Perfect Competition Long Run Overheads
description
Transcript of Perfect Competition Long Run Overheads
Perfect Competition
Long Run
Overheads
Review of short run equilibrium
The number of firms is fixed
The firm is operating on a short-run cost curve
Some inputs are fixed
Q S ΣL
i 1yi (p , w1 ,w2 , , z)
The market or industry supply curve, QS, is the horizontal summation of the individual firm supply curves
yi yi(p , w1 , w2 , , wn , z)
Industry Supply-Demand Equilibrium
$
Output
S(p)
p0
Q0
D(p)
Demand for Individual Firm
$
Output
p0 D(p)
AVC
MC
ATC
P = 120
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Short run equilibrium
Competitive markets in the long run
The number of firms in the industry can vary
The firm is operating on its long run cost curve
Conditions for a long run equilibrium
1. No individual firm wishes to change the amount of the good it is supplying to the market
2. No individual consumer wishes to change the amount ofthe good he or she is demanding
3. No individual firm in the market has an incentive to changethe amount of any of the inputs it is usingor to exit from the market
4. No firm outside the market has any incentive to enter it
5. The aggregate supply in the market equals theaggregate demand in the market
Plant size adjustment by the firmwith no change in the market price
P = Price = $292
Short run average and marginal costs as in the table
Assumptions for example problem
The firm is operating a plant with a capacity rating of 55
SRAC SRMC SRAC SRMC SRAC SRMC SRAC SRMC y Price 5 5 9 9 15 15 18 180.00 2921.00 292 851.00 103.00 2291.00 6251.00 9041.002.00 292 479.00 112.00 1079.00 2879.00 4184.004.00 292 303.50 148.00 483.50 1203.50 1766.005.00 292 275.00 175.00 371.00 875.00 1289.006.00 292 261.00 208.00 301.00 661.00 976.00 7.00 292 256.14 247.00 256.14 7.00 513.29 757.57 8.00 292 257.75 292.00 227.75 52.00 407.75 599.00 9.00 292 264.33 343.00 211.00 103.00 331.00 481.0010.00 292 275.00 400.00 203.00 160.00 275.00 392.0011.00 292 289.18 463.00 201.91 223.00 234.64 324.6412.00 292 306.50 532.00 206.50 292.00 206.50 274.0013.00 292 326.69 607.00 215.92 367.00 188.23 7.00 236.69 14.00 292 349.57 688.00 229.57 448.00 178.14 88.00 210.2915.00 292 375.00 775.00 247.00 535.00 175.00 175.00 193.00 16.00 292 402.88 868.00 267.88 628.00 177.88 268.00 183.50 88.0017.00 292 433.12 967.00 291.94 727.00 186.06 367.00 180.76 187.0018.00 292 465.67 1072.00 319.00 832.00 199.00 472.00 184.00 292.0019.00 292 500.47 1183.00 348.89 943.00 216.26 583.00 192.58 403.0020.00 292 537.50 1300.00 381.50 1060.00 237.50 700.00 206.00 520.0022.00 292 618.09 1552.00 454.45 1312.00 290.82 952.00 245.82 772.0023.00 292 661.61 1687.00 494.65 1447.00 322.48 1087.00 271.61 907.00
Conditions for short run equilibrium
Price = MC
Price AVC
SRAC SRMC SRAC SRMC SRAC SRMC SRAC SRMC y Price 5 5 9 9 15 15 18 180.00 2921.00 292 851.00 103.00 2291.00 6251.00 9041.002.00 292 479.00 112.00 1079.00 2879.00 4184.004.00 292 303.50 148.00 483.50 1203.50 1766.005.00 292 275.00 175.00 371.00 875.00 1289.006.00 292 261.00 208.00 301.00 661.00 976.00 7.00 292 256.14 247.00 256.14 7.00 513.29 757.57 8.00 292 257.75 292.00 227.75 52.00 407.75 599.00 9.00 292 264.33 343.00 211.00 103.00 331.00 481.0010.00 292 275.00 400.00 203.00 160.00 275.00 392.0011.00 292 289.18 463.00 201.91 223.00 234.64 324.6412.00 