blanchard_ch10

A market that consists of 1000 identical firms has a

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Unformatted text preview: identical firms has a supply schedule similar to that of one firm, but the quantity supplied by the market is 1,000 times as large as that of the one firm (see the table). The market supply curve is SM. Points A, B, C, and D correspond to the rows of the table. At the shutdown price of $17 a sweater, each firm produces either 0 or 7 sweaters a day and the quantity supplied by the market is between 0 and 7,000 sweaters a day. The market supply is perfectly elastic at the shutdown price. animation rises above $17 a sweater, each firm increases its quantity supplied and the quantity supplied by the market increases by 1,000 times that of one firm. 000200010270728684_CH10_p195-220.qxd 6/23/11 4:13 PM Page 203 O utput, Price, and Profit in the Short Run Short-Run Equilibrium price, each firm maximizes profit by decreasing its output. If each firm produces 7 sweaters a day, the market output decreases to 7,000 sweaters a day. If the demand curve shifts farther leftward than D3, the market price remains at $17 a sweater because the market supply curve is horizontal at that price. Some firms continue to produce 7 sweaters a day, and others temporarily shut down. Firms are indifferent between these two activities, and whichever they choose, they incur an economic loss equal to total fixed cost. The number of firms continuing to produce is just enough to satisfy the market demand at a price of $17 a sweater. Market demand and short-run market supply determine the market price and market output. Figure 10.7(a) shows a short-run equilibrium. The short-run supply curve, S, is the same as SM in Fig. 10.6. If the market demand curve is D1, the market price is $20 a sweater. Each firm takes this price as given and produces its profit-maximizing output, which is 8 sweaters a day. Because the market has 1,000 identical firms, the market output is 8,000 sweaters a day. A Change in Demand Changes in demand bring changes to short-run market equilibrium. Figure 10.7 shows these changes. If demand increases and the demand curve shifts rightward to D2, the market price rises to $25 a sweater. At this price, each firm maximizes profit by increasing its output to 9 sweaters a day. The market output increases to 9,000 sweaters a day. If demand decreases and the demand curve shifts leftward to D3, the market price falls to $17. At this In short-run equilibrium, although the firm produces the profit-maximizing output, it does not necessarily end up making an economic profit. It might do so, but it might alternatively break even or incur an economic loss. Economic profit (or loss) per sweater is price, P, minus average total cost, ATC. So economic profit (or loss) is (P – ATC ) Q. If price S 25 Price (dollars per sweater) Price (dollars per sweater) Profits and Losses in the Short Run Short-Run Equilibrium FIGURE 10.7 Increase in demand: price rises and firms increase production S 25 20 17 D2 20 17 Decrease in demand: price falls and firms decrease production D1 0 6 7 8 9 10 Quantity (thousands of sweaters per day) (a) Equilibrium 0 6 D1 D3 7 8 9 10 Quantity (thousands of sweaters per day) (b) Change in equilibrium In part (a), the market supply curve is S and the market demand curve is D1. The market price is $20 a sweater. At this price, each firm produces 8 sweaters a day and the market produces 8,000 sweaters a day. In part (b), if the market demand increases to D2, the animation 203 price rises to $25 a sweater. Each firm produces 9 sweaters a day and market output is 9,000 sweaters. If market demand decreases to D3, the price falls to $17 a sweater and each firm decreases its output. If each firm produces 7 sweaters a day, the market output is 7,000 sweaters a day. 000200010270728684_CH10_p195-220.qxd 6/23/11 4:13 PM Page 204 CHAPTER 10 Perfect Competition equals average total cost, a firm breaks even—the entrepreneur makes normal profit. If price exceeds average total cost, a firm makes an economic profit. If price is less than average total cost, a firm incurs an economic loss. Figure 10.8 shows these three possible short-run profit outcomes for Campus Sweaters. These outcomes correspond to the three different levels of market demand that we’ve just examined. Three Possible Short-Run Outcomes Figure 10.8(a) corresponds to the situation in Fig. 10.7(a) where the market demand is D1. The equilibrium price of a sweater is $20 and the firm produces 8 sweaters a day. Average total cost is $20 a sweater. Price equals average total cost (ATC ), so the firm breaks even (makes zero economic profit). Figure 10.8(b) corresponds to the situation in Fig. 10.7(b) where the market demand is D2. The equilibrium price of a sweater is $25 and the firm produces 9 sweaters a day. Here, price exceeds average total cost, so the firm makes an economic profit. Its economic profit is $42 a day, which equals $4.67 per sweater ($25.00 – $20.33) multiplied by 9, the Three Short-Run Outcomes for the Firm MC 30.00 Break-even point ATC 25.00 20.00 MR 15.00 0 8 10 Quantity (swe...
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This note was uploaded on 01/10/2013 for the course ECON 251 taught by Professor Blanchard during the Spring '08 term at Purdue.

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