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Lecture%207%20-%20Markets%20and%20Efficiency

Lecture%207%20-%20Markets%20and%20Efficiency - FIN 501...

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    1 FIN 501: Financial Economics Lecture 7: Markets and Efficiency Professor Nolan Miller
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    2 Announcements PS#3 … Midterms available on Compass … Midterm Review: at least half of the class on Tuesday, Sept. 21 will  review before the midter. Midterm: Thursday Sept. 23. MSFE Section: In class, 8am. MSF Section: 7 – 8:20pm.  In Mumford Hall 103. Additional professor/TA office hours will be announced.
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    3 Where we’ve been… Consumer theory   demand Producer theory   supply Market Equilibrium: a price P *  where the quantity demanded = quantity  supplied = Q * .
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    4 And where we’re going … Economic profit and equilibrium in the short- and long-run. Why do economists like markets so much? Efficiency (yes) Equity (no)
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    5 Short Run Equilibrium and Profit In the short run, the number of firms is fixed. Firms may earn an economic profit. This is really a rent to being one of the lucky firms in this industry! Q P D S Q* P* Q $ AC Q i * Firm i Positive profit MC
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    6 Long-run analysis In the long-run, a firm may adapt its technology/inputs to fit market  conditions. Firms will produce the output level for which price is equal to its long-run  MC. But at industry level, there is another key factor   entry and exit of  firms. If in the short run, economic profit is positive, assets are better used in  this industry than their alternative uses   entry. If in the short run, economic profits are negative, assets are better used  in other industries   exit.
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    7 Entry and Profit Q P D S Q* P* Entry shifts the supply curve to the right. SR equilibrium price falls. Profit decreases. Q $ AC Q i * Firm i S' P'
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    8 Entry and Profit Q P D S Q* Entry continues until profit is zero. Profit is zero when P = min AC. Q $ AC Q i * Firm i S' P' S'' Q i * P''
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    9 Similar idea for exit. Q P D S’’ Initially, p < min AC, and firms make a negative profit (red). Exit shifts supply back to the point where profit is zero LR price has P=minAC. Q $ AC Q’ Firm i S' P'' S Q P Q’’ P’
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    10 Long Run Equilibrium Long run equilibrium is a short-run equilibrium. Plus, firms can freely enter/exit market. LR equilibrium number of firms is such that P *  = min ATC. Firms earn zero economic profit in long run. This relates back to the idea that economic rents occur when there is  some input in short supply.  In this case, the rent is a return to being one  of the “lucky” firms in the industry in the short run.
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