ECS1010.05.post

ECS1010.05.post - UNIT II: Firms & Markets 7/6 Theory of...

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UNIT II: Theory of the Firm Profit Maximization Perfect Competition Review 7/15 MIDTERM 7/6
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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 solve for a competitive equilibrium and consider its welfare implications . We will also construct a general equilibrium model of Smith’s vision.
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Perfect Competition Assumptions and Implications (from last time) Solving for the Competitive Equilibrium Equilibrium and Efficiency General Equilibrium Welfare 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 Implications 1) Firms produce at minimum average cost, i.e., “efficient scale.” (AC = AC min ) 2) Price is equal to marginal cost. (P = MC) 3) Firms earn zero (economic) profits. ( π = 0) 4) Market equilibrium is Pareto-efficient.
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Perfect Competition In the Long-run… 1) Firms produce at minimum average cost, i.e., “efficient scale.” (AC = AC min ) 2) Price is equal to marginal cost. (P = MC) 3) Firms earn zero (economic) profits. ( π = 0) 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. We can use this account to understand (and solve for) the long-run competitive equilibrium. Π = 0 Π = 0
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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 AC AC q: firm Q: market Perfect Competition
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. 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
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This note was uploaded on 06/29/2010 for the course ECON ECON 1010 taught by Professor Robert during the Summer '10 term at Harvard.

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ECS1010.05.post - UNIT II: Firms & Markets 7/6 Theory of...

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