PowerPoint PresentationSlide 2Slide 3Slide 4Slide 5Slide 6Slide 7Slide 8Slide 9Slide 10Slide 11Slide 12Slide 13Slide 14Slide 15Slide 16Slide 17Slide 18Slide 19Slide 20Slide 21Slide 22Slide 23Slide 24Slide 25Slide 26Long Run Perfect Competitionwith Heterogeneous FirmsOverheads1. In the long run, every competitive firm will earn normal profit, that is, zero profit2. 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 of Long Run Competitive EquilibriumSummary of Long Run Competitive Equilibrium4. 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 LRACSummary (continued)P = MR = DemandSRACSRMCq*LRMCLRACQ$Long Run EquilibriumLong run equilibrium for low cost firmsNot all firms are identicalFactors leading to different long run costsLocationControl of strategic resourcesUnique skillsDifferent costs and competitive equilibriumPrice and minimum long run average costWhy doesn’t the low cost firm take over?CapacityWill price fall to the minimum of LRAC?For some firms but not othersConsider an industry with a low cost firmThis firm has inherently lower costsOther firms have higher costsLow cost firm can’t supply entireindustry at low costLong Run Equilibrium for Low-cost Firm 0Q$q*abcqSD$P = MR = Demandp*LRACLRMCWhy don’t other firms enter the market?LRACHCProfit0Q$abcq$q*SDP = MR = Demandp*LRACLRMCEconomic RentThe value (Profit) attributed to the strategicresource earns economic rentLRACHCEconomic rent is defined as what the supplier of a good or service gets paid above and beyond the amount necessary to induce it to supply the inputIf this factor is special, the firm should be able to sell it, because presumably, there is a market for a factor that brings extra-normal profits to its ownerThus there is an opportunity cost to holding this special factorIf we account for this opportunity cost, the firm makes normal (zero) profitChanges in Market EquilibriaShort run changes in demandShort run changes in demandFirms expand along SRMCOther firms do not enterQ$SD1D2Short-run Response to a Change in DemandpaqaapbqbbqbShort Run Equilibrium0Output$AVCATCMCpbpaqaLong run supply curvesAre they upward sloping?It dependsConstant cost industriesThe costs of inputs are constantEven if the industry uses lots more of themLong run industry costs do not changepapaS1D1LRACLong-run Supply Curve in a Constant-cost Industry 0Q$q$aQaSRAC SRMCqbD2bbQbS2Long-run supplypbpbdceLRMCqaIn the right panel of the figure, we see the market supply and demand curves S1 and D1 for an industry intersecting at point a and resulting in an equilibrium price of pa. In the left panel of this diagram we see the long-run and short-run average and marginal cost curves for a representative firm in the industry. To make matters simple, let us assume that the cost curves for all firms in the industry are identical to these cost curves. Note that since the price pa equals the minimum point on each firm's long-run (and short-run) average cost curve, price pa constitutes a long-run equilibrium price for this market.Now, let demand for this product shift to the right from D1 to D2. In the short run, this increase in demand will cause the price of the good to increase from pa to pb. It will also cause each firm in the industry to make extra-normal profits equal to the area pbdce in the left panel of the figure. Seeing these profits, other firms will enter this industry, which will cause the supply curve to shift to the right. As the supply curve shifts to the right, the price of the good will fall from its newly established level of pb. How much the price will fall depends on what happens to the cost of the inputs to production for the firms in the industry as new firms enter. In this figure it is assumed that as new firms enter, the cost functions of all firms in the industry will stay the same. This will be true if inputs are in abundant supply and if the industry we are looking at only consumes a small share of the inputs in the market. In this case, the expanded size of the industry will hardly be noticed and input prices and costs will remain unchanged. When costs do not change as new firms enter an industry, the short-run market supply curve will shift to S2, where the price of of the good is reestablished at pa. Entry into the industry will stop at this point. Note that the resulting long-run supply curve (the dark arrowed red line in the figure) is flat despite the fact that each short-run supply curve is upward-sloping. Industries such as this, in which the long-run supply curve is flat, are called constant-cost industries. In a constant cost industry, the long run supply curve is horizontal, because each firm's average total cost curve is unaffected by changes in industry supply.Pecuniary externalitiesWhen the actions of one firm cause the priceof an input in the market to rise, we saythat the firm creates a pecuniary externalityWhen the actions of one firm cause the priceof an input in the market to fall, we saythat the firm creates a pecuniary economyPecuniary externalitiesUse of all the “good” land or depositsHiring of all the skilled laborSigning of all the good baseball playersLocking up a whole range of patentsIncreasing cost industriesThe costs of inputs rise They rise because the demand for inputs rises as industry output risesThe cost of production risescpcpcSRMC1paapaS2QbbLRAC1S1D1Long-run Supply Curve in an Increasing-cost Industry 0Q$q$QapbpbD2bLRAC3SRMC3S3Long-run supplyQcqbWith profits to existing firms, other firms will enterqaBut input costs will rise with increased outputPecuniary economiesEconomies of scale in input productionLearning by doingIncreased competition among suppliersDecreasing cost industriesThe costs of inputs fallThe cost of production fallsqapapaLRAC1SRMC1bD2Long-run Supply Curve in a Decreasing-cost Industry 0Q$q$S1D1pbpbaQaWith higher prices, firms will expand outputWith profits available, firms will enter the industryqaSRMC3papaLRAC1SRMC1bD2Long-run Supply Curve in a Decreasing-cost Industry
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