Over time, profits induce entry, to the right, reducing P … …driving profits to zero and restoring long-run eq’m. A B C
Why the LR Supply Curve Might Slope Upward • The LR market supply curve is horizontal if 1) all firms have identical costs, and 2) costs do not change as other firms enter or exit the market. • If either of these assumptions is not true, then LR supply curve slopes upward.
1) Firms Have Different Costs • As P rises, firms with lower costs enter the market before those with higher costs. • Further increases in P make it worthwhile for higher-cost firms to enter the market, which increases market quantity supplied. • Hence, LR market supply curve slopes upward. • At any P , – For the marginal firm, P = minimum ATC and profit = 0. – For lower-cost firms, profit > 0.
2) Costs Rise as Firms Enter the Market • In some industries, the supply of a key input is limited (e.g. , amount of land suitable for farming is fixed). • The entry of new firms increases demand for this input, causing its price to rise. • This increases all firms’ costs. • Hence, an increase in P is required to increase the market quantity supplied, so the supply curve is upward-sloping.
CONCLUSION: The Efficiency of a Competitive Market • Profit-maximization: MC = MR • Perfect competition: P = MR • So, in the competitive eq’m: P = MC • Recall, MC is cost of producing the marginal unit. P is value to buyers of the marginal unit. • So, the competitive eq’m is efficient, maximizes total surplus.
S U M M A RY • For a firm in a perfectly competitive market, price = marginal revenue = average revenue. • If P > AVC , a firm maximizes profit by producing the quantity where MR = MC . If P < AVC , a firm will shut down in the short run. • If P < ATC , a firm will exit in the long run. • In the short run, entry is not possible, and an increase in demand increases firms’ profits. • With free entry and exit, profits = 0 in the long run, and P = minimum ATC .
You've reached the end of your free preview.
Want to read all 34 pages?
- Fall '06