Download How Does A Perfectly Competitive Market Reach Long Run Equili

How Does A Perfectly Competitive
Market Reach Long Run Equilibrium?
Side-by-side graph for perfectly completive
industry and firm.
Is the firm making a profit or a loss? Why?
P
S
P
MC
ATC
$15
MR=D
$15
AVC
D
5000
Industry
Q
8
Q
Firm
(price taker)
2
Where is the profit maximization point? How do you know?
What output should be produced? What is TR? What is TC?
How much is the profit or loss? Where is the Shutdown Point?
$25
MC
Cost and Revenue
20
Profit
15
MR=P
ATC
AVC
10
Total Revenue Total Cost
0
1 2 3 4 5 6 7 8 9 10
3
I. Supply
Revisited
4
Cost and Revenue
Marginal Cost and Supply
$5
0
45
40
35
30
25
20
15
10
5
0
As price increases, the quantity
increases
MC
ATC
MR5
AVC
MR4
MR3
MR2
MR1
1 2 3 4 5 6 7
9
Q
5
Marginal Cost and Supply
Cost and Revenue
When price increases, quantity increases
When price decrease, quantity decreases
$5
0
45
40
35
30
25
20
15
10
5
0
MC = Supply
ATC
MC above AVC is the
AVC
supply curve
1 2 3 4 5 6 7
9
Q
6
Marginal Cost and Supply
Cost and Revenue
What if variable costs increase (ex: tax)?
$5
0
45
40
35
30
25
20
15
10
5
0
MC2=Supply2
MC1=Supply1
AVC
AVC
When MC increases, SUPPLY decrease
1 2 3 4 5 6 7
9
Q
7
Marginal Cost and Supply
Cost and Revenue
What if variable costs decrease (ex: subsidy)?
$5
0
45
40
35
30
25
20
15
10
5
0
MC1=Supply1
MC2=Supply2
AVC
AVC
When MC decreases, SUPPLY increases
1 2 3 4 5 6 7
9
Q
8
II. Perfect Competition
in the Long-Run
You are a wheat farmer. You learn that
there is a more profit in making corn.
What do you do in the long run?
9
In the Long-run…
•Firms will enter if there is profit
•Firms will leave if there is loss
•So, ALL firms break even, they make NO
economic profit
(No Economic Profit=Normal Profit)
•In long run equilibrium a perfectly
competitive firm is EXTREMELY efficient.
10
Side-by-side graph for perfectly completive
industry and firm in the LONG RUN
Is the firm making a profit or a loss? Why?
P
S
P
MC
ATC
$15
MR=D
$15
D
5000
Industry
Q
8
Q
Firm
(price taker)
11
Firm in Long-Run Equilibrium
Price = MC = Minimum ATC
Firm making a normal profit
P
MC
ATC
$15
MR=D
There is no incentive
to enter or leave the
industry
TC = TR
8
Q
12
12
III. Going from LongRun to Short-Run
13
1.
2.
3.
4.
Is this the short or the long run? Why?
What will firms do in the long run?
What happens to P and Q in the industry?
What happens to P and Q in the firm?
P
S
P
MC
ATC
$15
MR=D
$15
D
5000
6000
Industry
Q
8
Firm
Q
14
Firms enter to earn profit so supply
increases in the industry
Price decreases and quantity increases
P
S
P
MC
S1
ATC
$15
MR=D
$15
$10
D
5000
6000
Industry
Q
8
Firm
Q
15
Price falls for the firm because they are
price takers.
Price decreases and quantity decreases
P
S
P
MC
S1
ATC
$15
$15
MR=D
$10
$10
MR1=D1
D
5000
6000
Industry
Q
5
8
Firm
Q
16
New Long Run Equilibrium at $10 Price
Zero Economic Profit
P
P
MC
S1
ATC
$10
MR1=D1
$10
D
5000
6000
Industry
Q
5
Firm
Q
17
1.
2.
3.
4.
Is this the short or the long run? Why?
What will firms do in the long run?
What happens to P and Q in the industry?
What happens to P and Q in the firm?
