Lecture17 - Long Run Equilibrium of the Firm in...

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Long Run Equilibrium of the Firm in Monopolistic Competition Model A: Long Run Equilibrium with New Firms Entering the Industry (the “tangency” solution) In this model we show how entry erases economic profits. For now, we will assume that the firms do not engage in price competition with each other. The key point here is that the entry of new firms shifts d F to the left since a larger number of firms must now share a fixed market demand structure. P d At each price, every firm sells less since part of the consumer’s dollar is now diverted to close substitutes offered by the entrant firms. F d F MR Since MR is derived from demand, the MR curve also shifts down and to the left. X MR’
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As entry takes place in the long run, we can think of the adjustment to a new quilibrium as a downward slide of F ntil it is tangent to ATC as shown in the equilibrium as a downward slide of dF until it is tangent to ATC as shown in the graph below. Short run equilibrium (before entry) is at ’ (where S denotes the quantity decision S’ (where S denotes the quantity decision ans P S denotes the marked-up equilibrium price). Long run equilibrium (after entry) is at T’ (where T denotes the quantity decision ans P T denotes the marked-up equilibrium price). Notice that at T’ we have “normal profits” where TR = TC. The firm is initially in their SR equilibrium at S’, selling X S at P S and making conomic profits In the long run new firms enter the industry (attracted by economic profits. In the long run, new firms enter the industry (attracted by economic profits) and d F “slides” toward point T’. As long as d F remains above ATC, economic profits are not exhausted and d F continues to “slide”.
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Long run equilibrium is reached at T’ where TR = TC and the representative firm makes “normal profits” (economic profits = 0), so that there are no further incentives for new firms to enter. Point T’ is called the “tangency solution” since at this point the long run demand curve (d F ’) is tangent to ATC. Notice that at the output level corresponding to T’ (i.e. X ), MR = MC at T. At any T output level smaller than X T, cost per unit exceeds the demand price (i.e. ATC is above d F ’), so the firm incurs economic losses. The same is true for any output level that is greater than X T. It follows that X T is the profit maximizing output level (normal profits in this case) where MR = MC. There is something to be gained by comparing the long run equilibrium in monopolistic competition with the long run equilibrium in perfect competition. Recall that in perfect competition the long run equilibrium occurs at the lowest point of the LRAC curve (point P in the following graph) where the firm sells X P at P P and makes normal profits.
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y contrast the representative firm in monopolistic competition is in long run By contrast, the representative firm in monopolistic competition is in long run equilibrium at M, where it also makes normal profits but sells a smaller output (X M ) at a higher price (P M ).
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Lecture17 - Long Run Equilibrium of the Firm in...

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