204_summer_2009_lecture_15

204_summer_2009_lecture_15 - University of Toronto...

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University of Toronto Department of Economics ECO 204 Summer 2009 Sayed Ajaz Hussain Lecture 15 1 Ajaz Hussain. Department of Economics
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Last Time ± Rational vs. irrational producers ± Competitive firms as price takers ± Market demand and supply reexamined ± Profit maximization algebra ± “Equilibrium” ± Competitive firm: supply curve 2 Ajaz Hussain. Department of Economics
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Today ± Long Run Equilibrium ± Market Shocks: ² Adjustment Dynamics ± The Aluminum Industry (1994) Ajaz Hussain. Department of Economics 3
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From Short to Long Run Ajaz Hussain. Department of Economics 4 Short Run = (P–AVC)Q–TFC 0 Continue operating = (P–AVC)Q–TFC < 0 Continue operating = (P–AVC)Q–TFC < 0 If rational, shut down Towards Long Run Attracts equally or more efficient firms If rational, eventually exit industry If irrational, will deter more efficient rivals If output price, AVC and TFC remain constant Number of firms is a variable (endogenous)
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Long Run Equilibrium Number of Firms If all firms are rational, there are no barriers to entry and there is perfect foresight: Equilibrium number of firms is the largest number of firms that can (all) break even = R–C = PQ–AC Q = (P–AC)Q = 0 produce where P = AC Ajaz Hussain. Department of Economics 5
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Competitive Firms Decreasing Returns Ajaz Hussain. Department of Economics 6 A FIRM Q P D MR P MC q MARKET Q S P D P Q AC Here: P = min AC ¾ Given firm’s cost function–say , estimated from data –f irms can predict long run price ¾ Given firm’s production function–say
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Example 1 ± Suppose all firms use: Q = L ½ k ½ ± P L = P K = $10, P = $20 and k = 10 ± Optimal short run Labor: L = [q/k ½ ] 2 = q 2 /10 ± C = P K K + P L L ² C = 10(10) + 10(q 2 /10) ² C = 100 + q 2 ± AC = 100/q + q ± Long run price? ² Given number of firms “build” supply curve Ajaz Hussain. Department of Economics 7 Long Run Price Produce where P = min AC AC = dAC/dq = 0 q = min AC = Long run price = AC q
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Example 1 Ajaz Hussain. Department of Economics 8 A FIRM Q P D MR 10 MARKET Q S P Q D
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204_summer_2009_lecture_15 - University of Toronto...

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