Transcript Lecture Week 08

Long Run: Equilibrium P.C.
• Profits and losses
– are inconsistent with P.C. LR equilibrium
– are signals to which firm owners respond
causing industry supply to shift.
• causing product prices to change
eliminating profits & losses in the long run.
• Profit = more firms enter and profit
disappears
• Loss = firms exit market and losses
disappear
Long Run Adjustment
• 1.) Exit and Entry
–stops when firms are making 0 economic
profit.
•2.) Change Size of Plant
–stops when firms have the plant that
coincides with the min. LRATC and firms are
making 0 economic profit
Long Run Adjustment
Entry & Exit
Initial Market Condition
S
MC
Price ($)
Price ($)
ATC
P
d = MR
1
Break-even
P=Min.ATC
D
Q1
Quantity of Sweaters (industry)
q1
Quantity of Sweaters
(firm)
Long Run Adjustment
Entry and Exit
Increased cold weather increases
demand for sweaters
S
MC
d2
P
Price ($)
Price ($)
ATC
2
P
d1
1
Higher
price
creates
economic
profit
D2
D1
Q1 Q2
Quantity of Sweaters
(industry)
q1 q2
Quantity of Sweaters (firm)
Long Run Adjustment
Entry and Exit
Economic profit attracts new firms.
Price falls to break-even point.
S1
MC
ATC
Price ($)
Price ($)
S2
P
d1
1
Break-even
P=Min.ATC
D2
D1
Q1
Quantity of Sweaters (industry)
q1
Quantity of Sweaters (firm)
Ease of Entry important for Long Run Adjustment
Long Run Supply
Constant Cost Industry
S1
Price ($)
S2
Demand shifts, offering
profit to current firms.
LRS
More firms enter, shifting
supply yet not increasing
input costs.
D2
Long run supply is
horizontal.
P
1
D1
Q1
Quantity of Sweaters (industry)
Additional firms do not increase costs.
Long Run Supply
Increasing Cost Industry
S1
Demand shifts, offering
profit to current firms.
S2
Price ($)
LRS
More firms enter, shifting
supply yet increasing input
costs
P
1
D2
D1
Q1
Quantity of Sweaters (industry)
Additional firms increase costs.
Long run supply is upward
sloping
Long Run Supply
Increasing Cost Industry
S1
Demand shifts, offering
profit to current firms.
Price ($)
S2
More firms enter, shifting
supply yet decreasing input
costs
P
1
LRS
D1
D2
Q1
Quantity of Sweaters (industry)
Additional firms decrease costs.
Long run supply is
downward sloping
Technological Change: Process of
Adjustment
• The first firms to adopt new technology will
make a profit, other firms will eventually exit
or switch
– Composition of industry is varied consisting of
new and old tech firms
– Technological change brings temporary gains to
producers
• Lower prices and better products resulting
from technological advance bring permanent
gains to consumers
Long Run Adjustment
Price (dollars per sweater)
Change Plant Size
(Firm-wide)
Short-run
profit
40
maximizing point
MC0
Changing plant size will
Result in changed MC and
Therefore SRAC curves
SRAC0
LRAC
MC1
SRAC1
25
MR0
20
MR1
m
Long-run
competitive
equilibrium
14
6
8
Quantity (sweaters per day)
Long-Run: Competitive Equilibrium

