ECE1010.06.post

ECE1010.06.post - UNIT II: Firms & Markets 10/22 Theory...

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UNIT II: Theory of the Firm Profit Maximization Perfect Competition Review 11/5 MIDTERM 10/22
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Perfect Competition Is it true that the rational pursuit of private interests produces coherence rather than chaos, and if so, how is it done? -- Frank Hahn Adam Smith described a world in which market competition weed-outs inefficient behavior, so that the ‘pursuit of private interests’ is led, as if by an invisible hand , to promote the general welfare of society. Today, we will use our models of consumers, firms and markets to construct a general equilibrium and consider its welfare implications .
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Perfect Competition Supply in the Long-Run Equilibrium and Efficiency General Equilibrium Qelfare Analysis
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Perfect Competition Assumptions Firms are price-takers : can sell all the output they want at P*; can sell nothing at any price > P*. Homogenous product : e.g., wheat, t-shirts, long- distance phone minutes. Perfect factor mobility : in the long run, factors can move costlessly to where they are most productive (highest w, r). Perfect information : firms know everything about costs, consumer demand, other profitable opportunities, etc.
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Perfect Competition In the Long-run… 1) Firms produce at minimum average cost, i.e., “efficient scale.” 2) Price is equal to marginal cost. 3) Firms earn zero (economic) profits. 4) Market equilibrium is Pareto-efficient.
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Perfect Competition In the short-run, firms adjust to price signals by varying their utilization of labor (variable factors). In the long-run, firms adjust to profit signals by varying plant size (fixed factors); and entering or exiting the market. Qhat determines the number of firms in the long-run?
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Supply in the Long-Run Short-run equilibrium with three firms. Firm A is making positive profits, Firm B is making zero profits, and Firm C is making negative profits (losses). Firm A Firm B Firm C q q q $ P MC MC MC AC AVC AC AC q: firm Q: market
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Supply in the Long-Run Short-run equilibrium with three firms . Firm A is making positive profits, Firm B is making zero profits, and Firm C is making negative profits (losses). Firm A Firm B Firm C q q q $ P In the long run, Firm C will exit the market. MC AC MC AC
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Supply in the Long-Run In the long-run, inefficient firms will exit, and new firms will enter, as long as some firms are making positive economic profits. Firm A Firm B Firm D q q q $ P MC MC AC MC AC AC
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Supply in the Long-Run In the long-run, if there are no barriers to entry, then new firms have access to the most efficient production technology. We call this the efficient scale . Firm A Firm D Firm E q* q q* q q* q $ P* MC MC AC MC AC AC
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The long-run supply curve. P* is the lowest possible price associated with non-negative profits, P* = AC min . $ P*
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ECE1010.06.post - UNIT II: Firms & Markets 10/22 Theory...

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