Micro.Week8.2007 - 8/1 FIRST SEVEN PAGES ARE REVIEW Review...

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8/1 FIRST SEVEN PAGES ARE REVIEW Review what happens in long run in perfect competition: Case 1: If negative profits, assume EXIT Case 2: If positive profits, assume ENTRY Reminder ! Profits are economic profits So if / > 0, that is, if economic profits are positive, the firm is covering all of its costs, making a reasonable return on capital and getting reasonable compensation for the efforts (time) of the entrepreneur PLUS ... getting something extra (the economic profits) Let’s do case 2 (positive profits) first. Positive profits makes this a very attractive industry for entrepreneurs looking to make money Buried behind this is the implicit assumption that there are entrepreneurs hunting for exactly these kinds of opportunities. So / > 0 leads these entrepreneurs to ENTER the industry as new firms
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8/2 But as we saw, more firms / shifts supply curve to the right So ENTRY I SUPPLY SHIFTS I PRICE FALLS I PROFITS FALL Diagram: NOTE : This continues until the entry stops But entry continues as long as / > 0 So entry continues until profits are driven down to zero.
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8/3 Now let’s look at case 1 (negative profits). Negative profits makes this a very unattractive industry for entrepreneurs, because they are not earning a decent return on their efforts. Again: Reminder ! Profits are economic profits So if / < 0, that is, if economic profits are negative but the firm is operating in the short run, then the firm is covering all of its variable costs, BUT the firm is not making a reasonable return on capital and is not getting reasonable compensation for the efforts (time) of the entrepreneur As soon as they can (that is, in the long run when they can get rid of their capital), entrepreneurs leave the industry to look for better opportunities elsewhere. So / < 0 leads these entrepreneurs to EXIT the industry. But as we saw, fewer firms / shifts supply curve to the left So EXIT I SUPPLY SHIFTS I PRICE RISES I PROFITS RISE
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8/4 Diagram: NOTE : This continues until the exit stops But exit continues as long as / < 0 So entry continues until profits are driven up to zero.
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This note was uploaded on 06/13/2011 for the course ECON A04 taught by Professor Mk during the Spring '07 term at University of Toronto- Toronto.

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Micro.Week8.2007 - 8/1 FIRST SEVEN PAGES ARE REVIEW Review...

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