Long Run: Equilibrium P.C. • Profits and losses
– are inconsistent with P.C. LR equilibrium
– are signals to which firm owners respond causing industry supply to shift.• causing product prices to change
eliminating profits & losses in the long run.• Profit = more firms enter and profit
disappears• Loss = firms exit market and losses
disappear
Long Run Adjustment
• 1.) Exit and Entry–stops when firms are making 0 economic
profit.
•2.) Change Size of Plant–stops when firms have the plant that coincides with the min. LRATC and firms are making 0 economic profit
Entry & Exit
Quantity of Sweaters(firm)
Pric
e (
$)
S
Quantity of Sweaters (industry)
Pric
e ($
)
D
P1
Q1
d = MR
ATCMC
Initial Market Condition
q1
Break-evenP=Min.ATC
Long Run Adjustment
Higherpricecreates economicprofit
d2P2
Q2
Quantity of Sweaters (firm)
Pric
e ($
)
Quantity of Sweaters(industry)
Pric
e ($
)
S
Entry and Exit
D1
P1
Q1
d1
ATCMC
q1
D2
q2Q1
Increased cold weather increasesdemand for sweaters
Long Run Adjustment
Quantity of Sweaters (industry)
Pric
e ($
)
S1
Entry and Exit
D1
P1
Q1
Economic profit attracts new firms.Price falls to break-even point.
Quantity of Sweaters (firm)
Pric
e ($
)
d1
ATCMC
q1Q1
D2
S2
Break-evenP=Min.ATC
Long Run Adjustment
Ease of Entry important for Long Run Adjustment
Quantity of Sweaters (industry)
Pric
e ($
)
S1
Constant Cost Industry
D1
P1
Q1
Demand shifts, offering profit to current firms.
Q1
D2
S2
Long Run Supply
Additional firms do not increase costs.
LRS More firms enter, shifting supply yet not increasing
input costs.
Long run supply is horizontal.
Quantity of Sweaters (industry)
Pric
e ($
)
S1
Increasing Cost Industry
D1
P1
Q1
Demand shifts, offering profit to current firms.
Q1
S2
Long Run Supply
Additional firms increase costs.
LRS
More firms enter, shifting supply yet increasing input
costs
Long run supply is upward sloping
D2
Quantity of Sweaters (industry)
Pric
e ($
)
S1
Increasing Cost Industry
D1
P1
Q1
Demand shifts, offering profit to current firms.
Q1
D2
S2
Long Run Supply
Additional firms decrease costs.
LRS
More firms enter, shifting supply yet decreasing input
costs
Long run supply is downward sloping
Technological Change: Process of Adjustment• The first firms to adopt new technology will
make a profit, other firms will eventually exit or switch– Composition of industry is varied consisting of
new and old tech firms– Technological change brings temporary gains to
producers
• Lower prices and better products resulting from technological advance bring permanent gains to consumers
Quantity (sweaters per day)
Pri
ce (d
olla
rs p
er s
wea
ter)
14
25
40
Change Plant Size(Firm-wide)
20
6 8
SRAC0
MC0
MR0
Short-run profitmaximizing point
MC1 SRAC1
LRAC
MR1
Long-runcompetitiveequilibrium
m
Long Run Adjustment
Changing plant size willResult in changed MC and Therefore SRAC curves
Long-Run: Competitive Equilibrium
Quantity per Time Period
Pric
e pe
r U
nit
d = MR = P = MC=SRATC=LRATC
LACSAC
MC
Qe
E
P (= MR) = MC : SR equilibrium
MC = SRATC : no incentive for firms to enter or leave
Min LRATC : minimum per unit costs achieved so plant size is optimal
In the Long Run: P=MC=minATCIn the Long Run: P=MC=minATC
Long Run: Summary
• Competition and the Desire for Profit– The forces that provide for both productive
and allocative efficiency in PC markets in the long run
• P = MC = min ATC (P.C. Long Run Equil.)– Indicates both productive and allocative
efficiency.
