McConnell 22nd edition

1. CHAPTER 10
Pure Competition in the Short Run

2. Four Market Models
Pure Competition: Characteristics and Occurrence
Demand as Seen by a Purely Competitive Seller
Profit Maximization in the Short Run: Total-Revenue-Total-Cost
Approach
Profit Maximization in the Short Run: Marginal-Revenue–
Marginal-Cost Approach
Marginal Cost and Short-Run Supply
10-2
Chapter Contents

3. Four Market Structures
• Pure competition (Perfect competition)
• Monopolistic competition
• Oligopoly
• Pure monopoly
LO10.1 10-3
Pure
Competition
Monopolistic
Competition Oligopoly
Pure
Monopoly
Market Structure Continuum
Imperfect Competition

4. Characteristics of the Four Market Structures
Market Structure
Characteristic Pure Competition Monopolistic Competition Oligopoly Pure Monopoly
Number of firms A very large number Many Few One
Type of product Standardized Differentiated Standardized or
differentiated
Unique; no close
substitutes
Control over price None Some, but within rather
narrow limits
Limited by mutual inter-
dependence;
considerable with
collusion
Considerable
Conditions of entry Very easy, no
obstacles
Relatively easy Significant obstacles Blocked
Nonprice Competition None Considerable emphasis on
advertising, brand names,
trademarks
Typically a great deal,
particularly with product
differentiation
Mostly public relations
advertising
Examples Agriculture Retail trade, dresses, shoes Steel, automobiles, farm
implements, many
household appliances
Local utilities
LO10.1 10-4

5. Pure Competition: Characteristics
• Four Conditions for Pure Competition
• Very large numbers of sellers
• Standardized product
• Easy entry and exit
• Complete information
• Price takers: Because many small firms are selling same
products and competing in market, no firm has any control
of market (price)
LO10.2 10-5

6. Purely Competitive Demand
• Competitive firm faces a perfectly elastic demand
• Firm’s demand curve is horizontal
• Firm produces and sells as much or little as they wish at
the market price
• Demand curve is horizontal
• Firm’s marginal revenue = Market price
LO10.3 10-6

7. Average, Total, and Marginal
Revenue Formulas
• Total revenue
• TR = P X Q
• Average revenue: Revenue per unit
• AR = TR/Q = P
• Marginal revenue: Extra revenue from 1 more unit of
product produced and sold
• MR = ΔTR/ΔQ
LO10.3 10-7

8. A Purely Competitive Firm’s Demand and Revenue Curves
42 6 8 10 12
$1,179
131
262
524
655
786
917
1,048
393
TR
D = MR = AR
Quantity demanded (sold)
PriceandrevenueLO10.3 10-8
0
_____Firm’s Demand Schedule_____
_________Firm’s Revenue
Data_________
(1)
Product Price (P)
Average Revenue
(2)
Quantity
Demanded (Q)
(3)
Total Revenue
(TR), (1) x (2)
(4)
Marginal Revenue
(MR)
$131 0 $ 0
131 1 131
131 2 262
131 3 393
131 4 524
131 5 655
131 6 786
131 7 917
131 8 1,048
131 9 1,179
131 10 1,310
$131
131
131
131
131
131
131
131
131
131

9. Profit
• Total profit
• TP = TR – TC
• Marginal profit: Extra profit from 1 more unit of
product produced and sold
• MP = ΔTP/ΔQ
= (ΔTR – ΔTC)/ΔQ
= MR – MC
10-9

10. Profit Maximization
• We assume that sole objective of firm is to maximize
its total profit.
• The competitive firm will ask three questions
• Should the firm produce?
• If so, in what amount?
• What economic profit (loss) will be realized?
10-10

11. Profit Maximization: TR – TC Approach
• A competitive firm should produce a quantity of
product where
• Its total profit is largest
• total revenue exceeds total cost by the greatest amount.
LO10.4 10-11

12. Profit Maximization: TR – TC Table
PRICE: $131
(1)
Total Product
(Output) (Q)
(2)
Total Fixed Cost
(TFC)
(3)
Total Variable
Costs (TVC)
(4)
Total Cost
(TC)
(5)
Total Revenue
(TR)
(6)
Profit (+)
or Loss ()
0 $100 $ 0 $ 100 $ 0 $100
1 100 90 190 131 59
2 100 170 270 262 8
3 100 240 340 393 +53
4 100 300 400 524 +124
5 100 370 470 655 +185
6 100 450 550 786 +236
7 100 540 640 917 +277
8 100 650 750 1,048 +298
9 100 780 880 1,179 +299
10 100 930 1,030 1310 +280LO10.4 10-12

