MBA201a: Entry, Exit & EquilibriumBasic definitions & principles (I)Basic definitions & principles (II)LR vs. SR example: Recall the t-shirt factoryT-shirt factory cost curvesSlide 6Short versus long runSR pricing & LR profitabilitySlide 9Slide 10Slide 11Slide 12Slide 13Mojave, CaliforniaSlide 14Slide 16Entry/expansion & exitSlide 18Slide 19Constructing the industry supply curveEntry and the industry supply curveEntry and the market equilibrium priceWhen does entry stop?Slide 24Which firms stay and which firms exit?Slide 26How much do the remaining firms produce?The third firm A’s entry decisionSlide 29Long run competitive equilibriumSlide 31Can an industry with a monopoly be in a LR equilibrium?TakeawaysMBA201a: Entry, Exit & EquilibriumProfessor Wolfram MBA201a - Fall 2009 Page 2Basic definitions & principles (I)•In the short run (SR),–for an individual firm, many costs are sunk, and–for an entire industry, the number of firms is fixed.•In the long run (LR),–everything is variable: production process within a firm and the number of firms.Professor Wolfram MBA201a - Fall 2009 Page 3Basic definitions & principles (II)Profit maximization implies the following decision rules:–In the short run:•Produce at the quantity level where MR=MC*, so long as your revenues cover your variable costs.•Otherwise, exit.–In the long run:•Enter markets or expand capacity as long as your incremental revenues will cover your incremental total costs.•Stay in the market as long as you continue to cover your total costs.•Exit if you can no longer cover your total costs. * Remember that MR=P for a price-taking firm (aka a firm in a perfectly competitive industry).Professor Wolfram MBA201a - Fall 2009 Page 4LR vs. SR example: Recall the t-shirt factoryTo produce T-shirts: •Lease one machine at $20 / week.•Machine requires one worker.•The machine, operated by the worker, produces one T-shirt per hour.•Worker is paid $1/hour on weekdays (up to 40 hours), $2/hour on Saturdays (up to 8 hours), $3 on Sundays (up to 8 hours).Professor Wolfram MBA201a - Fall 2009 Page 5T-shirt factory cost curvesCost ($)ATC103120 30 40 501.52MC48T-shirtsProfessor Wolfram MBA201a - Fall 2009 Page 6T-shirt factory cost curvesCost ($)ATC103120 30 40 501.52MC48T-shirtsAVCProfessor Wolfram MBA201a - Fall 2009 Page 7Short versus long runIt’s Monday morning. The weekly machine lease has been paid. p=$1.3. Should the factory shut down?–Not this week (short run). Lease is a sunk cost. Keep factory open for any p above min(AVC) = $1.It’s Friday afternoon. Should it pay for next week’s lease?–No, shut down if p=$1.3. (In fact, shut down for any p below $1.5.)General result: you typically have more control over costs in the long run than in the short run.Professor Wolfram MBA201a - Fall 2009 Page 8SR pricing & LR profitabilityCostACqcapp1p2MC/AVCD1Professor Wolfram MBA201a - Fall 2009 Page 9SR pricing & LR profitabilityCostACqcapp1p2MC/AVCD2Professor Wolfram MBA201a - Fall 2009 Page 10SR pricing & LR profitabilityCostACqcapp1p2MC/AVCD2Professor Wolfram MBA201a - Fall 2009 Page 11SR pricing & LR profitabilityCostACqcapp1p2MC/AVCD2Professor Wolfram MBA201a - Fall 2009 Page 12SR pricing & LR profitabilityCostACqcapp1p2MC/AVCD3Professor Wolfram MBA201a - Fall 2009 Page 13SR pricing & LR profitabilityCostACqcapp1p2MC/AVCD3Mojave, CaliforniaProfessor Wolfram MBA201a - Fall 2009 Page 14Professor Wolfram MBA201a - Fall 2009 Page 15Professor Wolfram MBA201a - Fall 2009 Page 16SR pricing & LR profitabilityCostACqcapp1p2In industries with low MC/high fixed costs, market pressures may produce prices that are highly volatile.MC/AVCProfessor Wolfram MBA201a - Fall 2009 Page 17Entry/expansion & exitATCCostMCmarket priceSay you:• observe the market price,• know your costs would look something like the curves on the graph.Would you want to get into this industry?QProfessor Wolfram MBA201a - Fall 2009 Page 18Entry/expansion & exitCostATCMCmarket priceSay you:• observe the market price,• know your costs would look something like the curves on the graph.Would you want to get into this industry?QProfessor Wolfram MBA201a - Fall 2009 Page 19Entry/expansion & exitCost ($)ATCMCmarket priceQSay you:• observe the market price,• know your costs would look something like the curves on the graph.Would you want to get into this industry?Would you want to stay in the industry if you were already in it?Professor Wolfram MBA201a - Fall 2009 Page 20Constructing the industry supply curveRecall that the industry supply curve is the sum ofindividual firms’ supply curves: 180100 10 100 30 10 100 130 PPPQQQFirm A Firm B IndustryProfessor Wolfram MBA201a - Fall 2009 Page 21Entry and the industry supply curveImagine that a firm identical to Firm A enters the industry. 180100 10 100 30 10 20 100 130 200 PPPQQQ2xFirm A Firm B IndustrySupply Curve with Firm A & Firm BSupply Curve with 2 Firm As & Firm BProfessor Wolfram MBA201a - Fall 2009 Page 22Entry and the market equilibrium price Entry shifts the supply curve to the right.As a result, the market equilibrium price goes down.PQPbefore entryPafter entryProfessor Wolfram MBA201a - Fall 2009 Page 23When does entry stop? PQP1P2CostMCATCQProfessor Wolfram MBA201a - Fall 2009 Page 24When does entry stop? PQP2P3CostMCATCQProfessor Wolfram MBA201a - Fall 2009 Page 25Which firms stay and which firms exit?If several firms have access to the same technology as Firm A, what will happen to Firm B? 180100 10 100 30 10 20 100 130 200 PPPQQQ2xFirm A Firm B IndustryDProfessor Wolfram MBA201a - Fall 2009 Page 26Which firms stay and which firms exit?If several firms have access to the same technology as Firm A, what will happen to Firm B? 180100 10 100 30 10 20 100 130 200 PPPQQQ2xFirm A Firm B IndustryDProfessor Wolfram MBA201a - Fall 2009 Page 27How much do the remaining firms produce? 140100 10 80 10 10 160 PPPQQQ2xFirm A 3rd Firm A IndustryDSupply Curve with 2 Firm A’sSupply Curve with 3 Firm A’sProfessor Wolfram MBA201a - Fall 2009 Page 28The third firm A’s entry decision 140100 10 80PQProfits at P = 140Professor Wolfram MBA201a - Fall 2009 Page 29The third firm A’s entry decision 120100 10