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

Midterm #2

• 1 Hour in length

• 50 questions multiple choice

• Allocate 1 min. per question

• Feel free to leave questions until end

• Non-cumulative: Covers all TOPICS since first midterm