7

Market structures:

Pure/Perfect
Competition
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 To ponder upon…

Using economics to explain everyday

life

• A shop owner does not like it when a similar shop

opens close by. Why?
• Jobs and business that do not have large entry
barriers tend to not be very profitable. Why?
• Sometimes firms get involved in price wars. Why
do they do this? Who benefits?

Copyright 2021 McGraw-Hill Education

 In this chapter you will learn:
• The names and main characteristics of the four basic
market models

• Which are the conditions for perfect competition

• How purely competitive firms maximize profits or

minimize losses

• Why the marginal cost and supply curves for competitive

firms are identical

• Why firms in a perfectly competitive market earn zero

economic profits in the long run

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 Where from now?

Four market Profit

structures
Pure competition
maximization MC = MR Supply

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 Four market models

Market structure continuum

Pure Monopolistic Oligopoly Pure

Competition Competition Monopoly

Imperfect Competition

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 Four market models

Aspects that differentiate the

market structures

• Number of firms in the industry

• Production of standardized or differentiated
product
• Difficulty to enter or exit the industry.

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 Four market models
Pure competition
• Very large number of firms, standardized product, very
easy entry/exit to and from industry.
Pure monopoly
• One firm, unique product, entry/exit is completely
blocked.
Monopolistic competition
• Large number of sellers, differentiated product, non-
price competition, entry/exit quite easy.
Oligopoly
• Few sellers, standardized or differentiated product.

Copyright 2021 McGraw-Hill Education

 Comparison of the markets
Feature Pure Monopolistic Oligopoly Monopoly
competition competition
Number of A very large Many Few One
firms number
Type of Homogenous Heterogeneous Either Unique
product
Conditions of Very easy Relatively easy Significant Completely
entry obstacles blocked
Non-price None Considerable Typically a Mostly public
competition emphasis on great deal relations,
advertising, advertising
brand names,
trademarks
Firm’s control None Some Limited by Considerable
over price mutual
interdepen-
dence

Copyright 2021 McGraw-Hill Education

 Some examples
• Classify the following industries:
– Restaurant industry
– Domestic airline industry
– Electricity transmission
– Bitcoin
– Beer production
– Milk production
– Wine production
– Foreign exchange markets
 Pure competition
Number of sellers
• Very large number of independently acting sellers.
• Offering products in large national or international markets.
Standardized product
• Identical or homogeneous product.
• If price is the same, consumers will be indifferent about which seller
to buy from.
• No non-price competition techniques.
Price takers
• No control over product price.
• Small fraction of the market produced by each firm.
• The competitive firm cannot change the market price.
Free entry and exit
• No significant legal, technological, financial or other obstacles.
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 Pure competition

Perfectly elastic demand of an individual firm

• The firm cannot obtain a higher price by

restricting its output nor can it increase its
sales volume by decreasing its price.
• Firms are ‘price takers’.
• Market demand is a downward sloping
curve: an entire industry can still affect price
by changing the total output.
• But the individual firm cannot affect the price
of the product it is supplying
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Market demand vs. the demand
faced by an individual firm
• The interaction of market supply
and demand determines the price
that applies to all firms operating in
this industry

• See the board for graphical

presentation

• Please note: this is not in your

textbook
 Pure competition
Average revenue
• The firm’s demand curve is also its AR curve. The
price per unit to the purchaser is also its revenue
per unit.
• AR = TR/Q = P*Q/Q = P that is constant for the firm
(price taker).
Total revenue
• It is found by multiplying price by the corresponding
quantity, TR = P*Q.
Marginal revenue
• Change in revenue from selling one more unit of
output.
• MR = P
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 Pure competition
R1179
Firm’s Firm’s
demand Revenue TR
1048
schedule data
(Average
Revenue) 917
P QD TR MR

Price and Revenue

786
R131 0 R0
] R131 655
131 1 131
] 131
131 2 262
] 131
131 3 393 524
] 131
131 4 524
] 131
131 5 655 393
] 131
131 6 786
] 131 262
131 7 917
] 131 D = MR = AR
131 8 1048
131 9 1179
] 131 131
131 10 1310 ] 131
2 4 6 8 10 12
Quantity Demanded (Sold)
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 Profit maximization in the short run
Two main
approaches

Total Revenue Marginal Revenue

(TR) - Total Cost (MR) - Marginal
(TC) Cost (MC)

Things to
consider:

What economic
Should product If so, in what
profit (loss) will
be produced? amount?
be realized?
Copyright 2021 McGraw-Hill Education
 Profit maximization in the short run
Total Revenue - Total Cost Approach
Price = R131
(1) (2) (3) (4) (5) (6)
Total Product Total Fixed Total Variable Total Cost Total Revenue Profit (+)
(Output) (Q) Cost (TFC) Cost (TVC) (TC) (TR) or Loss (-)

0 R100 R0 R100 R0 R-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 1048 +298
9 100 780 880 1179 +299
10 100 930 1030 1310 +280

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 Profit maximization in the short run
Total Revenue - Total Cost Approach
R1800
1700
Break-even point
1600 (Normal Profit)
Total Revenue, (TR)

Total Revenue and Total Cost

1500
1400
1300
1200
1100 Maximum
1000 Economic Total Cost,
900 Profit (TC)
800 R299
700
600
500 P=R131
400
300 Break-even point
200 (Normal Profit)
100
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14
Total Economic

Quantity Demanded (Sold)

R500
Total Economic R299
Profit

400
300 Profit
200
100
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14
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 Profit maximization in the short run

Marginal Revenue - Marginal

Cost Approach MR = MC Rule

Important features:

• We focus on the decision of the firm to increase

or decrease production, i.e. marginal decision
• Can/should a firm operate while making a loss?
• Under what conditions should the firm shut
down?

