Chapter 15

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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