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Unformatted text preview: ket supply decreases and the market supply curve gradually
shifts leftward. As market supply decreases, the price
rises. At each higher price, a firm’s profit-maximizing
output is greater, so the firms remaining in the market increase their output as the price rises. Each firm
moves up along its marginal cost or supply curve in
Fig. 10.10(b). That is, as some firms exit the market,
market output decreases but the output of the firms
that remain in the market increases.
Eventually, enough firms have exited the market
for the market supply curve to have shifted to S1 in
Fig. 10.10(a). The market price has returned to its
original level, P0. At this price, the firms remaining in
the market produce q0, the same quantity that they
produced before the decrease in demand. Because
firms are now making zero economic profit, no firm
has an incentive to enter or exit the market. The market supply curve remains at S1, and market output is
Q2. The market is again in long-run equilibrium.
The difference between the initial long-run equilibrium and the final long-run equilibrium is the
number of firms in the market. A permanent decrease
in demand has decreased the number of firms. Each
firm remaining in the market produces the same output in the new long-run equilibrium as it did initially
and makes zero economic profit. In the process of
moving from the initial equilibrium to the new one,
firms incur economic losses.
We’ve just worked out how a competitive market
responds to a permanent decrease in demand. A permanent increase in demand triggers a similar
response, except in the opposite direction. The
increase in demand brings a higher price, economic
profit, and entry. Entry increases market supply and
eventually lowers the price to its original level and
economic profit to zero.
The demand for Internet service increased permanently during the 1990s and huge profit opportunities arose in this market. The result was a massive rate 000200010270728684_CH10_p195-220.qxd 6/23/11 4:13 PM Page 209 C hanging Tastes and Advancing Technology FIGURE 10.10 209 A Decrease in Demand
Price and cost Price S1 S0 MC
ATC P0 P0 MR 0 P1 P1 MR 1 D0
0 Q2 Q1 Q0 Quantity (a) Industry 0 q1 q0 Quantity (b) Firm A market starts out in long-run competitive equilibrium. Part
(a) shows the market demand curve D0, the market supply
curve S0, the market price P0, and the equilibrium quantity
Q0. Each firm sells its output at the price P0, so its marginal
revenue curve is MR0 in part (b). Each firm produces q0 and
makes zero economic profit.
Market demand decreases permanently from D0 to D1
in part (a) and the market price falls to P1. Each firm
decreases its output to q1 in part (b), and the market output decreases to Q1 in part (a). Firms now incur economic
losses. Some firms exit the market, and as they do so, the
market supply curve gradually shifts leftward, from S0
toward S1. This shift gradually raises the market price from
P1 back to P0. While the price is below P0, firms incur economic losses and some firms exit the market. Once the price
has returned to P0, each firm makes zero economic profit
and has no incentive to exit. Each firm produces q0, and the
market output is Q2. animation of entry of Internet service providers. The process of
competition and change in the Internet service market is similar to what we have just studied but with
an increase in demand rather than a decrease in
We’ve now studied the effects of a permanent
change in demand for a good. In doing so, we began
and ended in a long-run equilibrium and examined
the process that takes a market from one equilibrium
to another. It is this process, not the equilibrium
points, that describes the real world.
One feature of the predictions that we have
just generated seems odd: In the long run, regardless
of whether demand increases or decreases, the market
price returns to its original level. Is this outcome
inevitable? In fact, it is not. It is possible for the
equilibrium market price in the long run to remain
the same, rise, or fall. External Economies and Diseconomies
The change in the long-run equilibrium price depends
on external economies and external diseconomies.
External economies are factors beyond the control of an
individual firm that lower the firm’s costs as the market
output increases. External diseconomies are factors outside the control of a firm that raise the firm’s costs as
the market output increases. With no external
economies or external diseconomies, a firm’s costs
remain constant as the market output changes.
Figure 10.11 illustrates these three cases and
introduces a new supply concept: the long-run market
A long-run market supply curve shows how the
quantity supplied in a market varies as the market
price varies after all the possible adjustments have
been made, including changes in each firm’s plant
and the number of firms in the market. 000200010270728684_CH10_p195-220.qxd 4:13 PM Page 210 CHAPTER 10 Perfect Competition Figure 10.11(a) shows...
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