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# 191T5 - ECON191(Spring 2010 18 19 22.3.2010(Tutorial 5...

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1 ECON191 (Spring 2010) 18, 19 & 22.3.2010 (Tutorial 5) Chapter 5 Perfectly competitive market (Chapter 8 & 9 of textbook) Short Run Equilibrium In the SR equilibrium, given market price, P * , Each individual firm takes P * and produce the profit maximizing output = q * n firms totally produce Q * = nq * given P * In the SR equilibrium, (a) Each firm is profit maximizing ( MR = MC ) (b) Quantity demanded equals quantity supplied (c) May earn positive, negative profit, or breakeven ( P * = min ATC ) SR supply curve for a competitive firm: MC above the min AVC Market supply curve is the horizontal aggregation of all individual firms’ supply In SR, the number of firms and the size of firms is fixed Long Run Equilibrium In LR, firms will enter if existing firms earn positive profit and firms will exit if existing firms earn negative profit (number of firms and size of firms varies in LR) Firms can change plant size in order to maximizing profit. In a long run equilibrium, given the market price and the numbers of firms, (a) Each firm is profit maximizing when all inputs are variable (b) Each firm earns zero profits, no further entry or exit (c) Quantity supplied equals quantity demanded In the LR equilibrium, P * = Min LRAC When the market is in SR and LR equilibrium, each firm produces at minimum efficient scale. (min LRAC) q* MC q P* AVC ATC Q* = nq* D S I Q Firm Industry Q*= nq* D S I Q P q* MC q P ATC LRAC Industry Firm

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2 Welfare properties of competitive equilibrium Consumer surplus: the amount a person is willing to pay over the amount he has to pay Producer surplus: the amount a seller actually received over the amount he must receive Deadweight loss: net loss of total surplus (consumer plus producer surplus) In a perfectly competitive market, (1) Consumer surplus and producer surplus are maximized (2) Price is set to MC (3) Goods are produced at the lowest possible cost and in the most efficient manner Comparative statistic analysis Taxes, subsidies, price ceiling, price floor, quotas, tariffs etc. Welfare implication on consumer surplus, producer surplus Example : Minimum wage (P. 315) Example : A tax on gasoline (P. 335) Consider a gas tax in the market during mid 1990s. The goal of a large gasoline tax is to raise government revenue, to reduce oil consumption Initially, Q D = 150 50 P Q S = 60 + 40 P Q S = Q D at \$1 and 100 billion gallons With a 50 cent tax 150 50 P B = 60 + 40 P S 150 50( P S + 0.50) = 60 + 40 P S P S = 0.72, P B = P S + 0.50 = \$1.22 Q D = Q S = 89 billion gallons Wage is set higher than market clearing wage Quantity demand for workers drops Those workers hired receive higher wages Unemployment results since not everyone who wants to work at the new wage can find a job
3 Contestable market

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191T5 - ECON191(Spring 2010 18 19 22.3.2010(Tutorial 5...

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