PURE COMPETITION IN THE SHORT RUN

Four Market Models

no power to influence price so the firm merely chooses to

produce a certain level of output at the price that is
given. The demand curve is not perfectly elastic for the
industry; it only appears that way to the individual firm,
since they must take the market price no matter what
quantity they produce. The firm faces a perfectly elastic
demand because each individual firm makes up such a
small part of the total market and the goods are perfect
substitutes. Note that this perfectly elastic demand
curve is a horizontal line at the price.
*Pure competition is rare in the real world, but the model is
important. The model helps analyze industries with
characteristics similar to pure competition. The model
provides a context in which to apply revenue and cost
concepts developed in previous chapters. Pure competition
provides a norm or standard against which to compare and
evaluate the efficiency of the real world.
Pure Competition: Characteristics

1. Very large numbers of independent sellers each

acting alone cannot influence the market price by
increasing or decreasing their output because each
has such a miniscule part of the entire market.
2. A standardized product is a product for which
all other products in the market are identical and thus
are perfect substitutes. The consequence of this is
that buyers are indifferent as to whom they buy from.
3. Price takers have no pricing power; in other words,
no ability to price their product.
4. Easy entry and exit means that there are no
obstacles to entry or to exit the industry.
5. Perfectly elastic demand means that firm has

*When a firm charges the same price for each unit of output,
the average revenue is just the price of the good. Total
revenue refers to the total amount of money that the firm
collects for the sale of all of the units of their good. Marginal
revenue reflects the additional revenue that the firm will
receive by producing one more unit of output. When the firm
is deciding how much to produce, the firm considers the
marginal revenue in their decision.
*The demand curve (D) of a purely competitive firm is a
horizontal line (perfectly elastic) because the firm can sell as
much output as it wants at the market price (here, $131).
Because each additional unit sold increases total revenue by
the amount of the price, the firms total-revenue (TR) curve is
a straight upsloping line and its marginal-revenue (MR) curve
coincides with the firms demand curve. The average-revenue
(AR) curve also coincides with the demand curve.
Profit Maximization: TR-TC Approach
Three
questions:

*Part of the profit-maximization rule is producing an output

that minimizes losses in the short run when that is the best
option.
Loss-Minimizing Case
Loss minimization
(1) Still produce because P > minAVC (2)Losses at a
minimum where MR=MC
*In the short run the firm only has two choices: produce or
shut-down. There is not enough time in the short run for the
firm to get out of business. Given these options, sometimes
the firm will produce, but still make a loss. In these situations,
the loss from producing is smaller than the loss if the firm
shut-down so this is the firms best choice.
*The market equilibrium condition is where quantity
demanded equals quantity supplied.
We can see that the industry demand curve is a typical,
downward sloping demand even though, for the firm, the
demand curve is perfectly elastic and horizontal.

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
* Firms have to determine whether or not producing in the
short run will make their losses bigger or smaller. Firms hope
that producing will help to reduce their losses, but if they are
wrong their losses (their hole) might grow greater. If firms are
forced to shut-down, the shut-down might be temporary. The
firm may re-open when prices rise and therefore will be large
enough for the firm to reap profits.