Department of Economics, Management and Humanities
Czech Technical Universinty in Prague
ECONOMICS
EXERCISES No. 6
PURE COMPETITION
Handout
Doc. Ing. Helena Fialová, CSc.
Ing. Jan Jandera
Ing. Michal Táborský
Prague
2003
The company is operating in pure competition. Let the company's marginal
cost be MC = 2 + 4Q and average variable cost be AVC = 2 + 2Q. How
much will the company be producing at price $10 ? Evaluate company's
fixed cost, when you know the company will generate no economic profit.
When the marginal cost is lower than average fixed cost, it is better to shut
down the business. Right or wrong ? Why ?
Assume, that all companies in purely competitive market produce exactly
the quantity, where their long-term marginal cost equals the price. This
market must be in long-term equilibrium. Right or wrong? Why?
Long-term average and marginal costs of taxis are constant in the town of
Pragopolis and are 20 CZK per 1 kilometer. Demand curve for taxi service
in this town can be expressed as P = 100 - 0.001Q (P is fare per 1 km and
Q is number of kilometers per year demanded). This branch is purely
competitive and every cab can offer 10 000 km of service per year.
How many cars will be operating and at what price per kilometer ?
Mayor of Pragopolis decides, that there are far too many cabs in city
streets and the number of cabs should be limited to only 6 cars. All drivers
také part in lottery and six lucky winners are awarded lifetime taxiing
permit.
What will the new price per kilometer be ? What economic profit will each
of the awarded drivers yield ? If these licence s were on sale, what would
their price be ? (Consider usuallO% long-term interest rate.)
Chapter 23: Pure Competition
MC
e
MR
ATC
~
ca
~
AVC
f
,--u_u
_h
h_hh,
--.
hU
o
Type:G
h'
/} k 11
Output
Topic:3
E:474-475
MI: 194-195
~9. Refer to the above diagram. The profil-maximizing outpul:
a) is 11. b) is k. c) ís h. d) Call110tbe detenl1ined[rom lhe infonl1ation given.
Allswer:
.
Type: G Topic: 3 12:474-475.,MI: 194-195
~O. Refer lo the above diagram. Allhe profíl-maximizing oulput, average variable cosl is:
a) eJ. b) fg. c) na. d) ae. e) ab.
Answer:
.
Type:G Topic:3 12:474-475 MI: 194-195
~I. Refer to the above diagram.Atthe profit-maximizingoulpul,lotalprofitis:
a) ejbc.
Answer:
.
b) Igab.
c) egac.
d) CJbn. e) Oec11.
Type:G Topic:3
12:474-475 MI: 194-195
)2. Refer to the above diagram. For any level of oulput, total fíxed cosi:
a)
isfgab.
Answer:
-
b) is Ogan
c) is ba.
ci) is eJbe.
.4. KEY QUESTIGN Assume the following unitcost data are for a purely competitive producer:
Average
Tota!
I
proauct
-
O
1
2
3
4
5
6
7
8
9
10
fixed
Average
variable
Average
total
Marginal
cost
cost
cost
cost
$60.00
30.00
20.00
15.00
12.00
10.00
8.57
7.50
6.67
6.00
$45.00
42.50
40.00
37.50
37.00
37.50
38.57
40.63
43.33
46.50
$105.00
72.50
60.00
52.50
49.00
47.50
47.14
48.13
50.00
52.50
$45
40.
35
30
35
40
45
55
65
75'
a. At a product price of $32, will this finn produce
in the short run? Whyor why not? If it does produce, what wilI be the profit-maximizing or 10ssminimizing output? Explain. VVhat economic
profit or 10sswill the firm realize per unit of out~~
.
b.Answer the questions of 4a assuming product
price is $41.
c. Answer the questions of 4a assuming product
price is $56.
g.
Suppose the market demand data. for the product
are as follows:
Price
Toto/
quantity
demanded
$26
32
38
41
46
56
66
17,000
15,000
13,500
12,000
10,500
9,500
8,000
VYnatwiIl be the equilibrium price? VYnatwiIl be the
equilibrium output for the indusrry? For each firni?
vVhat wili profi( ar 1055be per unit? Per finn: vVili
tl1Ísindusrry expand or contract in the 10ng run:
.
Department of Econornics, Management and Humanities
Czech Technical University in Prague
ECONOMICS
>LI PES
LECTURE No.6
PURE COMPETITION
Handout
Doc. Ing. Helena Fialová, CSc.
Ing. Jan Jandera
Prague
2000/2001
Lecture 6
PURE COMPETITION
Variety of market structures is unlimited.
One extreme: A single producer dominating a market
The other extreme: Thousands of small firms.
FOUR MODELS:
1. Pure competition
2. Pure monopoly
3. Monopolistic competition
4. Oligopoly
CHARACTERlSTICS OF PURE COMPETITION
Examples (rare in practice): farm commodities,stock market, foreign exchange market
1. Vel}' large number 0/firms
2. Standardized (homogeneous) product
3. No control over price (the producer is a price taker)
4. Free entry and exit
The demand curve for a firm is perfectly elastic (Fig. 6.1)
The demand curve = price = average revenue
D=P=AR=MR
= marginal
revenue (Fig. 6.2)
The curve of total revenue (TR) is a straight upsloping line (Fig. 6.3).
PROFIT MAXIMIZATION IN THE SHORT RUN
Total Revenue-Total CostApproach (Fig. 6.3, 6.4)
Marginal Revenue=Marginal Cost Approach (Fig. 6.5,6.6)
MR = MC Rule
The firm should produce at that point where price equals marginal cost (P = MC)
1
LOSS MlNlMIZlNG CASE
Price exceedsthe minimumAVe.