292 306.50 532.00 206.50 292.00 206.50 274.0013.00 292 326.69 607.00 215.92 367.00 188.23 7.00 236.69 14.00 292 349.57 688.00 229.57 448.00 178.14 88.00 210.2915.00 292 375.00 775.00 247.00 535.00 175.00 175.00 193.00 16.00 292 402.88 868.00 267.88 628.00 177.88 268.00 183.50 88.0017.00 292 433.12 967.00 291.94 727.00 186.06 367.00 180.76 187.0018.00 292 465.67 1072.00 319.00 832.00 199.00 472.00 184.00 292.0019.00 292 500.47 1183.00 348.89 943.00 216.26 583.00 192.58 403.0020.00 292 537.50 1300.00 381.50 1060.00 237.50 700.00 206.00 520.0022.00 292 618.09 1552.00 454.45 1312.00 290.82 952.00 245.82 772.0023.00 292 661.61 1687.00 494.65 1447.00 322.48 1087.00 271.61 907.00
SRAC SRMC SRAC SRMC y Price 5 5 9 96.00 292 261.00 208.00 301.00 7.00 292 256.14 247.00 256.14 7.008.00 292 257.75 292.00 227.75 52.00 9.00 292 264.33 343.00 211.00 103.0010.00 292 275.00 400.00 203.00 160.0011.00 292 289.18 463.00 201.91 223.0012.00 292 306.50 532.00 206.50 292.00
P = 292
SRMC 5
SRAC 5
MC = $292 y* = 8
Short Run Equilibrium 1
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Profit 274.00
SRAC SRMC SRAC SRMC SRAC SRMC SRAC SRMC y Price 5 5 9 9 15 15 18 180.00 2921.00 292 851.00 103.00 2291.00 6251.00 9041.002.00 292 479.00 112.00 1079.00 2879.00 4184.004.00 292 303.50 148.00 483.50 1203.50 1766.005.00 292 275.00 175.00 371.00 875.00 1289.006.00 292 261.00 208.00 301.00 661.00 976.00 7.00 292 256.14 247.00 256.14 7.00 513.29 757.57 8.00 292 257.75 292.00 227.75 52.00 407.75 599.00 9.00 292 264.33 343.00 211.00 103.00 331.00 481.0010.00 292 275.00 400.00 203.00 160.00 275.00 392.0011.00 292 289.18 463.00 201.91 223.00 234.64 324.6412.00 292 306.50 532.00 206.50 292.00 206.50 274.0013.00 292 326.69 607.00 215.92 367.00 188.23 7.00 236.69 14.00 292 349.57 688.00 229.57 448.00 178.14 88.00 210.2915.00 292 375.00 775.00 247.00 535.00 175.00 175.00 193.00 16.00 292 402.88 868.00 267.88 628.00 177.88 268.00 183.50 88.0017.00 292 433.12 967.00 291.94 727.00 186.06 367.00 180.76 187.0018.00 292 465.67 1072.00 319.00 832.00 199.00 472.00 184.00 292.0019.00 292 500.47 1183.00 348.89 943.00 216.26 583.00 192.58 403.0020.00 292 537.50 1300.00 381.50 1060.00 237.50 700.00 206.00 520.0022.00 292 618.09 1552.00 454.45 1312.00 290.82 952.00 245.82 772.0023.00 292 661.61 1687.00 494.65 1447.00 322.48 1087.00 271.61 907.00
MC = $292 y* = 12
SRAC 9SRMC 9
SRAC 5SRMC 5
Short Run Equilibrium 2
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P = 292
Profit 1026
SRAC SRMC SRAC SRMC SRAC SRMC SRAC SRMC y Price 5 5 9 9 15 15 18 180.00 2921.00 292 851.00 103.00 2291.00 6251.00 9041.002.00 292 479.00 112.00 1079.00 2879.00 4184.004.00 292 303.50 148.00 483.50 1203.50 1766.005.00 292 275.00 175.00 371.00 875.00 1289.006.00 292 261.00 208.00 301.00 661.00 976.00 7.00 292 256.14 247.00 256.14 7.00 513.29 757.57 8.00 292 257.75 292.00 227.75 52.00 407.75 599.00 9.00 292 264.33 343.00 211.00 103.00 331.00 481.0010.00 292 275.00 400.00 203.00 160.00 275.00 392.0011.00 292 289.18 463.00 201.91 223.00 234.64 324.6412.00 292 306.50 532.00 206.50 292.00 206.50 274.0013.00 292 326.69 607.00 215.92 367.00 188.23 7.00 236.69 14.00 292 349.57 688.00 229.57 448.00 178.14 88.00 210.2915.00 292 375.00 775.00 247.00 535.00 175.00 175.00 193.00 16.00 292 402.88 868.00 267.88 628.00 177.88 268.00 183.50 88.0017.00 292 433.12 967.00 291.94 727.00 186.06 367.00 180.76 187.0018.00 292 465.67 1072.00 319.00 832.00 199.00 472.00 184.00 292.0019.00 292 500.47 1183.00 348.89 943.00 216.26 583.00 192.58 403.0020.00 292 537.50 1300.00 381.50 1060.00 237.50 700.00 206.00 520.0022.00 292 618.09 1552.00 454.45 1312.00 290.82 952.00 245.82 772.0023.00 292 661.61 1687.00 494.65 1447.00 322.48 1087.00 271.61 907.00
