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Today
SR market equilibrium
Changes in equilibrium
LR equilibrium
Print out slides #26 & 28 full-sized to have more
room to work.
Short-Run Market Equilibrium
The price must clear the market (QD = QS).
Every firm must be profit-maximizing, given its
costs and the market price.
Firms may be making profits or losses.
Graph of SR Market Equilibrium
P
Typical Firm
P
Industry or Market
SRS
MC
ATC
P*
P*
AVC
D
q
Does this firm produce in the short run?
If so, how much?
Q*
Q
Graph of SR Market Equilibrium
P
Typical Firm
P
Industry or Market
SRS
MC
ATC
P*
=MR
P*
AVC
D
q*
q
Q*
Does this firm make profits in the short run?
If so, how much?
Q
Graph of SR Market Equilibrium
P
Typical Firm
P
Industry or Market
SRS
MC
ATC
P*
=MR
P*
AVC
D
q*
q
Q*
P - ATC = profit per unit.
Does the rectangle go to the bottom of ATC?
Q
Decrease in Demand
P
Typical Firm
P
Industry or Market
SRS
MC
ATC
P*
AVC
P’=MR
q’ q*
q
Q’
D’
D
Q*
Q
ATC - P = loss per unit.
Does the rectangle go to the bottom of ATC?
Results of Decrease in Demand
Market price falls.
Firm responds by cutting its output.
This firm makes losses but still produces in the
short run. (Why?)
Market quantity falls.
Further Decrease in Demand
P
Typical Firm
P
Industry or Market
SRS
MC
ATC
P*
AVC
P’’=
MR
D’
D
Q’’ Q’
Q*
What does this firm do in the short run? Why?
Q
D’’
q’’ q’ q*
q
Firm Supply in the Long Run
If price is less than ATC, a firm makes losses in
the short run.
Such a firm will shut down in the long run.
Therefore, the firm’s long-run supply curve is its
marginal cost curve above ATC.
Graphing the Firm’s Supply Curve
P
P3
LRS
SRS
MC
ATC
AVC
P2
P1
P0
q
Long-Run Equilibrium
The key to understanding the LR is firm
entry and exit.
The Key
Profits are a signal for resources to flow into the
industry: new firms enter.
Losses are a signal for resources to leave the
industry: firms exit.
Conditions for Long Run Equilibrium
The market price clears the market.
Firms must max. profits, given their SR
constraints.
Firms do not make profits or losses.
Firms must be at their lowest SRAC, given their
level of production.
– The assumption “room for many firms” implies firms
produce at the lowest level of their LRAC curve.
Adjustment to LR Equilibrium
P
Typical Firm
P
Industry or Market
SRS
MC
ATC
P*
P*
D
q
Q*
What do you expect will happen in the long run?
Q
Adjustment to LR Equilibrium
P
Typical Firm
P
MC
Industry or Market
SRS
SRS’
ATC
P*
P*
P’
D
q
Q
Q*
Profits attract entry. Price falls. Firm’s output falls,
market output rises (why?). What happens to the
firm’s profits? Is this LR equilibrium?
Adjustment to LR Equilibrium
P
Typical Firm
P
MC
Industry or Market
SRS
SRS’
ATC
P*
P*
SRS’’
P”
D
q”
Q
Q* Q”
Entry continues until the firm no longer earns profits.
Is this LR equilibrium?
q
LR Equilibrium
P
Typical Firm
P
Industry or Market
MC
ATC
LRATC
SRS’’
P”
D
q”
q
Q
Q* Q”
In long run equilibrium, firms in a perfectly
competitive market will operate at the lowest point on
their LRAC curves.
Adjustment to LR equilibrium: Case
of Initial Profits
Profits attract new firms into the market,
increasing market supply.
Market price falls. All firms must cut back output
and see lower profits.
Market quantity rises, though, due to larger
number of firms.
Process continues until profits fall to zero.
Initial Losses
P
Typical Firm
P
Industry or Market
SRS
MC
ATC
P*
AVC
P=MR
D
q*
q
Why is this not LR equilibrium?
What will happen in the LR?
Q*
Q
Firm Exit
If a firm is making losses, then it will get out of
business as soon as possible
– expiration of lease, sale of property, etc.
Exception: if it expects market conditions to
improve soon enough, it may decide to wait it
out.
– May wait for others to exit first, or demand to
increase. Note this could be quite costly. We usually
ignore this possibility.
Initial Losses
P
Typical Firm
P
MC
Industry or Market
SRS’ SRS
ATC
P*
AVC
P’=MR’
P=MR
D
q*
q
Q*
Firms exit. Market price rises. Remaining firms produce
more. Losses shrink. Market output falls. Is this a LR
equilibrium?
Q
Initial Losses
P
Typical Firm
P
MC
Industry or Market
SRS’ SRS
SRS”
ATC
P*
AVC
P”=MR”
P=MR
D
q*q”
q
Q” Q*
Firms exit until none make losses. Is this a LR
equilibrium?
Q
Coming Up:
LR Industry Supply—3 Cases
Market Efficiency
Group Work
LR supply
SR industry equilibrium
The Firm’s LR Supply Curve
In the long run, if the market price is $3, what
quantity will the firm produce? _____
In the long run, if the market price is $5.25,
what quantity will the firm produce? _____
In the long run, if the market price is $7.50,
what quantity will the firm produce? _____
Trace out the firm's long-run supply curve.
How does this compare to the SR supply
curve from the last lecture’s problem?
Firm’s LR Supply Curve
$/q
12
MC
10
8
ATC
AVC
6
4
2
0
0
2
4
6
8
10
12
14
16
18
20
22
24
Quantity
Short Run Market Equilibrium
Indicate all of the following answers on the
graph for the short run.
–
–
–
–
–
–
–
–
–
Equilibrium market price (P*)
Equilibrium market quantity(Q*)
Firm's output (q*)
Price firm charges (p*)
Demand for firm's output (d)
Firm's marginal revenue (MR)
Firm's average revenue (AR)
Firm's average profit/loss per unit
Firm's total profit/loss.
SR Industry Equilibrium
$/q
12
MC
SRS
Typical Firm
10
8
ATC
6
D
4
Industry
2
0
0
2
4
6
8
10
12
Quantity
0
200
400
600
800
1000
Quantity