In part (a) price equals average total cost and the firm makes zero economic profit (breaks even). In part (b), price exceeds average total cost and the firm makes a positive economic profit. In part (c) price is less than average total cost and the firm incurs an economic loss—economic profit is negative. In short-run equilibrium, a firm might make an economic profit, break even, or incur an economic loss. In long-run equilibrium, firms break even because firms can enter or exit the market. We’ll look at that next time…
Entry and Exit New firms enter an industry in which existing firms make an economic profit. Firms exit an industry in which they incur an economic loss A Closer Look at Entry When the market price is $25 a sweater, firms in the market are making economic profit New firms have an incentive to enter the market When they do, the market supply increases and the market price falls Firms enter as long as firms are making economic profit. In the long run, the market price falls until firms are making zero economic profit A Closer look at Exit When the market price is $17 a sweater, firms in the market are incurring economic loss. Firms have an incentive to exit the market When they do, the market supply decreases and the market price rises. Firms exit as long as firms are incurring economic losses. In the long run, the price continues to rise until firms make zero economic profit
Changes in Demand and Supply as Technology Advances An Increase in Demand An increase in demand shifts the market demand curve rightward The price rises and the quantity increases Starting from long-run equilibrium, firms make economic profits The market demand curve shifts rightward, the market price rises, and each firm increases the quantity it produces. The market price is now above the firm’s minimum average total cost, so firms make economic profit. Economic profit induces some firms to enter the market, which increases the market supply and the price starts to fall As the price falls, the quantity produced by all firms starts to decrease and each firm’s economic profit starts to fall. Eventually, enough firms have entered for the supply and increased demand to be in balance and firms make zero economic profit. Firms no longer enter the market. The main difference between the initial and new long-run equilibrium is the number of firms in the market. More firms produce the equilibrium quantity.
Technological Advances Change Supply Starting from a long-run equilibrium, when a new technology becomes available that lowers production costs, the first firms to use it make economic profit. But as more firms begin to use the new technology, market supply increases and the price falls. Part (a) shows the market Part (b) shows a firm using the original old technology.
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