13. 10 2 3 4 5 6 7 8 9 10 11 12 13 14
$1,800
1,700
1,600
1,500
1,400
1,300
1,200
1,100
1,000
900
800
700
600
500
400
300
200
100
Totalrevenueandtotalcost
Total revenue, TR
Maximum
economic
profit
$299
P = $131
Break-even point
(normal profit)
Total cost, TC
Break-even point
(normal profit)
Total-Revenue–Total Cost Approach to Profit Maximization
for a Purely Competitive Firm
LO10.4 10-13
Quantity demanded (sold)
$500
400
300
200
100
Totaleconomicprofit
Quantity demanded (sold)
Total economic
profit
$299
(b) Total economic profit(a) Profit maximizing case
10 2 3 4 5 6 7 8 9 10 11 12 13 14

14. Profit Maximization: MR = MC Approach
• A competitive firm should produce a quantity of
product where
• MR = MC or MP > 0
• As long as additional unit produced brings an additional profit
(MR is greater than MC), it should produce.
• If additional unit brings loss (MC > MR), it should not produce.
• For a price taker (only applied to purely competitive firms),
price = marginal revenue, so the MR = MC rule is
equivalent to P = MC rule.
LO10.5 10-14

15. Profit Maximization: MR = MC Table
(1)
Total Product
(Output)
(2)
Average Fixed
Cost (AFC)
(3)
Average Variable
Costs (AVC)
(4)
Average Total
Cost (ATC)
(5)
Marginal Cost
(MC)
(6)
Price = Marginal
Revenue (MR)
(7)
Total Economic
Profit (+) or Loss (-)
0 $ -100
1 $100.00 $90.00 $190.00 $ 90 $131 -59
2 50.00 85.00 135.00 80 131 -8
3 33.33 80.00 113.33 70 131 +53
4 25.00 75.00 100.00 60 131 +124
5 20.00 74.00 94.00 70 131 +185
6 16.67 75.00 91.67 80 131 +236
7 14.29 77.14 91.43 90 131 +277
8 12.50 81.25 93.75 110 131 +298
9 11.11 86.67 97.78 130 131 +299
10 10.00 93.00 103.00 150 131 +280
LO10.5 10-15
Short-run profit maximization for a purely competitive firm: Table

16. Costandrevenue
$200
150
100
50
0 1 2 3 4 5 6 7 8 9 10
Output
Total profit
MR = P
MC
MR = MC
AVC
ATC
P = $131
A = $97.78
10-16
Short-run Profit Maximization for a Purely Competitive Firm
• MR = MC: Find a point
where Demand curve
(P) crosses MC curve.
• Corresponding
quantity is a profit-
maximizing quantity.
• An area between Price
and ATC lines from 0
unit to 9 units of
output corresponds to
Total profit.
LO10.5
Figure 10.3

17. Loss Minimization
• If a firm is incurring an economic loss (Price is less than ATC),
what should it do?
• In short-run, it cannot exit from the market.
• Firm should choose a quantity which minimizes its loss.
• Two choices:
• Shuts down (zero production): it still has to pay for fixed input and
incurs fixed cost as its loss.
• Produces some: it earns revenues from production and sales, but
pays for variable inputs as well as fixed cost.
LO10.5 10-17

18. Temporary Shutdown Decision
• As long as each production of goods generates enough
revenue to cover variable cost, it should produce.
• Profit from each unit of production is used to pay a part of fixed
cost, but not enough (so, firm incurs loss).
• If revenue from each production of goods is not enough to pay
for variable cost, firm is digging hole further down.
• If MR (P) > minimum AVC, then it should produce at quantity
where MR = MC to minimize its loss.
• If MR (P) < minimum AVC, then it should shout down.
LO10.5 10-18

19. Short-Run Loss Minimization Table
(1)
Total
Product
(Output)
(2)
Average
Fixed Cost
(AFC)
(3)
Average
Variable
Cost (AVC)
(4)
Average
Total Cost
(ATC)
(5)
Marginal
Cost
(MC)
(6)
$81 Price
=
Marginal
Revenue
(MR)
(7)
Total
Economic
Profit (+)
or Loss (-)
(8)
$71 Price
=
Marginal
Revenue
(MR)
(9)
Profit (+)
or Loss (-),
$71
Price
0 $-100 $-100
1 $100.00 $90.00 $190.00 $ 90 $81 -109 $71 -119
2 50.00 85.00 135.00 80 81 -108 71 -128
3 33.33 80.00 113.33 70 81 -97 71 -127
4 25.00 75.00 100.00 60 81 -76 71 -116
5 20.00 74.00 94.00 70 81 -65 71 -115
6 16.67 75.00 91.67 80 81 -64 71 -124
7 14.29 77.14 91.43 90 81 -73 71 -143
8 12.50 81.25 93.75 110 81 -102 71 -182
9 11.11 86.67 97.78 130 81 -151 71 -241
10 10.00 93.00 103.00 150 81 -220 71 -320
LO10.5 10-19
Loss-Minimizing Case Shutdown Case