SRAC 9SRMC 9
Short Run Equilibrium 3
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P = 292
SRAC 15SRMC 15
Profit 1828.98
MC = $292 y* = 16.25
SRAC SRMC SRAC SRMC SRAC SRMC SRAC SRMC y Price 5 5 9 9 15 15 18 180.00 2921.00 292 851.00 103.00 2291.00 6251.00 9041.002.00 292 479.00 112.00 1079.00 2879.00 4184.004.00 292 303.50 148.00 483.50 1203.50 1766.005.00 292 275.00 175.00 371.00 875.00 1289.006.00 292 261.00 208.00 301.00 661.00 976.00 7.00 292 256.14 247.00 256.14 7.00 513.29 757.57 8.00 292 257.75 292.00 227.75 52.00 407.75 599.00 9.00 292 264.33 343.00 211.00 103.00 331.00 481.0010.00 292 275.00 400.00 203.00 160.00 275.00 392.0011.00 292 289.18 463.00 201.91 223.00 234.64 324.6412.00 292 306.50 532.00 206.50 292.00 206.50 274.0013.00 292 326.69 607.00 215.92 367.00 188.23 7.00 236.69 14.00 292 349.57 688.00 229.57 448.00 178.14 88.00 210.2915.00 292 375.00 775.00 247.00 535.00 175.00 175.00 193.00 16.00 292 402.88 868.00 267.88 628.00 177.88 268.00 183.50 88.0017.00 292 433.12 967.00 291.94 727.00 186.06 367.00 180.76 187.0018.00 292 465.67 1072.00 319.00 832.00 199.00 472.00 184.00 292.0019.00 292 500.47 1183.00 348.89 943.00 216.26 583.00 192.58 403.0020.00 292 537.50 1300.00 381.50 1060.00 237.50 700.00 206.00 520.0022.00 292 618.09 1552.00 454.45 1312.00 290.82 952.00 245.82 772.0023.00 292 661.61 1687.00 494.65 1447.00 322.48 1087.00 271.61 907.00
Profit 1944
MC = $292 y* = 18
SRAC 18SRMC 18
Short Run Equilibrium 4
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P = 292
SRAC 15SRMC 15
Profits are higher with the size 18 plantthan with the size 15 plant
With a price of $292, a size 18 plantmakes more sense than a size 15 plant
SRAC SRMC SRAC SRMC SRAC SRMC y Price 15 15 18 18 23 230.00 2921.00 292 6251.00 9041.00 14891.00 5.00 292 875.00 1289.00 2219.00 6.00 292 661.00 976.00 1701.00 8.00 292 407.75 599.00 1067.75 9.00 292 331.00 481.00 864.33 10.00 292 275.00 392.00 707.00 12.00 292 206.50 274.00 486.50 13.00 292 188.23 7.00 236.69 409.77 14.00 292 178.14 88.00 210.29 349.57 15.00 292 175.00 175.00 193.00 303.00 16.00 292 177.88 268.00 183.50 88.00 267.88 17.00 292 186.06 367.00 180.76 187.00 242.53 18.00 292 199.00 472.00 184.00 292.00 225.67 19.00 292 216.26 583.00 192.58 403.00 216.26 103.00 20.00 292 237.50 700.00 206.00 520.00 213.50 220.0021.00 292 262.43 823.00 223.86 643.00 216.71 343.0022.00 292 290.82 952.00 245.82 772.00 225.36 472.00 23.00 292 322.48 1087.00 271.61 907.00 239.00 607.00 25.00 292 395.00 1375.00 333.80 1195.00 279.80 895.00
SRAC 18SRMC 18
Short Run Equilibrium 5
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P = 292
SRAC 23SRMC 23
Profit 1591.39
MC = $292 y* = 20.59
Profits are lower with the size 23 plantthan with the size 18 plant
We would not want the size 23 plant withprices of $292
SRAC 23SRMC 23
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$P = 607
SRAC 18SRMC 18
When is the big plant optimal?Profit 8464
MC = $607 y* = 23
SRMC 15
SRAC 15
SRAC 9SRMC 9