Copyright 2021 McGraw-Hill Education

 Profit maximization in the short run
Marginal Revenue - Marginal Cost Approach

(2) (3) (4)

(1) Average Average Average (5) (6)
Total Fixed Variable Total Marginal Marginal (7)
Product Cost Cost Cost Cost Revenue Profit (+)
(Output) (AFC) (AVC) (ATC) (MC) (MR) or Loss (-)

0 R-100
R90 R131
1 R100.00 R90.00 R190.00 -59
80 131
2 50.00 85.00 135.00 -8
70 131
3 33.33 80.00 113.33 +53
60 131
4 25.00 75.00 100.00 +124
70 131
5 20.00 74.00 94.00 +185
80 131
6 16.67 75.00 91.67 +236
90 131
7 14.29 77.14 91.43 +277
110 131
8 12.50 81.25 93.75 +298
130 131
9 11.11 86.67 97.78 +299
150 131
10 10.00 93.00 103.00 +280

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 Profit maximization in the short run
Marginal Revenue - Marginal Cost Approach

R200

P=R131
MR = MC
Cost and Revenue

150 MC

MR = P
Economic Profit
ATC
100
AVC
ATC=R97.78

50

Profit=
0
(P-ATC)*Q 1 2 3 4 5 6 7 8 9 10
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Output
 Profit maximization in the short run
Marginal Revenue - Marginal Cost Approach
Loss-minimizing case
Cost and Revenue R200

150 MC
ATC=R91.67
Loss ATC
P=R81 100 AVC

MR = P

AVC = R75 50

0
1 2 3 4 5 6 7 8 9 10
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Output
 Profit maximization in the short run
Marginal Revenue - Marginal Cost Approach
Short-run shutdown case
Cost and Revenue R200

150 MC
V = R74
ATC
100 AVC

MR = P
50 Short-run
P=R71 shutdown point
P < Minimum AVC
R71 < R74
0
1 2 3 4 5 6 7 8 9 10
Copyright 2021 McGraw-Hill Education
Output
 To summarise
• Firm will shut down if the price <
AVC
• Firm will make economic loss but
continue production if price > AVC
and price < ATC
• Firm will make economic profit if the
price > ATC
• Shut down when price = AVC
• Break-even when price = ATC
 Marginal cost and short-run supply
Supply schedule of a competitive firm
Quantity Maximum Profit (+)
Price Supplied or Minimum Loss (-)
R151 10 R+480
131 9 +299
111 8 +138
91 7 -3
81 6 -64
The firm will not 71 0 -100
produce at price 61 0 -100
R71 and R61

The schedule shows the quantity a firm

will produce at a variety of prices and results.
Copyright 2021 McGraw-Hill Education
 Marginal cost and short-run supply
Generalizing the MR=MC relationship and
its use
Cost and Revenues (Rand)

MC
e
P5 MR5
d
ATC MR
P4 4
c
This price P3
b
AVC
MR3
is below P2
a MR2
AVC P1 MR1

and will not

be
produced
0 Q2 Q3 Q4 Q5
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 Marginal cost and short-run supply
MC above AVC becomes
the short-run Supply Curve

Break-even
(Normal Profit)
Cost and Revenues (Rand)

point
MC
e
P5 MR5
d
ATC MR
P4 4
This price P3
c AVC
MR3
is below P2
b
MR2
a
AVC P1 MR1
and will not
be Shutdown point
produced (if P is below)
0 Q2 Q3 Q4 Q5
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Perfect competition in the long
run
• Note: this is not in your textbook
• In the short run entry and exit of
firms from the industry is not
possible
• In the long-run entry and exit is
possible and easy
• Entry and exit is driven by profits
and losses made by individual firms
• Effect on the supply curve and the
market price
 The mechanism
• If the firms make economic profits,
competitors are attracted =>
increase in supply => reduced price
=> reduced profits

• If the firms make economic losses,

firms leave the industry=> decrease
in supply => increased price =>
losses are eliminated (normal profit
gets made)
 The implications of this
• Showing this graphically: See the board
(very important)

• Firms in this industry do not make economic

profits in the long run

• General lesson: if the barriers to entry are

very low, you are unlikely to make much
money in an industry
• Examples: domestic workers, unskilled
workers, garden services, basic
hairdressing, etc.
 Key terms
• Pure competition
• Pure monopoly
• Monopolistic competition
• Oligopoly
• Imperfect competition
• Price taker
• Average revenue
• Total revenue
• Marginal revenue
• Break-even point
• MR=MC
• Supply curve

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