©2004 Prentice Hall Publishing Ayers/Collinge, 1/e 1 Chapter 19 “Pure Competition”

1 ©2004 Prentice Hall Publishing Ayers/Collinge, 1/e

Chapter 19Chapter 19“Pure Competition”“Pure Competition”

Chapter 19Chapter 19“Pure Competition”“Pure Competition”

ECONOMICS: ECONOMICS: EXPLORE & APPLYEXPLORE & APPLYby Ayers and Collingeby Ayers and Collinge

ECONOMICS: ECONOMICS: EXPLORE & APPLYEXPLORE & APPLYby Ayers and Collingeby Ayers and Collinge


Learning ObjectivesLearning ObjectivesLearning ObjectivesLearning Objectives

1.1. Name four market types and describe the Name four market types and describe the characteristics of pure competition.characteristics of pure competition.

2.2. Illustrate how market demand and supply Illustrate how market demand and supply determine the competitive firm’s demand determine the competitive firm’s demand curve.curve.

3.3. Identify the competitive firm’s short-run Identify the competitive firm’s short-run supply curve.supply curve.

4.4. Describe the long-run equilibrium in pure Describe the long-run equilibrium in pure competition. competition.

1.1. Name four market types and describe the Name four market types and describe the characteristics of pure competition.characteristics of pure competition.

2.2. Illustrate how market demand and supply Illustrate how market demand and supply determine the competitive firm’s demand determine the competitive firm’s demand curve.curve.

3.3. Identify the competitive firm’s short-run Identify the competitive firm’s short-run supply curve.supply curve.

4.4. Describe the long-run equilibrium in pure Describe the long-run equilibrium in pure competition. competition.


Learning ObjectivesLearning ObjectivesLearning ObjectivesLearning Objectives

5.5. Explain how efficiency is achieved in a purely Explain how efficiency is achieved in a purely competitive market.competitive market.

6.6. Specify the difference between a constant-Specify the difference between a constant-cost, increasing cost, and decreasing cost cost, increasing cost, and decreasing cost industry.industry.

7.7. Show how competition can reduce Show how competition can reduce discrimination in society.discrimination in society.

5.5. Explain how efficiency is achieved in a purely Explain how efficiency is achieved in a purely competitive market.competitive market.

6.6. Specify the difference between a constant-Specify the difference between a constant-cost, increasing cost, and decreasing cost cost, increasing cost, and decreasing cost industry.industry.

7.7. Show how competition can reduce Show how competition can reduce discrimination in society.discrimination in society.


o There are clearly different types of markets which are There are clearly different types of markets which are commonly called commonly called industries.industries.

o Markets also differ according to whether the product is Markets also differ according to whether the product is homogenous or differentiated.homogenous or differentiated.o Homogeneous productsHomogeneous products are identical no matter which firms are identical no matter which firms

produces them, and are often called commodities.produces them, and are often called commodities.o Differentiated productsDifferentiated products will vary from one producer to the next. will vary from one producer to the next.

o These differences lead to four different These differences lead to four different market structures,market structures, which are models of the way markets work. which are models of the way markets work.

o There are clearly different types of markets which are There are clearly different types of markets which are commonly called commonly called industries.industries.

o Markets also differ according to whether the product is Markets also differ according to whether the product is homogenous or differentiated.homogenous or differentiated.o Homogeneous productsHomogeneous products are identical no matter which firms are identical no matter which firms

produces them, and are often called commodities.produces them, and are often called commodities.o Differentiated productsDifferentiated products will vary from one producer to the next. will vary from one producer to the next.

o These differences lead to four different These differences lead to four different market structures,market structures, which are models of the way markets work. which are models of the way markets work.