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$ P = 175
What about lower prices? Profit 0.00
MC = $175 y* = 15
The long run cost curve
The long run average total cost curve (LRATC)is an envelope curve that touches all the short runaverage total cost curves (SRATC) from below
For any given price (or output) , there isan “optimal” plant size that gives thelowest level of costs (highest level of profits)
Consider the family of short run cost curves
SRAC 18SRMC 18
SRAC 9SRMC 9
SRAC 5SRMC 5
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$
SRAC 15SRMC 15
SRAC 23SRMC 23
SRAC 18SRMC 18
SRAC 9SRMC 9
SRAC 5SRMC 5
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SRAC 15SRMC 15
SRAC 23SRMC 23ATCMC
We bound the short run curves with the long run curve
SRMC = LRMC at “optimal” plant size
SRAC 5SRMC 5
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ATCMC
SRMC = LRMC at “optimal” plant size
SRMC = LRMC SRAC = LRAC
SRAC 9SRMC 9
SRAC 5SRMC 5
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ATCMC
SRMC = LRMC at “optimal” plant size
SRMC = LRMC SRAC = LRAC
SRAC 18SRMC 18
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ATCMC
SRMC = LRMC at “optimal” plant size
SRMC = LRMC SRAC = LRAC
SRAC 18SRMC 18
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SRAC 15SRMC 15
ATCMC
SRMC = LRMC at “optimal” plant size
SRMC = LRMC = SRAC = LRAC
A less cluttered view
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ATCMC
SRAC 18SRMC 18
SRAC 5SRMC 5
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$Some clutter, some detail
SRAC 23SRMC 23ATCMC
Profit and Loss, Entry and Exit
In a competitive market, economic profit and lossare the forces driving long run change
The expectation of continued economic profitcauses outsiders to enter the market;
The expectation of continued economic lossescauses firms in the market to exit
Q D 670 P P 670 Q D
Demand for the example market
Assumptions about the industry structure
21 identical firms
Each firm operates a size 18 plant
Pricey* Supply Cost AC
17 187.00 3073.00 180.76
Optimal output at various prices -- Plant size = 18
18 292.00 3312.00 184.00 19 403.00 3659.00 192.58 20 520.00 4120.00 206.00 21 643.00 4701.00 223.86 22 772.00 5408.00 245.82
16.9410 181.00 3062.16 180.75
17.2046 208.00 3113.41 180.96 17.6068 250.00 3205.48 182.06
Supply is equal to MC above the minimum of AVC
Pricey* Supply Cost AC16.9410 181.00 3062.16 180.75 17 187.00 3073.00 180.76 17.2046 208.00 3113.41 180.96 17.6068 250.00 3205.48 182.06 18 292.00 3312.00 184.00 19 403.00 3659.00 192.58 20 520.00 4120.00 206.00 21 643.00 4701.00 223.86 22 772.00 5408.00 245.82
Optimal output at various prices -- Plant size = 18
Supply for One Firm with Plant Size = 18
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Supply - 1
Individual Firm SupplySupply is equal to MC above the minimum of AVC
Aggregate SupplyQ S L y(p , w1 ,w2 , , z)
Supply for 21 Firms with Plant Size = 18
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Supply - 1Supply - 21
Supply PriceQ y* 21 Firms AC355.76 16.941074 181.00 180.75 357.00 17 187.00 180.76 361.30 17.204651 208.00 180.96 369.74 17.606817 250.00 182.06 378.00 18 292.00 184.00 399.00 19 403.00 192.58 420.00 20 520.00 206.00 441.00 21 643.00 223.86 462.00 22 772.00 245.82
Market and Individual Firm Supply,Price, and Average Cost
