoutput decisions of its rivals.

Four Market ModelsImperfect CompetitionPure Competition Pure Monopolistic Oligopoly Monopoly Competition

Market Structure Continuum

Pure Competition: Characteristics and Occurrence

A.The characteristics of pure competition.1.Many sellers means that there are enough so that a single seller has no impact on price by its decisions alone. 2.The products in a purely competitive market are homogeneous or standardized; each sellers product is identical to its competitors.

Pure Competition: Characteristics and Occurrence

A.The characteristics of pure competition.(cont.)

3.Individual firms must accept the market price; they are price takers and can exert no influence on price. 4.Freedom of entry and exit means that there are no significant obstacles preventing firms from entering or leaving the industry.

Pure Competition: Characteristics and Occurrence (Cont.)5. Pure competition is rare in the real world, but the model is important. a. The model helps analyze industries with characteristics similar to pure competition. b. The model provides a context in which to apply revenue and cost concepts developed in previous chapters. c. Pure competition provides a norm or standards against which to compare and evaluate the efficiency of the real world.

Pure Competition: Characteristics and Occurrence (Cont.)

B.There are four major objectives in analyzing pure competition. 1. To examine demand from the sellers viewpoint 2. To see how a competitive producer responds to market price in the short run 3. To explore the nature of longrun adjustments in a competitive industry 4. To evaluate the efficiency of competitive industries

Demand from the Viewpoint of a Competitive Sellerdemand as A.The individual firm will view itsperfectly elastic. 1. see slides for illustrations 2. The demand curve is not perfectly elastic for the industry: It only appears that way to the individual firm, since it must take the market price no matter what quantity it produces. 3. Note that a perfectly elastic demand curve is a horizontal line at the price.

Demand from the Viewpoint of a Competitive Seller (Cont.)B.Definitions of average, total, and marginal revenue. 1. Average revenue (AR) is the price per unit for each firm in pure competition. 2. Total revenue (TR) is the price multiplied by the quantity sold. 3. Marginal revenue (MR) is the change in total revenue and will also equal the unit price in conditions of pure competition.

Table RepresentationProduct Price Quantity ($) Demanded (Average Revenue) AR Total Marginal Revenue (TR) Revenue (MR) ($) ($) (PXQ)(Change in TR) 2 2 2 2 2

2 2 2 2 2 2

0 1 2 3 4 5

0 2 4 6 8 10

Graphical Representation

Pure CompetitionFirms Demand Schedule (Average Revenue) Firms Revenue Data

$1179 1048 917

TR

Price and Revenue

P

QD TR$0 ] 131 ] 262 ] 393 ] 524 ] 655 ] 786 ] 917 ] 1048 ] 1179 ] 1310

MR$131 131 131 131 131 131 131 131 131 131

786 655 524 393 262

$131 0 131 1 131 2 131 3 131 4 131 5 131 6 131 7 131 8 131 9 131 10

D = MR = AR131 2 4 6 8 10 12

Quantity Demanded (Sold)

Questions to Ponderthe a. What can you conclude about

structure of the industry in which this firm is operating? Explain. b. Graph the demand, totalrevenue, and marginalrevenue curves for this firm. c. Why do the demand and marginalrevenue curves coincide? d. Marginal revenue is the change in total revenue associated with additional units of output. Explain verbally and graphically, using the data in the table.

Profit Maximization in the Short Run: Two ApproachesA.In the short run the firm has a fixed plant and maximizes profits or minimizes losses by adjusting output; profits are defined as the difference between total costs and total revenue. - Two ways to determine the level of output 1) Compare TR and TC Applicable to all firm in all 2) Compare MR and MCMarket conditions

Profit Maximization in the Short RunTotal Revenue-Total Cost Approach

Consider:Should Product Be

Produced?If So, In What Amount? What Economic Profit

(Loss) Will Be Realized?

Profit Maximization in the Short Run 1 Compare TR and TC ApproachTotal Revenue-Total Cost Approach

Price = $131

MR-MC TABLE

(1) Total Product (Output) (Q)

(2) (3) (4) (5) (6) Total Fixed Total Variable Total Cost Total Revenue Profit (+) Cost (TFC) Cost (TVC) (TC) (TR) or Loss (-)

0 1 2 3 4 5 Do You 6 See Profit Maximization? 7 8 9 10

$100 100 100 100 100 100 100 100 100 100 100Muhammad Hasib Difari

$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

Now Lets Graph The Results

Profit Maximization in the Short RunTotal Revenue-Total Cost Approach$1800 1700 1600 1500 1400 1300 1200 1100 1000 900 800 700 600 500 400 300 200 100

Total Revenue and Total Cost

Break-Even Point (Normal Profit) Total Revenue, (TR) Maximum Economic Profit $299

Total Cost, (TC)

P=$131Break-Even Point (Normal Profit)0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 Quantity Demanded (Sold)

Total Economic Profit

$500 400 300 200 100

Total Economic Profit

$299

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 Quantity Demanded (Sold) Muhammad Hasib Difari

Profit Maximization in the Short Run: Two Approaches (Cont.)Approach 1 - Compare TR and TC 1. The firm should produce if the difference between total revenue and total cost is profitable, or if the loss is less than the fixed cost. 2. In the short run, the firm should produce that output at which it maximizes its profit or minimizes its loss. 3. The profit or loss can be established by subtracting total cost from total revenue at each output level. 4. The firm should not produce, but should shut down in the short run if its loss exceeds its fixed costs. Then, by shutting down its loss will just equal those fixed costs. 5. A graphical representation is shown Note: The firm has no control over the market price.

