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Unformatted text preview: Principles of Economics I
Economics 101 Announcements Readings: Chapter 10: Production, Technology and Costs Chapter 11: Competitive Markets Chapter 14: Monopoly Discussion Sections this week New problem set available on Ctools this evening Last discussion section Long Run and Short Run Costs
MC, AC ($) ATCSR MCSR MCLR ACLR AFCSR AVCSR Output What does profit maximization mean now? We know that firms look to choose output so that
P = MC, and The firm makes no avoidable losses But what is MC? MCSR is relevant in the short run MCLR is relevant in the long run Does the firm make avoidable losses? Compare prices to AVC in the short run Compare prices to ACLR in the long run Responses to a price change in the long and short run MC, AC ($) MCSR Long Run Profit P1 MCLR ACLR AC1 P0 Q0 QSR QLR Output Responses to a price change in the long and short run MC, AC ($) MCSR ACSR AC1 Min AC = P0 AVC1 P1 AVC1 Avoidable loss ACLR MCLR AVC Short run loss Output QSR Q0 Additional losses incurred if firm shuts down Lessons In the long run If P > min ACLR then choose Q so that = P If P < min AC then shut down LR MC In the short run If P > min AVC then choose Q so that = P If P < min AVC then shut down MC Industry Equilibrium In a dynamic market, firms are able to enter and exit the industry These are actions available to individual firms in the long run Entry or exit occurs in response to firm profit levels
Profits induce entry Losses induce exit Industry Equilibrium Long run equilibrium will imply:
1. Individual firms maximize profits P = MC 2. Marginal firm earns zero profits P = AC Marginal firm must produce at minimum AC MC = AC AC is at a minimum If all firms have access to the same technology, then all firms produce at minimum AC All firms earn zero profits Dynamics in the competitive industry (identical firms)
AC, MC ($) Short run profits MC AC PSR Min AC P0 SLR P SSR D q0 qSR q Q0 QSR Q1 Q Dynamics in the competitive industry (identical firms)
AC, MC ($) MC Short run losses P AC SSR Min AC P0 P1 SLR D qSR q0 q Q1 QSR Q0 Q Supply shocks How does the competitive market respond to supply shocks? Technological innovation Changes in input prices Environmental changes Dealt with on this week's assignment In the long run, an individual (active) firm's behavior will only vary as a result of supply shocks Summary In the long run, competitive markets tend to Offer little or no profit to firms Generate changes in output primarily through entry and exit (rather than individual firms varying output) Prices reflect average costs of production When firms have the same production technology, P = minimum AC Production is efficient Why are there no profits in the competitive industry? Profits forced to zero by free entry and exit Implication: (Supernormal) profits only available if there are barriers to entry If there are barriers to entry, no reason to think that prices reflect average production costs Likelihood of inefficiency Competitive Spectrum
Very competitive Not competitive Perfect competition: Free entry and exit, price takers, identical products Monopolistic Competition: Free entry and exit, price setting, differentiated products Oligopoly: Barriers to entry, strategic pricing concerns Monopoly: Barriers to entry, price setting Monopoly Means "one seller" Barrier to entry protects firm from competition Lack of competition gives firm power over price Profits not forced to zero No longer price taker Price-taking Pricetaker believes $ that any quantity can be sold at the given price P If the price is P, then selling an extra unit generates an extra $P. Additional Revenue = P Effective Demand Revenue Q Q+1 Qi Price Setting Pricemaker faces the market demand curve To sell an additional unit the price must fall Extra revenue from selling the marginal unit is lower than the price for which it sells P Decrease in revenue = Q . P Increase in revenue = P1 P0 P1 Demand Q Q+1 Q Marginal Revenue Marginal Revenue (MR) = Increase in revenue generated by selling an additional unit of output If MR > MC increase output If MR < MC decrease output If the firm is a price taker, MR = P If the firm is a price maker, MR < P ...
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