Putting supply and demand together
P = $292QS = 378
yi = 18
i = $19440
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Supply - 21D
In equilibrium, at a given quantity, supply and demand price must be equal
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Supply - 21D
NOPE
In equilibrium, at a given quantity, supply and demand price must be equal
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Supply - 21D
NOPE
P = $292QS = 378
yi = 18
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Supply - 21D
In equilibrium, at a given quantity, supply and demand price must be equal
Supply Price DemandQ y* 21 Firms AC Price355.76 16.941074 181.00 180.75 314.24 357.00 17 187.00 180.76 313.00 361.30 17.204651 208.00 180.96 308.70 369.74 17.606817 250.00 182.06 300.26 378.00 18 292.00 184.00 292.00 399.00 19 403.00 192.58 271.00 420.00 20 520.00 206.00 250.00 441.00 21 643.00 223.86 229.00 462.00 22 772.00 245.82 208.00
Market and Individual Firm Supply,Supply Price, Average Cost and Demand Price
Supply Price DemandQ y* 21 Firms AC Price355.76 16.941074 181.00 180.75 314.24 357.00 17 187.00 180.76 313.00 361.30 17.204651 208.00 180.96 308.70 369.74 17.606817 250.00 182.06 300.26 378.00 18 292.00 184.00 292.00 399.00 19 403.00 192.58 271.00 420.00 20 520.00 206.00 250.00 441.00 21 643.00 223.86 229.00 462.00 22 772.00 245.82 208.00
What about profits?Looks good!
With high profits, other firms will want to enter
Let the number of firms increase to 26
Plant Size 18Number of firms 26
Price PriceQ y* Supply - 26 AC Demand440.47 16.941 181.00 180.75 229.53 442.00 17 187.00 180.76 228.00 450.33 17.320 220.00 181.18 219.67 468.00 18 292.00 184.00 202.00 494.00 19 403.00 192.58 176.00 520.00 20 520.00 206.00 150.00 546.00 21 643.00 223.86 124.00 572.00 22 772.00 245.82 98.00
Market and Individual Firm Supply,Supply Price, Average Cost and Demand Price
Plant Size 18Number of firms 26
Price PriceQ y* Supply - 26 AC Demand440.47 16.941 181.00 180.75 229.53 442.00 17 187.00 180.76 228.00 450.33 17.320 220.00 181.18 219.67 468.00 18 292.00 184.00 202.00 494.00 19 403.00 192.58 176.00 520.00 20 520.00 206.00 150.00 546.00 21 643.00 223.86 124.00 572.00 22 772.00 245.82 98.00
Market and Individual Firm Supply,Supply Price, Average Cost and Demand Price
Supply and Demand for 26 Firms, Plant Size = 18
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Supply - 26D
P $220, QS 450
Notice that price falls from $292 to $220
Firms will want to cut output and change plant size
Suppose plant size declines to size 15
P $257, QS 413
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Supply - 26D
Plant Size 15Number of Firms 26
Price PriceQ y* Supply - 26 ACDemand390.00 15 175.00 175.00 280.00 397.72 15.297 202.00 175.26 272.28 413.01 15.885 257.00 177.26 256.99 416.00 16 268.00 177.88 254.00 422.45 16.248 292.00 179.43 247.55 442.00 17 367.00 186.06 228.00 468.00 18 472.00 199.00 202.00 494.00 19 583.00 216.26 176.00 520.00 20 700.00 237.50 150.00
Plant Size 15Number of Firms 26
Price PriceQ y* Supply - 26 ACDemand390.00 15 175.00 175.00 280.00 397.72 15.297 202.00 175.26 272.28 413.01 15.885 257.00 177.26 256.99 416.00 16 268.00 177.88 254.00 422.45 16.248 292.00 179.43 247.55 442.00 17 367.00 186.06 228.00 468.00 18 472.00 199.00 202.00 494.00 19 583.00 216.26 176.00 520.00 20 700.00 237.50 150.00
What about profits?