P
S
P
$15
MC
ATC
MR=D
$15
D
4000
5000
Industry
Q
8
Firm
Q
18
Firms leave to avoid losses so supply
decreases in the industry
Price increases and quantity decreases
S1
P
S
P
MC
ATC
$20
$15
MR=D
$15
D
4000
5000
Industry
Q
8
Firm
Q
19
Price increase for the firm because they
are price takers.
Price increases and quantity increases
S1
P
S
P
$20
MC
$20
$15
$15
ATC
MR1=D1
MR=D
D
4000
5000
Industry
Q
8 9
Firm
Q
20
New Long Run Equilibrium at $20 Price
Zero Economic Profit
S1
P
P
$20
MC
$20
ATC
MR1=D1
D
Q
4000
Industry
9
Firm
Q
21
IV. Going from LongRun to Long-Run
22
Currently in Long-Run Equilibrium
If demand increases, what happens in the short-run
and how does it return to the long run?
P
S
P
MC
ATC
MR1=D1
$15
MR=D
$15
D
5000
Industry
Q
8
Firm
Q
23
Demand Increases
The price increases and quantity increases
Profit is made in the short-run
P
S
P
MC
ATC
$20
$20
$15
$15
MR1=D1
MR=D
D1
D
5000
Industry
Q
8 9
Firm
Q
24
Firms enter to earn profit so supply
increases in the industry
Price Returns to $15
S S1
P
P
MC
ATC
$20
$20
$15
$15
MR1=D1
MR=D
D1
D
5000
7000
Industry
Q
8 9
Firm
Q
25
Back to Long-Run Equilibrium
The only thing that changed from long-run to
long-run is quantity in the industry
S1
P
P
MC
ATC
$15
MR=D
$15
D1
D
7000
Industry
Q
8
Firm
Q
26
V. Efficiency
27
PURE COMPETITION AND EFFICIENCY
In general, efficiency is the optimal use of
societies scarce resources
•Perfect Competition forces producers to use
limited resources to their fullest.
•Inefficient firms have higher costs and are
the first to leave the industry.
•Perfectly competitive industries are
extremely efficient
There are two kinds of efficiency:
1. Productive Efficiency
2. Allocative Efficiency
28
Efficiency Revisited
Which points are productively efficient?
Which are allocatively efficient?
14
A
B
Bikes
12
G
10
Productive Efficient
combinations are A through D
(they are produced at the
lowest cost)
Allocative Efficient
combinations depend on
the wants of society
8
C
E
6
4
F
2
D
0
0
2
4
6
8
10
Computers
29
Productive Efficiency
The production of a good in a least
costly way. (Minimum amount of
resources are being used)
Graphically it is where…
Price = Minimum ATC
30
Short-Run
Price
MC
ATC
D=MR
Profit
P
Notice that the product is NOT being made at
the lowest possible cost
(ATC not at lowest point).
Q
Quantity
31
Short-Run
MC
Price
ATC
P
Loss
D=MR
Notice that the product is NOT being made at the lowest possible cost
(ATC not at lowest point).
Q
Quantity
32
Long-Run Equilibrium
Price
MC
ATC
D=MR
P
Notice that the product is being made at
the lowest possible cost (Minimum ATC)
Q
Quantity
33
Allocative Efficiency
Producers are allocating resources to
make the products most wanted by
society.
Graphically it is where…
Price = MC
Why? Price represents the benefit
people get from a product.
34
Long-Run Equilibrium
Price
MC
MR
P
Optimal amount
being produced
The marginal benefit to society (as measured
by the price) equals the marginal cost.
Q
Quantity
35
What if the firm makes 15 units?
Price
MC
MR
The marginal benefit to
society is greater the
marginal cost.
Not enough produced.
Society wants more
$5
$3
15 20
Quantity
Underallocation
of resources
36
What if the firm makes 22 units?
MC
Price
$7
MR
$5
The marginal benefit to society is
less than the marginal cost.
Too much Produced.
Society wants less
20 22
Quantity
Overallocation of
resources
37
Long-Run Equilibrium
Price
MC
ATC
D=MR
P
P = Minimum ATC = MC
EXTREMELY EFFICIENT!!!!
Q
Quantity
38