Profit Maximization in the Short Run: Two Approaches (Cont.)Approach 2 - Compare MR and MC 1. The MR = MC rule states that the firm will maximize profits or minimize losses by producing at the point at which marginal revenue equals marginal cost in the short run. 2. Three features of this MR = MC rule are important. a. The rule assumes that marginal revenue must be equal to or exceed minimum-average-variable cost or firm will shut down. b. The rule works for firms in any type of industry, not just pure competition. c. In pure competition, price = marginal revenue, so in purely competitive industries the rule can be restated as the firm should produce that output where P = MC, because P = MR.

Profit Maximization in the Short RunMarginal Revenue-Marginal Cost Approach MR = MC Rule

Important Features: Firm Will Shut Down Unless MR at Least Meets MC Profit Maximization in All Market Structures Can Be Restated P = MC

Profit Maximization in the Short RunMarginal Revenue-Marginal Cost Approach MR = MC RuleTR-TR TABLE(2) Average Fixed Cost (AFC) (3) Average Variable Cost (AVC) (4) Average Total Cost (ATC) (6) Marginal Revenue (MR) (P)

(1) Total Product (Output)

(5) Marginal Cost (MC)

(7) Profit (+) or Loss (-)

Shut down 0 $100.00 1 50.00 2 33.33 3 Do You 25.00 4 See Profit 20.00 5 Maximization 6 Loss 16.67 Now? 7 Min. 14.29 12.50 8 11.11 9 10.00 10

$90.00 85.00 80.00 75.00 74.00 75.00 77.14 81.25 86.67 93.00

mr2 $90 $190.00 $71 80 135.00 $71 70 113.33 $71 60 100.00 $71 70 94.00 $71 80 91.67 $71 90 91.43 $71110 93.75 $71130 97.78 $71150 103.00 $71

mr1 $81 $131 $81 131 $81 131 $81 131 $81 131 $81 131 $81 131 $81 131 $81 131 $81 131

$-100 -59 -8 +53 +124 +185 +236 64.02 +277 +298 +299 +280

No Surprise - Now Lets Graph It

Profit Maximization in the Short Run: Two Approaches (Cont.)Approach 2 - Compare MR and MC (cont.) 3. See slide as an illustrationCompare MC and MR at each level of

output. At the tenth unit MC exceeds MR. Therefore, the firm should produce only nine (not the tenth) units to maximize profits.

Profit Maximization in the Short Run: Two Approaches (Cont.) Approach 2 - Compare MR and MC (cont.) Profit-maximizing case:

The level of profit = $1179 - $880.02 Economic Profit = $299 Step 1 ATC x Qty 97.78 x 9 = $880.02 Step 2 TR = P x Q = $131 x 9 = $1179 P=$131 Cost & Revenue $97.78

MR=MC MC ATC

MR = P

Alternatively, Economic profit = (P ATC) Q = ($131 - $97.78) 9 = $29923022011 (TOPIC5) Muhammad Hasib Difari

output

9

Profit Maximization in the Short RunMarginal Revenue-Marginal Cost Approach MR = MC Rule$200

Cost and Revenue

150

P=$131

MR = MC

MC MR = P ATC AVC

Economic Profit100 A=$97.78 50

0

1

2

3

4

Output

5

6

7

8

9

10

Profit Maximization in the Short Run: Two Approaches (Cont.) Approach 2 - Compare MR and MC (cont.) FC

Loss-minimising case:

< - $486 The level of Loss = $550.02$100 = $64.02 A=$91.67 Cost & Revenue P=$81 V=$75

Economic loss

MC=MR

MCATC AVC

Step 1 ATC x Qty 91.67 x 6 = $550.02 Step 2 TR = P x Q = $81x6 = $486

MR=P output

6

Profit Maximization in the Short RunMarginal Revenue-Marginal Cost Approach MR = MC Rule$200

Loss Minimizing Case

Cost and Revenue

Loss = $91.67 x 6 - $81x6 = $550.02 -$486 =$64.02

150

Lower the Price to $81 and Observe the Results!A=$91.67

MC

LossATC AVC MR = P

100 P=$81 50 V = $75

0

1

2

3

4

Output

5

6

7

8

9

10

Profit Maximization in the Short Run: Two Approaches (Cont.) Approach 2 - Compare MR and MC (cont.)

Shut-down caseThe smallest loss = $100

:

FC it will lose MC=MR MCATC AVC

Even at MC=MR, the Cost & firm will lose at a total Revenue loss of $115. Hence in the SR it is best to shut down if the P