19.119.1TYPES OF MARKETSTYPES OF MARKETS19.119.1TYPES OF MARKETSTYPES OF MARKETS


Types of MarketsTypes of MarketsTypes of MarketsTypes of Markets

o Monopoly:Monopoly: Only one seller of a good with no Only one seller of a good with no close substitutes.close substitutes.

o Oligopoly:Oligopoly: More than one seller, where at least More than one seller, where at least one of the sellers can significantly influence one of the sellers can significantly influence price.price.

o Monopolistic Competition:Monopolistic Competition: Numerous firms, Numerous firms, each with slight ability to control price.each with slight ability to control price.

o Pure competition:Pure competition: a market in which there are a market in which there are many buyers and sellers of a homogeneous many buyers and sellers of a homogeneous product.product.

o Monopoly:Monopoly: Only one seller of a good with no Only one seller of a good with no close substitutes.close substitutes.

o Oligopoly:Oligopoly: More than one seller, where at least More than one seller, where at least one of the sellers can significantly influence one of the sellers can significantly influence price.price.

o Monopolistic Competition:Monopolistic Competition: Numerous firms, Numerous firms, each with slight ability to control price.each with slight ability to control price.

o Pure competition:Pure competition: a market in which there are a market in which there are many buyers and sellers of a homogeneous many buyers and sellers of a homogeneous product.product.


Types of MarketsTypes of MarketsTypes of MarketsTypes of Markets

Homogeneous product Differentiated product

One firmMonopoly

(example: city drinking water) Not applicable

Few firmsOligopoly

(example: gasoline refineries)Oligopoly

(example: automakers)

Many firmsPure competition

(example: farmers)Monopolistic competition (example: restaurants)


The Spectrum of Market ModelsThe Spectrum of Market ModelsThe Spectrum of Market ModelsThe Spectrum of Market Models

00Pure Pure

CompetitionCompetitionMonopolistic Monopolistic CompetitionCompetition

OligopolyOligopoly MonopolyMonopoly

Less Market PowerLess Market Power More Market PowerMore Market Power

The term The term market powermarket powerrefers to the degree of refers to the degree of influence over price by influence over price by the individual firm.the individual firm.


Characteristics of Characteristics of Pure CompetitionPure Competition

Characteristics of Characteristics of Pure CompetitionPure Competition

Numerous buyers and sellersNumerous buyers and sellersHomogeneous productHomogeneous product

Firms do not advertise in pure Firms do not advertise in pure competitioncompetition

Costless entry and exit of all firms.Costless entry and exit of all firms.Firms are price takers with a perfectly Firms are price takers with a perfectly elastic demand! A price taker always sells at elastic demand! A price taker always sells at the market price.the market price.

Numerous buyers and sellersNumerous buyers and sellersHomogeneous productHomogeneous product

Firms do not advertise in pure Firms do not advertise in pure competitioncompetition

Costless entry and exit of all firms.Costless entry and exit of all firms.Firms are price takers with a perfectly Firms are price takers with a perfectly elastic demand! A price taker always sells at elastic demand! A price taker always sells at the market price.the market price.


19.219.2THE FIRM AND THE MARKET IN THE FIRM AND THE MARKET IN PURE COMPETITIONPURE COMPETITION

19.219.2THE FIRM AND THE MARKET IN THE FIRM AND THE MARKET IN PURE COMPETITIONPURE COMPETITION

Market Market SupplySupply

Market Market DemandDemand

Market Price

Market Quantity

Dol

lars

Quantity(millions)

Firm’s Firm’s SupplySupply

Firm’s Firm’s DemandDemand

Firm’s Output

Quantity(thousands)

MarketMarket FirmFirm


Short-Run SupplyShort-Run SupplyShort-Run SupplyShort-Run Supply

o At any price above the shutdown price, the At any price above the shutdown price, the profit-maximizing firm equates marginal profit-maximizing firm equates marginal revenue and marginal cost.revenue and marginal cost.

o Because the price taking firm’s marginal Because the price taking firm’s marginal revenue equals the market price, the firm revenue equals the market price, the firm produces the quantity associated with its produces the quantity associated with its marginal cost curve at that price.marginal cost curve at that price.

o The price taking firm’s short-run supply curve is The price taking firm’s short-run supply curve is that part of its marginal cost curve that lies above that part of its marginal cost curve that lies above average variable cost. average variable cost.

o At any price above the shutdown price, the At any price above the shutdown price, the profit-maximizing firm equates marginal profit-maximizing firm equates marginal revenue and marginal cost.revenue and marginal cost.

o Because the price taking firm’s marginal Because the price taking firm’s marginal revenue equals the market price, the firm revenue equals the market price, the firm produces the quantity associated with its produces the quantity associated with its marginal cost curve at that price.marginal cost curve at that price.

o The price taking firm’s short-run supply curve is The price taking firm’s short-run supply curve is that part of its marginal cost curve that lies above that part of its marginal cost curve that lies above average variable cost. average variable cost.