Price per Unit
MC
SAC
LAC

E
d = MR = P
= MC=SRATC
=LRATC

P (= MR) = MC : SR
equilibrium
MC = SRATC :
no incentive for
firms to enter or
leave
Min LRATC :
minimum per unit
costs achieved so
plant size is optimal
Qe
Quantity per Time Period
In the Long Run: P=MC=minATC
Long Run: Summary
• Competition and the Desire for Profit
– The forces that provide for both productive
and allocative efficiency in PC markets in the
long run
• P = MC = min ATC (P.C. Long Run Equil.)
– Indicates both productive and allocative
efficiency.
Micro Efficiency and the Long Run
Productive Efficiency
–Requires that each good in the optimal
product mix be produced in the least costly
way.
• 1.) Productive Efficiency - occurs when
• P = min ATC
–firms produce at min ATC and receive a
price =min ATC. Firms must use the best
available, least-cost technology, or they
will not survive.
Allocative Efficiency
–Requires resources be allocated to firms so as
to obtain the optimal mix of products
• 2.)Allocative Efficiency - occurs when
• P = MC
–resources are used to produce the
total output whose composition best
fits consumer preferences, the
optimal product mix.
Allocative Efficiency:P=MC
Recall:
Price of X
– society’s measure of the relative worth of that product at
the margin.
• measures the extra benefit or value society gets from
additional units of X (MSB – Marginal Social Benefit)
Marginal Cost of X
– society’s measure of the value of the other goods
that the resources used in the production of an extra
unit of X could otherwise have produced.
•
measures the sacrifice or opportunity cost to society
of using resources to produce additional X (MSC –
Marginal Social Cost)
Allocative Efficiency
• When P = MC \MSB = MSC
• each good is produced to the point at
which
–society’s value of the last unit =
society’s value of the alternative goods
sacrificed by its production.
Efficiency of the Equilibrium Quantity
MC,
MB $
B0
Consumer + Producer
Surplus is Maximized
Consumer
Surplus
Allocative
Efficiency,
MSC=MCB
P*
C0
MSC
Producer
Surplus
MSB
Q0
Q*
Quantity
Allocative Efficiency
• When P = MC \MSB = MSC
• each good is produced to the point at
which
–society’s value of the last unit =
society’s value of the alternative goods
sacrificed by its production.
•economic well being is maximized; that is,
consumer surplus + producer surplus, is
maximized
Summary: Perfect Competition &
The Invisible Hand
– Consumers and producers pursue their
own self-interest and interact in markets.
– Market transactions generate an
efficient—highest valued—use of
resources.
Usefulness of the Perfectly
Competitive Model
• It reduces the complexity of reality into
manageable size
• It highlights the idea of an efficient allocation &
use of resources
• It shows the role of prices, profits and
competition in the market system
Usefulness of
the Perfectly Competitive Model
• Serves as a yardstick against which realworld market structures, resource
allocation, prices, profits, competition and
firm behaviour can be compared.
• Acts as a guide to public policy and
corrective action.
Failure of Perfect Competition
• Inefficient resource allocation can lead to
MARKET FAILURE (ie: externalities and
public goods)
• PC firm are too small to engage in
extensive R&D, slowing technological
growth (ie: Microsoft wouldn’t be making
so many advances if it where in a PC
market)
Monopoly
a single seller of a product which has no
close substitutes.
Market power is the ability to influence
the market price by influencing the
total quantity offered for sale.
Characteristics of Monopoly
1. Single seller
• firm & industry are the same
2. Unique product
3. Barriers to entry
4. Good will advertising
5. Price maker/searcher
Why do monopolies arise?
•
Barrier to Entry: something that prevents new
firms from entering and competing
1.
2.
•
Key resources owned by a single firm.
Government grants exclusive right (eg.
patent) to produce product .
Economies of Scale
- Natural Monopoly: single firm can supply a
product to an entire market at a lower per unit
cost than could 2 or more firms.
- Using economies of scale to predate and
maintain monopoly power is illegal in Canada
Price (cents per kilowatt-hour)
Natural Monopoly
•There are economies of scale
over the relevant range of output.
1 firm can supply 4 million kWh
at 5 cents/kWh
15
2 firms can supply 4 million kWh
at 10 cents/kWh
10
4 firms can supply 4 million kWh
at 15 cents/kWh
5
ATC
D Demand cuts LAC to the
left of the min. LAC
0
1
2
3
4
Quantity (millions of kilowatt-hours)
Pricing & Output Decision: Monopolist
• Monopolists have the ability to influence
the output price by choosing the output
level.
• The firm’s demand curve is the
market demand curve.
• A monopolist’s MR is always less than
price (except for the first unit)
Marginal Revenue: Always Less Than Price
Price of Electricity
To sell 3 units, each unit sold for $8
To sell 4 units, each unit sold for $7
Lose $1/unit on 3 units or -$3
Gain $7 on the 4th unit or +$7
Net Gain (MR) = $4 (TR/ TO)
8
P = $8
TR = $24
Area B (-)
Demand curve = AR curve
7
Loss =
-$3
D
Area A (+)
Gain =
$7
3
4
Quantity of Electricity per Time Period
P = $7
TR = $28
To increase quantity
sold
– the monopolist
lowers selling price
– lowering price to sell
an additional unit
also lowers price on
the previous units which previously
would have sold for
more.
Price, and Marginal Revenue per Unit
Demand & Marginal Revenue
\Marginal revenue lies below
D/AR for the monopolist
P2
P1
P3
MR
Q2 Q1 Q3
Quantity per Time Period
D=AR
Monopoly: Profit Max. Decision
Ed’s Costs of Showing Movie
$
C
Film rental
1800
O
Auditorium rental
S
Operator
50
T
Ticket takers
100
TOTAL
$2200
250
S
Auditorium

holds 700
people
Ed’s Profit Maximizing Decision
$1800
250
50
100
$2200
Demand (AR)
100
200
300
400
500
600
700
800
900
1000
$ Per Ticket
10
9
8
7
6
5
4
3
2
1
Costs
Film Rental
Auditorium
Operator
Ticket Takers
Total
Tickets Per Week
What will Ed
charge for
admission to
maximize profits?
Profit Maximizing Rule
• PRODUCE ALL THOSE UNITS FOR WHICH
 MC.
– All costs are sunk/fixed:
– TC = $2200
– MC = $0
Look at demand for revenue information
P
Q
$
TR
MR
Profit
$
$
$
7
300
2100
TR/ TO
6
400
2400
3.00
200
5
500
2500
1.00
300
4
600
2400
-1.00
200
3
700
2100
TR-TC
-100
MR
TC=$2200
MC=0
The Profit Maximizing Decision
Profit Maximization
MR MC
MC = 0  MR = 0
$ Per Ticket
10
9
8
7
6
5
4
3
2
1
Demand (AR)
100
200
300
400
500
600
700
800
900
1000
MR
Tickets Per Week
Q* = 500
P* = $5.00
TR
TC
$2500
$2200
Profit
$300
Change Cost Conditions
• Now suppose the distributor of the films
changes the rental fee from a flat $1800 to
$800 and $2.00 for every ticket sold.
• TFC=$800 +$400 = $1200
Revenue Info
Cost Info
Demand
FC = $1200
P,$’s
Qn
MR,$’s
TC,$’s
MC,$’s
7.00
300
6.00
400
3.00
2000
2.00
5.00
500
1.00
2200
2.00
4.00
600
-1.00
2400
2.00
1800
The Profit Max Decision when MC = $2.00
Profit Maximization
MR MC
MC = 2  MR = 2
$ Per Ticket
10
9
8
7
6
5
4
3
2
1
Demand (AR)
Q* = 400
P* = $6.00
Profit=$400
MR
100
200
300
400
500
600
700
800
900
1000
MC
Tickets Per Week
Midterm #2
•
•
•
•
•
1 Hour in length
50 questions multiple choice
Allocate 1 min. per question
Feel free to leave questions until end
Non-cumulative: Covers all TOPICS since
first midterm