Micro Efficiency and the Long Run
Productive Efficiency
• 1.) Productive Efficiency - occurs when Productive Efficiency - occurs when
• P = min ATC–firms produce at min ATC and receive a
price =min ATC. Firms must use the best available, least-cost technology, or they will not survive.
–Requires that each good in the optimal product mix be produced in the least costly way.
Allocative Efficiency
• 2.)Allocative Efficiency - occurs whenAllocative Efficiency - occurs when
• P = MC–resources are used to produce the total
output whose composition best fits consumer preferences, the optimal product mix.
–Requires resources be allocated to firms so as to obtain the optimal mixoptimal mix of products
Allocative Efficiency:P=MC
Price of X – society’s measure of the relative worth of that product at
the margin.• measures the extra benefit or value society gets from
additional units of X (MSB – Marginal Social Benefit)
Marginal Cost of X
– society’s measure of the value of the other goods that the resources used in the production of an extra unit of X could otherwise have produced.
• measures the sacrifice or opportunity cost to society of using resources to produce additional X (MSC – Marginal Social Cost)
Recall:
Allocative Efficiency
• When P = MC MSB = MSC
• each good is produced to the point at which
–society’s value of the last unit = society’s value of the alternative goods sacrificed by its production.
Efficiency of the Equilibrium Quantity
MSC
MSB
Q0 Q*
B0
C0
P*AllocativeEfficiency,MSC=MCB
Quantity
MC,MB $
ProducerSurplus
ConsumerSurplus
Consumer ++ Producer Surplus is Maximized
Allocative Efficiency
• When P = MC MSB = MSC
• each good is produced to the point at which
–society’s value of the last unit = society’s value of the alternative goods sacrificed by its production.
•economic well being is maximized; that is, consumer surplus + producer surplus, is maximized
Summary: Perfect Competition &The Invisible Hand
– Consumers and producers pursue their own self-interest and interact in markets.
– Market transactions generate an efficient—highest valued—use of resources.
Usefulness of the Perfectly Competitive Model
• It reduces the complexity of reality into manageable size
• It highlights the idea of an efficient allocation & use of resources
• It shows the role of prices, profits and competition in the market system
Usefulness of the Perfectly Competitive Model
• Serves as a yardstick against which real-world market structures, resource allocation, prices, profits, competition and firm behaviour can be compared.
• Acts as a guide to public policy and corrective action.
Failure of Perfect Competition
• Inefficient resource allocation can lead to MARKET FAILURE (ie: externalities and public goods)
• PC firm are too small to engage in extensive R&D, slowing technological growth (ie: Microsoft wouldn’t be making so many advances if it where in a PC market)
Monopoly
a single seller of a product which has no close substitutes.
Market power is the ability to influence the market price by influencing the total quantity offered for sale.
Characteristics of Monopoly
1. Single seller • firm & industry are the same
2. Unique product
3. Barriers to entry
4. Good will advertising
5. Price maker/searcher
Why do monopolies arise?
• Barrier to Entry: something that prevents new firms from entering and competing
1. Key resources owned by a single firm.
2. Government grants exclusive right (eg. patent) to produce product .
• Economies of Scale- Natural Monopoly: single firm can supply a product to an entire market at a lower per unit cost than could 2 or more firms.
- Using economies of scale to predate and maintain monopoly power is illegal in Canada
ATCATC
Quantity (millions of kilowatt-hours)Quantity (millions of kilowatt-hours)
55
1010
1515
Natural MonopolyNatural Monopoly
00 11 22 33 44
DD
Pri
ce (
cen
ts p
er
kilo
wat
t-h
our)
Pri
ce (
cen
ts p
er
kilo
wat
t-h
our) 1 firm can supply 4 million kWh 1 firm can supply 4 million kWh at 5 cents/kWhat 5 cents/kWh
2 firms can supply 4 million kWh 2 firms can supply 4 million kWh at 10 cents/kWhat 10 cents/kWh
4 firms can supply 4 million kWh 4 firms can supply 4 million kWh at 15 cents/kWhat 15 cents/kWh
Demand cuts LAC to the Demand cuts LAC to the left of the min. LACleft of the min. LAC
•There are economies of scale There are economies of scale over the relevant range of over the relevant range of output.output.