Supply in Pure CompetitionSupply in Pure CompetitionSupply in Pure CompetitionSupply in Pure CompetitionD

olla

rs

Quantity Quantity


Marginal CostMarginal Cost

AverageAveragevariablevariablecostcost

Shutdownprice

$160

6

$250

7 6000 7000

Firm’s Firm’s supplysupply

Market Market supplysupply


Supply in Pure CompetitionSupply in Pure CompetitionSupply in Pure CompetitionSupply in Pure CompetitionD

olla

rs

Quantity Quantity


Marginal CostMarginal Cost

AverageAveragevariablevariablecostcost

Shutdownprice

$160

6

$250

7 6000 7000

Firm’s Firm’s supplysupply

Market Market supplysupply

Firms supply is itsFirms supply is itsmarginal cost marginal cost curve above its curve above its shutdown price.shutdown price.

For each price,For each price,the market supplythe market supplyadds up the adds up the Quantities suppliedQuantities suppliedby each firm.by each firm.


19.319.3THE LONG-RUN THE LONG-RUN - Entry, Exit, and Efficiency- Entry, Exit, and Efficiency

19.319.3THE LONG-RUN THE LONG-RUN - Entry, Exit, and Efficiency- Entry, Exit, and Efficiency

In the short-run, the market price could be In the short-run, the market price could be sufficiently high that the firm earns profits, or sufficiently high that the firm earns profits, or it could be so low that the firm loses money.it could be so low that the firm loses money.

Short-run profits attract new firms to enter the Short-run profits attract new firms to enter the market.market.Short-run losses cause existing firms to leave the Short-run losses cause existing firms to leave the industry.industry.

The The long-run equilibriumlong-run equilibrium market price results market price results in the expectation of in the expectation of zero profitzero profit for a firm that for a firm that is considering entry into the industry.is considering entry into the industry.

Zero profit means the firm is breaking even, that is, Zero profit means the firm is breaking even, that is, earning a normal profit.earning a normal profit.

In the short-run, the market price could be In the short-run, the market price could be sufficiently high that the firm earns profits, or sufficiently high that the firm earns profits, or it could be so low that the firm loses money.it could be so low that the firm loses money.

Short-run profits attract new firms to enter the Short-run profits attract new firms to enter the market.market.Short-run losses cause existing firms to leave the Short-run losses cause existing firms to leave the industry.industry.

The The long-run equilibriumlong-run equilibrium market price results market price results in the expectation of in the expectation of zero profitzero profit for a firm that for a firm that is considering entry into the industry.is considering entry into the industry.

Zero profit means the firm is breaking even, that is, Zero profit means the firm is breaking even, that is, earning a normal profit.earning a normal profit.


Profit Attracts New Entrants Profit Attracts New Entrants Losses Cause Firms to LeaveLosses Cause Firms to Leave

Profit Attracts New Entrants Profit Attracts New Entrants Losses Cause Firms to LeaveLosses Cause Firms to Leave

Dol

lars

Quantity

Initial SupplyInitial Supply

DemandDemand

Initial Price

Supply after ExitSupply after Exit

Supply after Supply after EntryEntry

Higher Price after Exit

Lower Price after Entry


Long-Run Equilibrium in Long-Run Equilibrium in Pure CompetitionPure Competition

Long-Run Equilibrium in Long-Run Equilibrium in Pure CompetitionPure Competition

Market Market SupplySupply

Market Market DemandDemand

Market Price

Market Quantity

Dol

lars

Quantity(millions)

Marginal Marginal costcost

Firm’s Firm’s DemandDemand

Firm’s Output

Quantity(thousands)


AverageAveragecostcostAdjusts until price

leaves firms with only a normal profit.

= price= marginal revenue

The long-run equilibrium in pure competition occurs when the The long-run equilibrium in pure competition occurs when the last firm to enter the market earns zero profits, as shown by last firm to enter the market earns zero profits, as shown by the firm’s average cost curve just tangent to its demand. There the firm’s average cost curve just tangent to its demand. There would be no reason for a new firm to enter and no reason for would be no reason for a new firm to enter and no reason for an existing firm to exit.an existing firm to exit.


