CH9_Welfare_of_Competitive_Model

CH9_Welfare_of_Competitive_Model - Intermediate...

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Intermediate Microeconomics Welfare of Competitive Model Instructor: Bin Xie Spring 2015
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Zero Profit for Competitive Firms in the Long Run I With Free Entry into the Market I Along with identical costs and constant input prices, implies firms each face a horizontal LR supply curve I Firms operate at minimum LR average cost I Firms earn zero economic profit in the LR I When Entry into the Market is Limited I May occur because of limited supply of an input. Bidding for scarce input drives up input price, causing economic rent. LR economic profit is still driven to zero I The scarce input could be land, or even licenses issued by the government. I To enter the profitable market, firms will bid up the price of scarce input until the price is equivalent to the potential profit in the market.
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Producer Surplus I Producer surplus (PS) is the difference between the amount for which a good sells (market price) and the minimum amount necessary for sellers to be willing to produce it (marginal cost). I For both step function and smooth inverse supply function, producer surplus (PS) is the area above the inverse supply curve and below the market price up to the quantity purchased by the consumer.
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Producer Surplus (Cont.) I Producer surplus is closely related to profit. PS - π = F I Profit: π = R - C = R - ( VC + F ) I Producer Surplus: PS = R - VC (All the marginal cost of goods produced adds up to variable cost.) I In long-run, producer surplus equals profit because there is no fixed cost. I Producer surplus is useful for examining the effects of any shock that doesn’t affect a firm’s fixed costs.
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Competition Maximizes Welfare I How should we measure society’s welfare? I If we are agree to weighting the well-being of consumers and producers equally, then welfare can be measured W = CS + PS I A competitive market produces quantities that maximizes the society’s welfare.
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