Post on 15-Jan-2016
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Pure Competition in the Long Run
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McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
The Long Run in Pure Competition
• In the long run
• Firms can expand or contract capacity
• Firms enter and exit the industry
LO1
Profit Maximization in the Long Run
• Easy entry and exit
• The only long-run adjustment we consider
• Identical costs
• All firms in the industry have identical costs
• Constant-cost industry
• Entry and exit do not affect resource prices
LO2
Long-Run Equilibrium
• Entry eliminates profits
• Firms enter
• Supply increases
• Price falls
• Exit eliminates losses
• Firms exit
• Supply decreases
• Price rises
LO3
Entry Eliminates Economic Profits
LO3
ATC
MR
MC
$60
50
40D1
S1
D2
$60
50
40
S2
Exit Eliminates Losses
LO3
ATC
MR
MC
$60
50
40D3
S3
D1
$60
50
40
S1
Long Run Supply
• Constant cost industry
• Entry/exit does not affect LR ATC
• Constant resource price
• Special case
• Increasing cost industry
• Most industries
• LR ATC increases with expansion
• Specialized resources
• Decreasing cost industryLO4
LR Supply: Constant-Cost Industry
LO4
90,000 100,000 110,000Q3 Q1 Q2
$50 SZ1 Z2Z3
D3 D1 D2
LR Supply: Increasing-Cost Industry
LO4
90,000 100,000 110,000Q3 Q1 Q2
$50P1
S
Y1
Y2
Y3
D3
D1
D2
$40
$55P2
P3
LR Supply: Decreasing-Cost Industry
LO4
90,000 100,000 110,000Q3 Q1 Q2
$50P1
S
X1
X2
X3
D3
D1
D2
$40
$55P3
P2
Pure Competition and Efficiency
• In the long run, efficiency is achieved
• Productive efficiency
• Producing where P = min. ATC
• Allocative efficiency
• Producing where P = MC
LO5
Pure Competition and Efficiency
LO5
P MR
D
S
QeQf
ATC
MCP=MC=MinimumATC (Normal Profit)
P
Consumer Surplus
Producer Surplus
Dynamic Adjustments
• Purely competitive markets will automatically adjust to
• Changes in consumer tastes
• Resource supplies
• Technology
• Recall the “Invisible Hand”
LO6
Technological Advance: Competition
• Entrepreneurs would like to increase profits beyond just a normal profit
• Decrease costs by innovating
• New product development
LO6
Creative Destruction
• Competition and innovation may lead to “creative destruction”
• Creation of new products and methods destroys the old products and methods
LO6
Efficiency Gains from Entry
• Patent protected prescription drugs earn substantial economic profits for the pharmaceutical company
• Generic drugs become available as the patent expires on the existing drug
• Results in a 30-40% reduction price
• Greater consumer surplus and efficiency
Efficiency Gains from Entry
Q1 Q2
P1
S
D
P2
a
b c
df