The Efficiency of Pure CompetitionThe Efficiency of Pure CompetitionThe Efficiency of Pure CompetitionThe Efficiency of Pure Competition

The competitive market equilibrium The competitive market equilibrium produces an allocatively efficient amount of produces an allocatively efficient amount of output.output.

Competition also forces firms to keep cost in Competition also forces firms to keep cost in check, thus inducing technological efficiency check, thus inducing technological efficiency as well.as well.

For these reasons the model of pure For these reasons the model of pure competition is often used as the standard of competition is often used as the standard of efficiency by which other market structures efficiency by which other market structures are judged.are judged.

The competitive market equilibrium The competitive market equilibrium produces an allocatively efficient amount of produces an allocatively efficient amount of output.output.

Competition also forces firms to keep cost in Competition also forces firms to keep cost in check, thus inducing technological efficiency check, thus inducing technological efficiency as well.as well.

For these reasons the model of pure For these reasons the model of pure competition is often used as the standard of competition is often used as the standard of efficiency by which other market structures efficiency by which other market structures are judged.are judged.


The Efficiency of Pure CompetitionThe Efficiency of Pure CompetitionThe Efficiency of Pure CompetitionThe Efficiency of Pure Competition

SupplySupply

DemandDemandCompetitive

OutputQuantity

Too MuchOutput

Quantity

SupplySupply

Competitive Output

Too LittleOutput

DemandDemand

Maximum social surplus

Surplus lost from producing too much

Surplus foregone from producing too little


19.419.4LONG RUN SUPPLYLONG RUN SUPPLY19.419.4LONG RUN SUPPLYLONG RUN SUPPLY

The expansion or contraction of The expansion or contraction of industries over time sometimes affects industries over time sometimes affects the cost of production in that industry.the cost of production in that industry.In response to entry, input prices might In response to entry, input prices might remain unchanged, rise, or fall, which remain unchanged, rise, or fall, which gives rise to three industry types….gives rise to three industry types….

Constant-cost industryConstant-cost industryIncreasing-cost industryIncreasing-cost industryDecreasing-cost industryDecreasing-cost industry

The expansion or contraction of The expansion or contraction of industries over time sometimes affects industries over time sometimes affects the cost of production in that industry.the cost of production in that industry.In response to entry, input prices might In response to entry, input prices might remain unchanged, rise, or fall, which remain unchanged, rise, or fall, which gives rise to three industry types….gives rise to three industry types….

Constant-cost industryConstant-cost industryIncreasing-cost industryIncreasing-cost industryDecreasing-cost industryDecreasing-cost industry


Constant-cost industry;Constant-cost industry; an increase in the an increase in the industry’s output does not affect the cost industry’s output does not affect the cost of production. of production. Increasing-cost industry;Increasing-cost industry; an increase in an increase in the industry’s output causes input prices the industry’s output causes input prices to rise.to rise.Decreasing-cost industry;Decreasing-cost industry; an increase in an increase in the industry’s output causes input prices the industry’s output causes input prices to fall.to fall.

Constant-cost industry;Constant-cost industry; an increase in the an increase in the industry’s output does not affect the cost industry’s output does not affect the cost of production. of production. Increasing-cost industry;Increasing-cost industry; an increase in an increase in the industry’s output causes input prices the industry’s output causes input prices to rise.to rise.Decreasing-cost industry;Decreasing-cost industry; an increase in an increase in the industry’s output causes input prices the industry’s output causes input prices to fall.to fall.

Long-Run CharacteristicsLong-Run Characteristics of Industries of Industries

Long-Run CharacteristicsLong-Run Characteristics of Industries of Industries


Perfect Competition and Perfect Competition and Long-Run SupplyLong-Run Supply


Perfect competitionPerfect competition is a variant of pure competition. is a variant of pure competition. Perfect competition adds to the model of pure Perfect competition adds to the model of pure

competition a further assumption that all firms are competition a further assumption that all firms are identical, with access to resources and technology, identical, with access to resources and technology, with all information fully and freely available.with all information fully and freely available.

