# Chapter 09 - 15.04.2011 Chapter 9 Properties & Applications...

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15.04.2011 1 Chapter 9 Properties & Applications of the Competitive Model No more good must be attempted than the public can bear. Thomas Jefferson ECON201 – Spring 2011 9-2 QUIZ! 15 minutes 1. Each firm in a competitive market has a cost function of C = 16 + q 2 . The market demand function is Q = 24 – p. Determine the long-run equilibrium price, quantity per firm, market quantity and number of firms. 2. True or false, explain your answer. “The lawn chair industry is a constant cost industry. This means that the law of diminishing returns does not operate, and the marginal cost curve is flat.” ECON201 – Spring 2011 9-3 Answers 1. In the long run price equals marginal cost, and profits are zero. Thus given that industry output Q = nq, the following will be true in long-run equilibrium, p = 24 - nq. Therefore, 24 – nq = 2q (24 – nq)q = 16 + q 2 Solving these equations for q, n, Q, and p yields q = 4, n = 4, Q = 16, p = 8. 2. This statement is false. Diminishing marginal returns, which leads to increasing marginal cost, are a short-run phenomenon. They are caused by the overutilization of a fixed input, usually capital. In the long run, all inputs are variable, and constant average cost, which implies constant marginal cost, occurs when firm’s cost does not increase or decrease as industry output expands or contracts.

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15.04.2011 2 ECON201 – Spring 2011 9-4 Chapter 9 Outline 9.1 Zero Profit for Competitive Firms in the Long Run 9.2 Producer Welfare 9.3 How Competition Maximizes Welfare 9.4 Policies That Shift Supply Curves 9.5 Policies That Create a Wedge Between Supply and Demand Curves 9.6 Comparing Both Types of Policies: Trade ECON201 – Spring 2011 9-5 9.1 Zero Profit for Competitive Firms in the Long Run • With Free Entry into the Market Along with identical costs and constant input prices, implies firms each face a horizontal LR supply curve Firms operate at minimum LR average cost Firms earn zero economic profit in the LR • When Entry into the Market is Limited May occur because of limited supply of an input Bidding for scarce input drives up input price LR economic profit is still driven to zero ECON201 – Spring 2011 9-6 E. Cakmak, Economics, METU 9-6 Zero Long-Run Profit with Free Entry • One implication of the shutdown rule is that the firm is willing to operate in the long run even if it is making zero profit. – But how can this be? – Because opportunity cost includes the value of the next best investment, at a zero long-run economic profit, the firm is earning the normal business profit that the firm could earn by investing elsewhere in the economy.
15.04.2011 3 ECON201 – Spring 2011 9-7 E. Cakmak, Economics, METU 9-7 Zero Long-Run Profit When Entry Is Limited • Rent - a payment to the owner of an input beyond the minimum necessary for the factor to be supplied ECON201 – Spring 2011 9-8 Figure 9.1 Rent ECON201 – Spring 2011 9-9 9.2 Producer Welfare Producer surplus

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## This note was uploaded on 03/22/2012 for the course ECON 201 taught by Professor Çakmak during the Fall '10 term at Middle East Technical University.

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Chapter 09 - 15.04.2011 Chapter 9 Properties & Applications...

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