Principles of EconomicsEC 201California State Polytechnic University, PomonaDr. BresnockFall, 2002Principles of EconomicsEC 201California State Polytechnic University, PomonaDr. BresnockFall, 2002Lecture 11 This chapter begins our coverage of 4 market models, or market structures.First we will summarize the key characteristics of these models in Table 1below. Then we will begin an in depth analysis of how each market structureselects its price and output.Table 1 Market Structure CharacteristicsMarket StructureCharacteristicPureCompetitionMonopolisticCompetitionOligopoly Monopoly# of Firms Very Large Many Few OneType ofProductStandardizedDifferentiatedDifferentiated (D)or Standardized(S)UniqueControloverPriceNone; “pricetakers”Some, butlimitedMutualInterdependenceto ConsiderableConsiderable; “pricemaker”ConditionsofEntry + ExitVery easy RelativelyeasySignificant “barriers to entry”Substantial“barriers toentry”NonpriceCompetition,i.e.advertising,brandnames,trademarksProductrather thanbrand useConsiderableGreat forDifferentiatedTrade-oriented forStandardizedMostly publicserviceExamplesEC 201 Lecture 11Fall, 2002 A. Bresnock2EC 201 Lecture 11Fall, 2002 A. BresnockPrice and Output Determination: Pure CompetitionCharacteristics:1. Large # of Independent Sellers 2. Standardized, or Homogeneous, Product – little ability for sellers todifferentiate product; buyers indifferent between sellers3. “Price Takers” not “Price Makers – sellers are “quantity adjusters”.**(see below) 4. No Barriers to Entry or Exit – no significant financial, technological, orlegal obstacles5. Only “Product” Advertising – i.e. California raisins, California cheese,“pork the other white meat”, “where’s the beef”Graph 1 Price Determination for Purely Competitive Firm INDUSTRY FIRMSome Terms:TR = Total Revenue = Price X QuantityAR = Average Revenue = Per Unit Revenue = TR QMR = Marginal Revenue = Additional Revenue per an Additional Unitof Output =  TR = TR2 – TR1  Q Q2 – Q13EC 201 Lecture 11Fall, 2002 A. BresnockExample: Assume P = $12 per unit. Price is “parametric”, or given.Table 2 Revenue Functions for a Purely Competitive FirmP Q12345678Graph 2 Revenue Functions for the Purely Competitive FirmNote: The demand for the purely competitive firm in Graph 2 shows us thatits demand is perfectly elastic at the price that was determined by theindustry. This demand is unique in this respect and we can see that P = MR =AR at the industry level. Each of the many firms has a negligible impact onthe industry price.Note: Notice that the MR is the slope of the TR (or first derivative of the TR).In this market structure, notice also that P is the slope of TR as well, since MR= P.4EC 201 Lecture 11Fall, 2002 A. BresnockTwo Approaches to Profit Maximization: Purely Competitive Firm(SHORT RUN)(1) Total Approach -- Pick Q so that the firm willMax (TR – TC) or Max Total “Economic” ProfitsWhere TC = Total “Economic” Costs = rent, wages and salaries,interest expenses, and “normal profits” (recall discussion of thisin Ch. 9)(2) Marginal Approach -- Pick Q so that MR = MC or (Necessary condition to Max TOTAL Marginal Profit = 0 “Economic” Profits)andMC is Rising or MC > 0 (Sufficient condition to MaxTOTAL “Economic” Profits)Table 3 Total Approach to Profit Maximization (Purely Competitive Firm,Short Run) P Q TR TFC TVC TC Total “Economic” Profit or Loss $12 0 $10 $ 0 1 10 2 19 3 27 4 36 5 46 6 57 7 69 8 82Why is this a Short Run analysis?(1)5EC 201 Lecture 11Fall, 2002 A. Bresnock(2)6EC 201 Lecture 11Fall, 2002 A. BresnockGraph 3 Total Approach to Profit Maximization (Purely Competitive Firm,Short Run)Note: The profit max quantity is QMAX and is found where the TR > TC by thelargest amount, or at 7 units. Graph 4 Changes in Total Revenue (Purely Competitive Firm)Note: If TR changes while TC are constant, then there are several outcomesother than profit maximization that may result. These are shown on thenext page.7EC 201 Lecture 11Fall, 2002 A. BresnockGraph 5 Total Approach : Breakeven (Purely Competitive Firm)Note: The breakeven quantity is QBE and is found where the TR = TC. If thisoutcome occurs, the firm makes only “normal profits” and “economicprofits” are zero. Graph 6 Total Approach: Loss Minimization (Purely Competitive Firm)Note: The loss minimization quantity is QMIN and is found where the TR < TCby the smallest amount, and so long as the total loss is less than the TFC. 8EC 201 Lecture 11Fall, 2002 A. BresnockGraph 7 Total Approach: Shut Down (Purely Competitive Firm) Note: The loss minimization quantity is found where the TR < TC by thesmallest amount and this occurs at Q = 0. Thus, the shut downquantity, QSD, is zero.Table 4 Marginal Approach to Profit Maximization (Purely CompetitiveFirm, Short Run) Q P TC MC 0 $10 1 20 2 29 3 37 4 46 5 56 6 67 7 79 8 929EC 201 Lecture 11Fall, 2002 A. BresnockGraph 8 Marginal Approach to Profit Maximization (Purely CompetitiveFirm, Short Run)Note: The first step is to select Q where MR = MC (and MC > 0). Thesecond step, is to compare the AR and ATC at that Q level. In this case,you will see that the AR > ATC at that quantity. Thus, you have locatedthe quantity that will maximize profits given the costs and product price,or QMAX.Graph 9 Marginal Approach: Breakeven (Purely Competitive Firm, ShortRun)10EC 201 Lecture 11Fall, 2002 A. BresnockNote: