Transcript Chapter 15
Chapter 15 Competitive Markets in the Long Run Objective • Long Run Equilibrium ▫ Identical firms ▫ Heterogeneous firms • Constant / Increasing/ Decreasing cost industries • Welfare properties of competitive markets 3 LR or SR equilibrium? Price Price MC π1 ATC S pe pe D 0 q1e FIRM 1 0 Q Market 4 Short-Run Equilibrium • Short run: A period of time not long enough for ▫ Existing firms to adjust all factors of production Firms will not be able to contract their capital stock if they are making losses Firms will not be able to expand their capital stock if they are making profits ▫ Outside firms to enter the market 5 The adjustment to a long-run equilibrium Price, Cost (a) Price, Cost S LRMC (b) d LRAC p1 1 SRACK1 SRMCK1 S2 b p1’ S* f p* D 0 q1K1’ q1K1 q* 0 Quantity Quantity Positive profits attract the entry and shift the supply curve to the right until each firm has a capacity of K* and the market supply curve is S*. In a long-run equilibrium, each firm produces q* units and earns zero profits 6 Long-Run Equilibrium for Identical Firms • Long-run equilibrium ▫ (1) Firms - Quantity supplied - no change ▫ (2) Consumers Quantity demanded - no change ▫ (3) Existing firms Inputs - no change No exit ▫ (4) New firms – don’t enter ▫ (5) Aggregate supply = Aggregate demand 7 The Long-Run Equilibrium for Heterogeneous Firms • Difference in long-run costs ▫ Location / assets 8 Heterogeneous Firms Price Price Price FIRM 1 MC FIRM 2 ATC Price FIRM 3 MC ATC S MC π2 π1 ATC pe pe D 0 q1e 0 q2e 0 q3e 0 Why do firms have different ATC curves? qe=q1e+q2e+q3e 9 The Long-Run Equilibrium for Heterogeneous Firms • Economic rent ▫ Return to an input Over and above Need to secure it • Rent-inclusive average cost ▫ Average cost ▫ Economic rent - included as a cost 10 Rent and long-run competitive equilibria Price, Cost (a) LRAC’ Price (b) MC S LRAC p* p* a c b D 0 Quantity 0 LRAC’ includes the opportunity cost of the firm’s special asset or location Quantity 11 Dynamic Changes in Market Equilibria • In the short run ▫ Supply is upward sloping • The long run supply can be ▫ Flat ▫ Upward sloping ▫ Downward sloping • The shape of the LR supply will depend on how entry affects the costs of production 12 Dynamic Changes in Market Equilibria • Constant-cost industries ▫ Flat long-run supply curve ▫ As new firms enter No change in cost functions 13 Constant-cost industries Price Cost Long-run supply curve SRMC S1 SRAC S2 b pb LRAC a pa D2 D1 0 Quantity 0 Quantity With constant costs, the long-run response to an increase in demand re-establishes the original price of pa. 14 Increasing-cost industries • Pecuniary externality ▫ Action of one agent Other agents: increase in price • Increasing-cost industries ▫ Upward sloping long-run supply curve ▫ As new firms enter Increase costs of inputs LRAC curves – shift up 15 Increasing-cost industries Price Cost Long-run supply curve LRAC2 LRAC1 S1 S3 b c pb pc pa a D2 D1 0 Quantity 0 With increasing costs, the long-run response results in a higher price Quantity 16 Decreasing-cost industries ▫ Downward sloping long-run supply curve ▫ As new firms enter Decrease costs of inputs LRAC curves – shift down 17 Decreasing-cost industries Price Cost Long-run supply curve LRAC1 S1 LRAC2 b S2 pa pc a c D2 D1 0 Quantity 0 With decreasing costs, the long-run response results in a lower price. Quantity 18 Why Are Long-Run Competitive Equilibria So Good? • Welfare Proposition # 1: Consumer & producer surplus are maximized ▫ No deadweight loss • Welfare Proposition # 2: Price is set at marginal cost • Welfare Proposition # 3: Goods are produced at the lowest possible cost and the most efficient manner 19 Welfare Proposition # 1: Consumer & producer surplus are maximized Price S e f p1 A p* d B g c D 0 q1 q* q1’ Quantity Welfare Proposition #2: Price is set at marginal cost • Firms maximize profit ▫ Take prices as given in a competitive market ▫ Produce until P=MC 21 Welfare Proposition #3: Goods produced at lowest possible cost Price (a) Price (b) S K* p* p* D 0 q* Quantity 0 Quantity