This preview shows pages 1–3. Sign up to view the full content.
This preview has intentionally blurred sections. Sign up to view the full version.View Full Document
Unformatted text preview: Chapter 11 Competitive equilibrium Analytical frameworks for describing consumers and producers have now been described. The process of utility maximization subject to a budget constraint generates consumer demand functions. The decisions of profit maximizing firms given input costs and technology result in cost functions and ultimately supply functions. In the present chapter, these ideas are assembled into a total picture of how an industry operates under the as- sumption that the industry is competitive. The initial focus is strictly on how decision-making by firms and consumers can be applied to solve for market quantity and price (and perhaps other things such as firms profits) in both the short and the long run (recall these are distinguished by the planning horizon of the firm). In the following chapter, we will turn to an examination of the welfare properties of the results of this exercise. We consider the behavior of the industry in both the short run and the long run. As elucidated in our chapter on costs and production, the short run is a period of time short enough so that firms have at least one input in production fixed - which is usually taken to be capital, and in which no entry into the industry can occur. This means that the number of firms in the industry, and, roughly construed, the size of each firm, is fixed in the short run. Thus, the reader might imagine that the short run is a period of time short enough so that no new capital can be installed, and creation of a new firm requires the installation of new units of capital. 235 236 CHAPTER 11. COMPETITIVE EQUILIBRIUM In the long run, firms are free to enter (and exit) the industry, and are free to adjust any inputs of production that were fixed in the short run. Thus, new firms may enter, and existing firms may alter the size of their capital stocks in the long run. But, in a competitive industry, in either the short or long run, all firms believe that the decisions they make have no impact on the market price of the product. Thus, in both spans of time, the market price of the product is a given parameter from the perspective of the individual firm. Perhaps paradoxically, while individual firms take market prices as given, their decisions en masse determine market prices. Thus, the situation is one in which firms collectively determine market prices through their actions, without acknowledging this explicitly in the decision-making process. Ob- viously, this is a simplification (albeit a useful one for a variety of reasons), and we will take up this and related issues in a subsequent chapter in which firms recognize that their decisions have a market-wide impact. The analysis proceeds in logical steps. First, a market demand curve is constructed by aggregating the demands of individual consumers. Then, at least if we are considering a short-run model of market behavior, a market supply curve is formed by aggregating the profit-maximizing decisions of individual firms, and prices and quantities can be found by equating demand...
View Full Document
- Fall '09