In a constant-cost industry, the entry of new firms In a constant-cost industry, the entry of new firms would have no effect on the production cost of other would have no effect on the production cost of other firm’s, and with perfect competition, expansion of firm’s, and with perfect competition, expansion of the industry would lead to the same equilibrium the industry would lead to the same equilibrium output price. output price.

Perfect competitionPerfect competition is a variant of pure competition. is a variant of pure competition. Perfect competition adds to the model of pure Perfect competition adds to the model of pure

competition a further assumption that all firms are competition a further assumption that all firms are identical, with access to resources and technology, identical, with access to resources and technology, with all information fully and freely available.with all information fully and freely available.

In a constant-cost industry, the entry of new firms In a constant-cost industry, the entry of new firms would have no effect on the production cost of other would have no effect on the production cost of other firm’s, and with perfect competition, expansion of firm’s, and with perfect competition, expansion of the industry would lead to the same equilibrium the industry would lead to the same equilibrium output price. output price.




In an increasing -cost industry, the entry of new In an increasing -cost industry, the entry of new firms would not only increase industry output, but firms would not only increase industry output, but would shift up the cost curves of each firm in the would shift up the cost curves of each firm in the industry.industry.

Thus, an expansion of the industry would lead to a Thus, an expansion of the industry would lead to a higher equilibrium price of the industry’s output.higher equilibrium price of the industry’s output.

Conversely, in a decreasing-cost industry, the entry Conversely, in a decreasing-cost industry, the entry of new firms would lower production cost for all of new firms would lower production cost for all firms and thus lead to a lower equilibrium price of firms and thus lead to a lower equilibrium price of output.output.

In an increasing -cost industry, the entry of new In an increasing -cost industry, the entry of new firms would not only increase industry output, but firms would not only increase industry output, but would shift up the cost curves of each firm in the would shift up the cost curves of each firm in the industry.industry.

Thus, an expansion of the industry would lead to a Thus, an expansion of the industry would lead to a higher equilibrium price of the industry’s output.higher equilibrium price of the industry’s output.

Conversely, in a decreasing-cost industry, the entry Conversely, in a decreasing-cost industry, the entry of new firms would lower production cost for all of new firms would lower production cost for all firms and thus lead to a lower equilibrium price of firms and thus lead to a lower equilibrium price of output.output.




Supply

Demand

Price

Averagecost

Industry’s quantity

Firm’s quantity

$

•

Long-run supply

Constant average cost curve as industry size grows

Constant-cost industry




Supply

Demand

Price


Firm’s quantity

$

•

Long-run supply

Higher average cost curve as industry size grows

•

Average cost

••

Increasing-cost industry




Supply

Demand

Price

Average cost


Firm’s quantity

$

•Long-run supply

Lower average cost curve as industry size grows

••

•

Decreasing-cost industry


19.519.5Discrimination – What a Difference Market Discrimination – What a Difference Market Structure MakesStructure Makes

19.519.5Discrimination – What a Difference Market Discrimination – What a Difference Market Structure MakesStructure Makes

Two features of purely competitive firm’s prevents Two features of purely competitive firm’s prevents racial racial discrimination.discrimination.

One feature is the homogeneous product, which One feature is the homogeneous product, which means that the firm has no opportunity to vary the means that the firm has no opportunity to vary the product in discriminatory ways.product in discriminatory ways.

Pure competition gives firms a strong profit Pure competition gives firms a strong profit incentive to avoid discrimination.incentive to avoid discrimination.

In pure competition a firm that inflicts higher In pure competition a firm that inflicts higher input cost on itself can find itself going from profit input cost on itself can find itself going from profit to loss. to loss.

Two features of purely competitive firm’s prevents Two features of purely competitive firm’s prevents racial racial discrimination.discrimination.

One feature is the homogeneous product, which One feature is the homogeneous product, which means that the firm has no opportunity to vary the means that the firm has no opportunity to vary the product in discriminatory ways.product in discriminatory ways.

Pure competition gives firms a strong profit Pure competition gives firms a strong profit incentive to avoid discrimination.incentive to avoid discrimination.

In pure competition a firm that inflicts higher In pure competition a firm that inflicts higher input cost on itself can find itself going from profit input cost on itself can find itself going from profit to loss. to loss.


