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Lecture 19 - Announcement s H W due t onight H Ws due on...

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Announcements HW due tonight. HWs due on Wednesday (11:45pm) until next midterm!! Starting ch. 9 on Friday 1 of 26
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Short Run to Long Run (cont.) If firms in an industry earn negative profits in the short run (P<AC), then in the long run firms will exit (or drop out of) this industry. Such exit will shift the supply curve back thus forcing prices up. Firms will keep exiting until the remaining firms get profits=0 2 of 36
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3 of 36 LONG-RUN ADJUSTMENTS TO SHORT-RUN CONDITIONS SHORT-RUN LOSSES: CONTRACTION TO EQUILIBRIUM Long-Run Contraction and Exit in an Industry Suffering Short-Run Losses
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4 of 36 LONG-RUN ADJUSTMENTS TO SHORT-RUN CONDITIONS As long as losses are being sustained in an industry, firms will shut down and leave the industry, thus reducing supply —shifting the supply curve to the left. As this happens, price rises. This gradual price rise reduces losses for firms remaining in the industry until those losses are ultimately eliminated. Whether we begin with an industry in which firms are earning profits or suffering losses, the final long-run competitive equilibrium condition is the same: P* = SRMC = SRAC = LRAC and profits are zero. At this point, individual firms are operating at the most efficient scale of plant—that is, at the minimum point on their LRAC curve.
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5 of 36 LONG-RUN ADJUSTMENTS TO SHORT-RUN CONDITIONS Investment—in the form of new firms and expanding old firms— will over time tend to favor those industries in which profits are being made, and over time industries in which firms are suffering losses will gradually contract from disinvestment. long-run competitive equilibrium When P = SRMC = SRAC = LRAC and profits are zero.
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6 of 36 LONG-RUN ADJUSTMENTS TO SHORT-RUN CONDITIONS
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Long Run Adjustments Thought experiment: Suppose that the minimum ATC is $5 and the price is $5. This means zero profits in the industry. Now suppose demand increases due to a change in tastes. 7 of 36
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Long Run Adjustments 8 of 36 LR Adjustment to an Increase in D Q P S D q P MR 1 MC AC D 1 MR 2 Q 1 Q 2 q 1 q 2 $ 7 $ 5
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Long Run Adjustments When the market demand curve shifts out, the price that firms face (their demand = marginal revenue curve) increases to $7 and firms increase production to q 2 in the SR and the market quantity increases to Q 2 .
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