Lecture13a--LONG-RUNCOMPETITIVEEQUILIBRIUM

Lecture13a--LONG-RUNCOMPETITIVEEQUILIBRIUM - Course...

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Unformatted text preview: Course Examination 2 Date: Monday, March 30 s Coverage: s x Microeconomics, Chapters 8-12 x Macroeconomics: Chapters 21-23 Long-Run Competitive Equilibrium How the lure of profit in perfectly competitive markets reduces it to zero in the long run and guarantees consumers the lowest possible price consistent with firms covering their costs of production Firms do not always earn profits: If market price falls below minimum possible average cost, maximum possible profit is negative. Selling the output for which P = MC minimizes losses Cost and Price ($ per unit) Marginal cost Losses Average cost Average variable cost 200 Demand = Price = MR 0 1 2 3 4 5 6 7 8 Output Units per day in thousands The Shutdown Point: When price falls to minimum possible AVC, economic losses = fixed cost Cost and Price ($ per unit) Marginal cost Losses=FC Average cost Average variable cost 155 0 1 2 3 4 5 6 Demand = Price = MR 7 8 Output Units per day The competitive firm's supply curve Price and cost ($ per unit) MC AVC The portion of the marginal cost curve above the AVC curve is the short-run supply curve 0 Output Long-Run Competitive Equilibrium An industry is in long-run competitive equilibrium when there is no tendency for firms to either enter or leave the market s If economic profits are possible in the industry, new firms will enter the market s If firms in the industry are incurring economic losses, firms will leave the market s When economic profit is zero the industry s Conditions for long-run competitive equilibrium: P=ACmin. All firms must expand in the long run to the most efficient plant. When P=ACmin, economic profit is zero and cannot be increased by improving efficiency s Freedom of entry and exit into and out of markets by sellers, full information on prices, technology, and other factors affecting profit opportunities will result in s How the process works-- Step 1: An industry in equilibrium: P=MC=ACmin P Market Supply P Typical Firm MC AC LRAC P1 Demand Q1 Output (Millions of Units) P=MR q1 Output (units per year) Step 2: Market Demand Increases P Market Supply P Typical Firm MC AC P2 P1 Profit New Demand Initial Demand Q1 Q'Output (Millions of Units) LRAC P=MR q1 q' Output (units per year) Step 3: The higher price allows firms to earn economic profits.This attracts new firms to the market which increases supply P Market Supply P Typical Firm MC AC P2 P1 New Demand Initial Demand Q1 Q'Q2Output (Millions of Units) Profit P=MR q1 q' Output (units per year) Step 4: Supply continues to increase until price falls ACmin. If there is no change in input prices as industry adjusts, this price will once again equal the original ACmin P Market Supply New Supply P Typical Firm MC AC LRAC P=MR P1 New Demand Initial Demand Q1 Output (Millions of Units) q1 Output (units per year) A change in technology or in input prices can also cause an industry to move to a new equilibrium P Market Supply P Typical Firm MC AC LRAC P1 Demand Q1 Output (Millions of Units) P=MR q1 Output (units per year) As input prices fall or technology improves, the AC curves shift down P Market Supply P Typical Firm MC AC P1 Demand Q1 Output (Millions of Units) AC' LRAC LRAC' P=MR q1 Output (units per year) As AC shifts down, economic profits are possible at the current price. This encourages new firms to enter. Supply increases until P=ACmin again P Market Supply P Typical Firm MC AC P1 P2 Demand Q1 Q2 Output q1 AC' LRAC LRAC' P=MR (Millions of Units) Output (units per year) Allocative Efficiency: Exists when a net gain is no longer possible by producing more Price, MB,MC ($ per unit) MC=Supply A net gain is possible whenever MB is greater than MC MB=Demand 0 Q1 Q* Q2 Q Allocative efficiency is automatically achieved under perfect competition because P = MB=MC Price, MB,MC ($ per unit) MC=Supply P Q* is the efficient output because MB=MC MB=Demand 0 Q1 Q* Q2 Q Pure Monopoly A single seller of a product that has no close substitutes s Barriers to entry of additional sellers in the market must prevail for a profitable monopoly to be maintained: s 3 Patents, secret processes, control of a key input, cost advantage of large scale production, government franchises, special ability or technological advantages that others cannot duplicate, force and coercion ...
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