Pricing & Output Decision: Monopolist
• Monopolists have the ability to influence
the output price by choosing the output
level.
• The firm’s demand curve is the market demand curve.
• A monopolist’s MR is always less than price (except for the first unit)
Area B (-)
Loss =-$3
Area A (+)
Gain =$7
D
Demand curve = AR curve
Marginal Revenue: Always Less Than Price
Quantity of Electricity per Time Period
Pric
e of
Ele
ctric
ity
8
3
P = $8TR = $24
7
4
P = $7TR = $28
To sell 3 units, each unit sold for $8To sell 4 units, each unit sold for $7Lose $1/unit on 3 units or -$3Gain $7 on the 4th unit or +$7Net Gain (MR) = $4 (TR/ TO)
Demand & Marginal Revenue
• To increase quantity sold– the monopolist
lowers selling price – lowering price to sell
an additional unit also lowers price on the previous units - which previously would have sold for more.
Q1
P1
Quantity per Time Period
Pric
e, a
nd M
argi
nal R
even
ue p
er U
nit
D=AR
P2
Q2
P3
Q3
Marginal revenue lies below D/AR for the monopolist
MR
Monopoly: Profit Max. Decision
$
C Film rental 1800 Auditorium
O Auditorium rental 250 holds 700
S Operator 50 people
T Ticket takers 100
S
TOTAL $2200
Ed’s Costs of Showing MovieEd’s Costs of Showing Movie
CostsFilm Rental $1800Auditorium 250Operator 50Ticket Takers 100
Total $2200
Ed’s Profit Maximizing DecisionEd’s Profit Maximizing Decision
What will Ed charge for admission to maximize profits?10
0
1000
900
800
700
600
500
400
300
2000
123
8
56
4
7
910
Tickets Per Week
$ P
er T
icke
t
Demand (AR)
Profit Maximizing Rule
Look at demand for revenue information
P Q TR MR Profit
$ $ $ $
7 300 2100 TR/ TO TR-TC
6 400 2400 3.00 200
5 500 2500 1.00 300
4 600 2400 -1.00 200
3 700 2100 -100
TC=$2200 MC=0
• PRODUCE ALL THOSE UNITS FOR WHICH MR MC.
– All costs are sunk/fixed:
– TC = $2200
– MC = $0
100
1000
900
800
700
600
500
400
300
2000
123
8
56
4
7
910
Tickets Per Week
$ P
er T
icke
tThe Profit Maximizing DecisionThe Profit Maximizing Decision
Demand (AR)
MR
Profit MaximizationMR MCMC = 0 MR = 0
Q* = 500P* = $5.00
TR $2500TC $2200
Profit $300
Change Cost Conditions
• Now suppose the distributor of the films changes the rental fee from a flat $1800 to $800 and $2.00 for every ticket sold.
• TFC=$800 +$400 = $1200
Revenue Info Cost Info
Demand FC = $1200
P,$’s Qn MR,$’s TC,$’s MC,$’s
7.00 300 1800
6.00 400 3.00 2000 2.00
5.00 500 1.00 2200 2.00
4.00 600 -1.00 2400 2.00
The Profit Max Decision when MC = $2.00
Profit MaximizationMR MCMC = 2 MR = 2
Q* = 400P* = $6.00Profit=$400
MC
Demand (AR)
MR
100
1000
900
800
700
600
500
400
300
2000
123
8
56
4
7
910
Tickets Per Week
$ P
er T
icke
t