Discrimination – What a Difference Discrimination – What a Difference Market Structure MakesMarket Structure Makes

Discrimination – What a Difference Discrimination – What a Difference Market Structure MakesMarket Structure Makes

Quantity

Price

Marginal Cost

Average cost

$

Firm’s quantity

•• • •Profit

Loss

Discrimination can turn a profit into a loss

By increasing costs…


Terms Along the WayTerms Along the Way

homogenous producthomogenous productdifferentiated differentiated

productproductmarket structuremarket structuremonopolymonopolyoligopolyoligopolymonopolistic monopolistic

competitioncompetitionpure competitionpure competition

homogenous producthomogenous productdifferentiated differentiated

productproductmarket structuremarket structuremonopolymonopolyoligopolyoligopolymonopolistic monopolistic

competitioncompetitionpure competitionpure competition

market powermarket powerconstant-cost constant-cost

industryindustry increasing-cost increasing-cost

industryindustrydecreasing-cost decreasing-cost

industryindustryperfect competitionperfect competition long-run supplylong-run supply

market powermarket powerconstant-cost constant-cost

industryindustry increasing-cost increasing-cost

industryindustrydecreasing-cost decreasing-cost

industryindustryperfect competitionperfect competition long-run supplylong-run supply


Test YourselfTest YourselfTest YourselfTest Yourself

1.1. Price takers are found in Price takers are found in

a.a. pure competition.pure competition.

b.b. monopolistic competition.monopolistic competition.

c.c. oligopoly.oligopoly.

d.d. all of the above.all of the above.

1.1. Price takers are found in Price takers are found in

a.a. pure competition.pure competition.

b.b. monopolistic competition.monopolistic competition.

c.c. oligopoly.oligopoly.

d.d. all of the above.all of the above.



2.2. In pure competition the firm’s demand In pure competition the firm’s demand curve will becurve will be

a.a. upward sloping.upward sloping.b.b. downward sloping.downward sloping.c.c. hump shaped.hump shaped.d.d. horizontal.horizontal.

2.2. In pure competition the firm’s demand In pure competition the firm’s demand curve will becurve will be

a.a. upward sloping.upward sloping.b.b. downward sloping.downward sloping.c.c. hump shaped.hump shaped.d.d. horizontal.horizontal.



3.3. For a price taking firm, demand is For a price taking firm, demand is

a.a. equal to price.equal to price.

b.b. less than price.less than price.

c.c. greater than price.greater than price.

d.d. unrelated to price.unrelated to price.



4. 4. A price taking firm’s short-run supply A price taking firm’s short-run supply curve is associated with itscurve is associated with its

a.a. total revenue curve.total revenue curve.

b.b. average cost curve.average cost curve.

c.c. marginal revenue curve.marginal revenue curve.

d.d. marginal cost curve.marginal cost curve.



5.5. Profit maximization calls for the purely Profit maximization calls for the purely competitive firm to produce at the point competitive firm to produce at the point where its demand curve intersects itswhere its demand curve intersects its





5.5. Profit maximization calls for the purely Profit maximization calls for the purely competitive firm to produce at the point competitive firm to produce at the point where its demand curve intersects itswhere its demand curve intersects its







6.6. Which statement best describes the long run Which statement best describes the long run in a purely competitive market?in a purely competitive market?

a.a. The firm’s demand curve is downward The firm’s demand curve is downward sloping.sloping.

b.b. The market will shrink as firms exit.The market will shrink as firms exit.

c.c. The number of firms will be stable because The number of firms will be stable because there no incentive for entry or exit.there no incentive for entry or exit.

d.d. In the long run, the market will slowly In the long run, the market will slowly become a monopoly.become a monopoly.

6.6. Which statement best describes the long run Which statement best describes the long run in a purely competitive market?in a purely competitive market?

a.a. The firm’s demand curve is downward The firm’s demand curve is downward sloping.sloping.

b.b. The market will shrink as firms exit.The market will shrink as firms exit.

c.c. The number of firms will be stable because The number of firms will be stable because there no incentive for entry or exit.there no incentive for entry or exit.

d.d. In the long run, the market will slowly In the long run, the market will slowly become a monopoly.become a monopoly.


The End!The End!Next Chapter 20Next Chapter 20““Monopoly and Monopoly and

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©2004 Prentice Hall Publishing Ayers/Collinge, 1/e 1 Chapter 19 “Pure Competition”