Price PriceQ y* Supply - 26 ACDemand390.00 15 175.00 175.00 280.00 397.72 15.297 202.00 175.26 272.28 413.01 15.885 257.00 177.26 256.99 416.00 16 268.00 177.88 254.00 422.45 16.248 292.00 179.43 247.55 442.00 17 367.00 186.06 228.00 468.00 18 472.00 199.00 202.00 494.00 19 583.00 216.26 176.00 520.00 20 700.00 237.50 150.00
Now should the firm consider expanding again?
Prices are up
Profits are good
The plant is too small
Maybe??
But with positive profits, other firmswill keep entering the market
Long run equilibriumLong run equilibrium
If there are profits, firms will enterand supply will increaseIf the firm does not have the optimal size plant,it will modify plant size so that it is producingusing the “optimal” long run technology.
This will go on until there are no profitsand all firms have their optimal plant size
This implies that long and short runmarginal costs will be equal
What if price is $292 and plant size is variable?
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P = 292
ATCMC
The firm produces 18 units of output
The optimal long run plant size is 18
SRAC 18SRMC 18
SRMC = LRMC
What about profits?
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P = 292
ATCMC
The firm produces 18 units of output
The optimal long run plant size is 18
SRAC 18SRMC 18
Lots of profits
Why not a bigger plant?
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SRAC 18SRMC 18SRAC 23SRMC 23
P = 292
ATCMC
Cost > Min
What if price drops to $256?
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SRAC 5SRMC 5
SRAC 18SRMC 18
P = 292P = 256
ATCMC
The firm could reduce size to a smaller plantTry size 5
What about profits with this smaller plant?
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SRAC 5SRMC 5
SRAC 18SRMC 18
P = 292P = 256
ATCMC
Profit = 0
Not a good decisionP = SRAC LRMCP = SRMC
P = 256
ATC
MC
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SRAC 18
SRMC 18
SRAC 5
SRMC 5
SRMC = LRM
CInstead pick a plant where SRMC = LRMC
Is a size 5 plant a good choice with P = 256?
P = 292
ATC
MC
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SRAC 5
SRMC 5
SRAC 18
SRMC 18
SRAC 5
SRMC 5
SRMC LRM
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Pick a plant where SRMC = LRMC
A size 5 plant is not optimal with P = 256
ATC
MC
SRAC 17.21
SRMC 17.21
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SRAC 18
SRMC 18
SRAC 5
SRMC 5
SRMC = LRM
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SRMC LRM
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Pick a plant where SRMC = LRMC
ATC
MC
SRAC 17.21
SRMC 17.21
0
50
100
150
200
250
300
350
400
5 10 15 20 25
But with a price of $256, there are still profits
Profit
P = 175
Only with a price of $175are long run profits zero
0
50
100
150
200
250
300
350
400
0 5 10 15 20 25 30 35
SRAC 15SRMC 15
ATCMC
LRMC = SRMC = LRAC
Long Run Equilibrium
Q Q
S1
IndustryFirm
q̂1
PS0
Consider a firm with long run average cost LRAC
LRAC
Is the plant size PS0 an equilibrium size for the firm?
D
Suppose demand is given by D and industry supply is S1
NO!!
Optimal Plant Size with Supply = S1
Q Q
S1
IndustryFirm
q1
PS1 LRAC
Q Q
S1
IndustryFirm
q1
PS1 LRAC
Profits are high and so firms will want to enter the market
What about Profits?