20. Short-run Loss Minimization vs. Shutdown
LO10.5 10-20
Costandrevenue
$200
150
100
50
0
1 2 3 4 5 6 7 8 9 10
Output
Loss
MR = P
MC
AVC
ATC
P=$81
A=$91.67
V = $75
Costandrevenue
$200
150
100
50
0
1 2 3 4 5 6 7 8 9 10
Output
MR = P
MC
AVC
ATC
P=$71
V = $74
Short-run shut down point
P < minimum AVC
$71 < $74
Loss minimization
Produce Q where MR = MC.
Shutdown
Produce 0 unit.

21. Short-Run Supply
• Firm’s Short-run supply
• Quantities of products that a competitive firm produces at
various prices
• As long as P exceeds minimum AVC, a competitive firm
continues to produce a quantity of products that
maximizes its profit for given price: MR (= P) = MC rule
LO10.6 10-21

22. Marginal Cost and Short-Run Supply
Price
Quantity
Supplied
Max Profit (+)
Min Loss (-)
$151 10 $+480
131 9 +299
111 8 +138
91 7 -3
81 6 -64
71 0 -100
61 0 -100
10-22
LO10.6
The Supply Schedule of a Competitive Firm
(1)
Total
Product
(Output)
(2)
Average
Fixed Cost
(AFC)
(3)
Average
Variable
Cost (AVC)
(4)
Average
Total Cost
(ATC)
(5)
Marginal
Cost
(MC)
1 $100.00 $90.00 $190.00 $ 90
2 50.00 85.00 135.00 80
3 33.33 80.00 113.33 70
4 25.00 75.00 100.00 60
5 20.00 74.00 94.00 70
6 16.67 75.00 91.67 80
7 14.29 77.14 91.43 90
8 12.50 81.25 93.75 110
9 11.11 86.67 97.78 130
10 10.00 93.00 103.00 150
Firm’s cost schedule

23. Quantity supplied
MR1
MR2
MR3
MR4
MR5
MC
AVC
ATC
Q2 Q3 Q4 Q5
a
b
d
e
Shut-down point
(if P is below)
10-23
c
Break-even point
(normal profit)
MC Becomes Short-Run Supply Curve
P1
0
Costandrevenues(dollars)
P2
P3
P4
P5
LO10.6
• For each price (P), a
firm chooses quantity
(Q) where MR = MC.
• Four combinations of
P and Q (b, c, d, e)
that firm chose are
on MC curve.
• A part of MC curve
above minimum AVC
becomes firm’s short-
run supply curve.

24. Summary: Output Determination
Question Answer
Should this firm produce? Yes, if price is equal to, or greater than,
minimum average variable cost. This means
that the firm is profitable or that its losses are
less than its fixed cost.
What quantity should this firm produce? Produce where MR (= P) = MC; there, profit is
maximized (TR exceeds TC by a maximum
amount) or loss is minimized.
Will production result in economic profit? Yes, if price exceeds average total cost (TR will
exceed TC). No, if average total cost exceeds
price (so that TC exceeds TR).
LO10.6 10-24
Output Determination in Pure Competition in the Short Run

25. Short-run Market Supply
• Industry’s short-run supply is sum of individual firm’s short-
run supply in market.
• The market short-run supply curve is a horizontal sum of
individual firm’s short-run supply curves.
• A quantity supplied in market is a sum of individual firm’s
quantity supplied at each price.
10-25

26. Firm and Industry: Equilibrium Price
(1)
Quantity Supplied,
Single Firm
(2)
Total Quantity
Supplied, 1,000 Firms
(3)
Product
Price
(4)
Total Quantity
Demanded
10 10,000 $151 4,000
9 9,000 131 6,000
8 8,000 111 8,000
7 7,000 91 9,000
6 6,000 81 11,000
0 0 71 13,000
0 0 61 16,000
LO10.6 10-26
Firm and Market Supply and Market Demand
Suppose there are 1,000 identical firms in market. At $111 of price, each
firm produces 8 units. Total output in market is 8 x 1,000 = 8,000 units.

27. Short-run Competitive Equilibrium
Economic
profit
d
ATC
AVC
s = MC
$111 $111
D
S = ∑MCs
8 8,000
(a) Single firm (b) Industry 10-27
P
0 0 Q
P
q
LO10.6

28. Fixed Costs: Digging Out of a Hole
• Shutting down in the short run does not mean shutting
down forever
• Low prices can be temporary
• Some firms switch production on and off depending on the
market price
• Examples: oil producers, resorts, and firms that shut down
during a recession
10-28