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Today
LR industry supply
Constant cost,
 increasing cost, and
 decreasing cost industries

Market efficiency in perfect competition
Industry Supply in the Long Run
Three Cases
Case 1: Constant Cost Industry
Assumes that firms’ costs are independent
of the size of the market. Expanding or
contracting demand yields the same price in
the long run.

Firms’ cost curves do not shift as industry
output changes.
Leads to a horizontal long-run industry
supply curve.
Initial LR Equilibrium
P
Typical Firm
P
MC
Industry or Market
SRS
ATC
LRATC
P
D
q
q
Q
Q
Thought experiment: What happens to the industry LR
equilibrium as market demand expands?
SR Response to Increase in
Demand
P
Typical Firm
P
MC
Industry or Market
SRS
ATC
LRATC
P
D
D
q
q
Q
Q’
SR: price rises. Firms earn profits. Why isn’t this a
new LR equilibrium?
Q
LR Response to Increase in
Demand
P
Typical Firm
P
MC
1
ATC
SRS’
1
LRATC
0
0
P
Industry or Market
SRS
2
2
D
D
Q
Q”
LR: Firms enter until no more profits can be made.
Given our assumption, that is when price falls original
level. Second LR equilibrium.
q
q
Q
LR Response to Increase in
Demand
P
Typical Firm
P
MC
Industry or Market
SRS
SRS’
ATC
LRATC
P
D
D
Q
Q”
LR: Firms enter until no more profits can be made. For
case 1, that is when price falls original level. Second
LR equilibrium.
q
q
Q
LR Industry Response to an
Increase in Demand
Assuming that firms’ costs do not depend
on the size of the industry, and
Beginning in LR equilibrium and increasing
demand:
in the SR, price rises, firms’ profits and outputs
rise.
 In the LR, price returns to original level, firms
earn zero profits, each firm makes same q as
before, but market output is higher.

LR Response to Increase in
Demand
P
Typical Firm
P
Industry or Market
MC
ATC
LRATC
LRS
P
D
D
q
q
Q”
Case 1: Horizontal Long-Run Supply Curve
Q
Q
Significance of Result
For these industries, growing demand will
not result in higher (or lower) prices.
(Ceterus Paribus)
Remember LRS is not predicting prices
over time.
Case 2: Increasing Cost Industry
Assumes factor prices rise as industry (or
market) output expands, causing firms’
costs to rise.

Ex: market for milk & price of dairy land
Results in an upward-sloping long-run
industry supply curve
Case 2 & LR Industry Supply
P
Typical Firm
P
LRATC (Q1)
Industry or Market
SRS
LRS
LRATC(Q0)
P
D
D
q
Q0
Q1
Case 2: Upward-sloping Long-Run Supply Curve
Q
Significance of Case 2
Growing demand for milk forces up the
prices of dairy land.
Cost of producing milk rises.
Price of milk rises in the long run, even
though there are more milk farms.
***Result comes from the underlying
scarcity of dairy land.***
Case 3: Decreasing Cost Industry
Assumes costs fall as industry (or market)
output expands.
Results in an downward-sloping long-run
industry supply curve
Ex: Software Production
It’s less costly to produce software as the
industry grows because of a larger pool of
possible programmers in the same area
Don’t need to relocate programmers to your
area, cheaper.
 Programmers informally spread new ideas,
reducing costs.

The price of software falls as the industry
expands.
Economic Efficiency
Definition
Economic Efficiency: When goods are
produced in the least costly manner and
distributed to those who value them most.
Requires:
Productive Efficiency
 Allocative Efficiency

Productive Efficiency
There is no way to re-direct production
among firms to increase total output.
Perfect Comp and Productive
Efficiency
In LR firms produce at lowest possible
LRAC.

There is no way to cut costs by changing plant
size.
Since all firms take the same price, all firms
have same MC (why?)

There is no way to re-direct production to other
firms and get lower marginal costs.
Productive efficiency holds.
Allocative Efficiency
Goods are consumed by those who most
value them.
There is no alternative comb. of goods that
could be produced that would increase
society’s well-being.
Measuring Allocative Efficiency
The sum of consumers’ surplus and
producers’ surplus.
Recall: Consumers’ Surplus
The difference
between what a
consumer is willing to
pay & what he does
pay.
$/unit
8
A
6
4
B
D
2
1
2
3 4
5 6
7
units
Producers’ Surplus-SR
perspective
The difference between the amount of
revenue the firm earns and the minimum
amount necessary to get the firm to produce
that quantity of the good in the short run.
Revenue - total variable costs.
Producers’ Surplus-Market
$/unit
SRS
8
6
4
B
C
2
1
2
3 4
D
5 6
7
units
Selling 4 units
@$6/unit.
Total revenue = B + C.
TVC for all firms is
represented by the area
under the SRS curve
(why?) = C
B = producers’ surplus
Allocative Efficiency
$/unit
SRS
8
A
6
4
B
C
2
1
2
3 4
D
5 6
7
units
A + B = The sum of
consumers’ and
producers’ surplus.
Vertical distance
between D and S is the
difference between
value to consumer and
MC to producer.
What Q maximizes
CS+PS?
Allocative Efficiency & Perfect
Competition
Perfectly competitive markets provide the
allocatively efficient quantity of a good.
Perfect Comp and Econ
Efficiency
Conclusion: Perfectly competitive markets
are economically efficient!
This is one reason why we use them as a
benchmark for our study of other market
structures.
Coming Up:
Begin Monopoly
Second midterm exam is 1 week from
today!

We will use Monday’s class to review for the
exam. Bring your copy of the study guide.
Group Work
Thought problem on perfect competition.
Graph of Case 3: Downward-sloping LR
industry supply.
Profits and Perfect Competition
Assume dairy production is a perfectly
competitive, increasing cost industry (case 2
in our notes).
Suppose demand for dairy products is
growing.
Some farmers have really good land for
grazing, others have land that is rather poor.
Questions about Dairy Example
Which farmer earns the most profits?
Explain in full.
Hint: Don’t forget, this is a perfectly
competitive industry.
Hint: Don’t forget opportunity costs.
Case 3 & LR Industry Supply
On the following graph, derive the LR
Industry supply curve. Assume that firms’
costs decrease as the industry grows.
Case 3 & LR Industry Supply
P
Typical Firm
P
Industry or Market
SRS
LRATC(Q0)
P
D
q
D’
Q0
Case 3: Downward-sloping Long-Run Supply Curve
Q