Firms will enter and supply will increase to S2
Q Q
S1
S2
IndustryFirm
q1
PS1 LRAC
Prices in the market will fall
The firm will want a slightly smaller plant in the long run Firm level output will fall
Profits are still quite good
Q Q
S1
S2
IndustryFirm
q1
PS1 LRAC
More firms will enter the market
Long Run Equilibrium Occurs When SRMC = LRMC
Q Q
S1
S2
S*
IndustryFirm
q1
PS1
q*
LRAC
And there is no incentive for entry or exit -- profits are zero
With supply = S2, there are still profits
Supply will increase until Price is equal to LRAC
Long Run Equilibrium Occurs whenthere is no incentive for entry or exit
Q Q
S1
S2
S*
IndustryFirm
q1
PS1
PS*
q*
LRAC
Long Run Equilibrium Occurs When SRMC = LRMC
Price =LRAC
In the long run, the firm will have zero profits and will operate at the minimum on the long run average cost curve
Long Run Equilibrium Occurs when there is no incentive for entry or exit
Long Run Equilibrium Occurs When SRMC = LRMC
What have we learned?
1. In the long run, every competitive firm will earn normal profit, that is, zero profit
2. In the long run, every competitive firm will produce where price (P) is equal to marginal cost (MC), P = MC.
3. In the long run, every competitive firm will produce where price (P) is equal to the minimum of short run average cost (SRAC), P = SRAC. This implies zero economic profit.
Summary
4. In the long run, every competitive firm will produce where price (P) is equal to the minimum of long run average cost (LRAC = ATC), P = minimum LRAC.This implies that no identical firms will want to enter or exit.
5. Putting it all together:
P = MC = min SRAC = min LRAC
Summary (continued)
P = MR = Demand
SRACSRMC
q*
LRMC
LRAC
Q
$
Long Run Equilibrium
The End
SRAC 18SRMC 18
SRAC 9SRMC 9
SRAC 5SRMC 5
Long Run Equilibrium ??
0
50
100
150
200
250
300
350
400
450
500
0 5 10 15 20 25 30 35Output
$
P = 292
SRAC 15SRMC 15
SRAC 23SRMC 23ATCMC
1944.00 Profit
SRMC 15
SRAC 15
SRAC 23SRMC 23
SRAC 9SRMC 9
050
100150200250300350400450500550600650
0 5 10 15 20 25 30 35Output
$P = 607
SRAC 18SRMC 18
P = 175
Long Run Equilibrium
0
50
100
150
200
250
300
350
400
0 5 10 15 20 25 30 35
SRAC 5SRMC 5 SRAC 15SRMC 15SRAC 18SRMC 18SRAC 23SRMC 23ATCMC
P = 175
P = 292P = 256
SRAC 17.21
SRMC 17.21
ATC
MC
0
50
100
150
200
250
300
350
400
5 10 15 20 25
SRAC 5
SRMC 5
SRAC 18
SRMC 18
SRAC 5
SRMC 5
SRAC 15
SRMC 15
P = 175
Only with a price of $175are long run profits zero
0
50
100
150
200
250
300
350
400
0 5 10 15 20 25 30 35
SRAC 5SRMC 5 SRAC 15SRMC 15SRAC 18SRMC 18SRAC 23SRMC 23
P = 292P = 256
ATCMC
The short run and long run equilibrium for an individual firm with a price of 292 is output and a plant size of 18. Here the long and short run marginal cost curves are equivalent. But this price and output combination gives large profits. A larger plant size of 23 will give positive but smaller profits.
If price drops to $256, then the firm will want to cut output. If it cuts all the way back to a size 5 plant, it will have zero profits and no firms will want to enter. But with a price of $256, the firm would prefer a larger plant so that SRMC = LRMC. If the firm increases to a size 18 plant it will have zero profits with a price of 175.
Long Run Equilibrium Occurs whenthere is no incentive for entry or exit
Q Q
S1
S2
S*
IndustryFirm
q1
PS1
PS*
q*
LRAC
Supply will increase until Price is equal to LRAC
Long Run Equilibrium Occurs When SRMC = LRMC
Long Run Equilibrium
Q Q
S1
S2
S*
IndustryFirm
q1
PS1
q̂1
PS0
q2
PS*
q*
Consider a firm with long run average cost LRAC
LRAC
Suppose the industry supply is S1. If the plant size is PS0 and the firm produces qhat_1, the firm is not in an equilibrium position because this is not the best plant size for the market price.