SHUT-DOWN CASE (Fig. 6.7)
Price equals the minimumAve or is less than the minimumAve.
PROFIT MAXIMIZATION
~
THE LONG RUN (Fif!.6.8)
Firms can expand or contract tbeir plant capacities.
Tbe entry of new firms will compete away economicprofits.
Tbe exodus of existing firms will eliminate losses.
RESULT: P = minimum ATC
2
Fig. 6.1
Demand Curve for a Firm Under Perfect Competition
o
Industry
supply
curve
~
s
~'Io.
..............
(j)
Q)
~-
ro
-
A
(j) o
::1-0
co
'- o
e-e-e
8
C
7
Q)'o.O
0.(0
Q).S?
()~
.;:: U
Firm's demand
curve
CLc:
s
o
I
100
I
200
I
300
I
400
Total Sales in Chicago.
(thousands of truckloads)
(per year)
o
1
2
3
4
Truckloads of Com
Sold by Farmer Jones
(per year)
Fig. 6.2
Sbort Run EQuilibrium oe tbc Compctitivc Firm
+-'--..
AC
cn Q)
OJ::
ocn
::J
"'tJ.Q
c:
~
co Q)
Q)o..
::J ~cn
c:
8
I
>=
6
o::::s
4
Q) co
'.
'jA
Q) o
o
I
I
I
I
I
I
I
I
.
.
50,000
Bushets af Carn per Year
Fig. 6.3
Profit Maximization in tbe Sbort Run: Total Revenue- Total Cost Approacb
$1,700
1,600
1,500
-
1 ,400
(J)
2
1,300
~ 1,200
o
-
1,100
"C
~
~
t:
1,000'
Q)
>
-~
~o
I-
900 .,'
I
800
..
700
600
500
400
300
200
100
o
1
2
3
4
5
6
7
8
9 10 11 12 13 14
Quantity demanded (sald)
(a) Profit-maximizing case
-
.-
'O $500
400
(,)
10.0
Co
E
o
300
§
200
~
~
1°°,
(.)
(13
;:
,1
°
1
2
3
4
5
6
7
8
9 10 11 12 13 14
Quantity demanded (sold)
(b) Total economic profit
Fig. 6.4
The Profit Maximizin2 Output for a Purelv Competitive Firm in the Short
Run: Total Revenue-Total Cost Approach (Price
mn
, :?\:,:'i:c,;-::;,};','c;'t';r~Jo
fixed
o
1
2
3
4
5
6
7
8
~
10
c,' ",,',,'
tdl::dN::,\\;c,.'
""variable
cost, TFC
cost, rvc
$100
100
100
100
100
100
100
100
100
100
100
$ O
90
170
240
300
370
450
540
650
780
930
TC
$ 100
190
270
340
400
470
550
640
750
880
1030
O
131
262
393
524
655
786
917
1048
J 779
1310
$
$ - 100
- 59
- 8
+ 53
+124
+ 185
+236
+277
+298
+299
+280
Fig. 6.5
The Demand and Revenue Schedules for a Purelv Competitive Firm in the
Short Run
Firm's demand or averoqe....
revenue schedule
(1)
Product
.
pnce
(average
revenue)
Revenue data
.
(2)
Quantity
(3)
Totol
demanded
(sold)
revenue
$131
131
O
1
13J
131
131
131
2
3
4
262}
393}
524J
131
131
13}
5
6
7
655J
786J
917J
131
131
8
9
1048 J
131
10
$
/
1179
1310 ]
(4)
Marginal
revenue
$131
131
131
.131
131
131
131
131
131
131
Fig. 6.6
The Profit Maximizin2 Output for a Purely Competitive Firm in the Short Run: Mar2inal Revenue=Mar2inal
Approach (Pric~131)
A verage
(3)
A verage
(4)
A verage
CQist
cost
cost
(1)
(2)
To/al
product
fixed
variable
total
2
3
4
5
6
7
8
.J.
10
$1100.00
50.00
33.33
25.00
20.00
16.67
14.29
12.50
11J
188"'
1.
10.00
85.00
80.00
75.00
74.00
75.00
77. 14
81.25
$190.00
135.00
113.33
100.00
94.00
91.67
91 .43
93.75
97.
97.78
$90.00
93.00
cost
=
marginal
revenue
O
1
(6)
Price
(5)
Marginal
",""""'_..
103.00
$ 90
$131
80
70
60
70
80
90
110
131
131
131
131
131
131
131
130.
150
,',
(7)
Total economic
profit (+)
or 1055 (-)
$ - 100
- 59
-
8
-
53
+124
+185
+236
+277
+298
131.
131
Cost
.
+299
'''.;+.
+280
Fig. 6.7
Shut-Down Analvsis
MC
P3
P3
P2
p,L
P1
P1
Q)
()
~
o...
Quantity Supplied
Fig. 6.8
Long-RunEguillibrium
of the Comvetitive Fir_mand Industrv
MC
Q)
.J::
Cf)
::I
..Q
Q) "u Q)
'C o..
o... Cf)
"-
Q)
.J::
Cf)
::I
..Q
Q) "u Q)
'C o..
o... "Cf)
co
o
:s
5
O2
o
207~; firrYlSi
'-'2
co
o
:s
°:::
40
Quantity af Com
(thausands af bushels)
~'D
.
Quantity af Com
(millians af bushels)
83