Download Chapter 11 Economic Change in a Competitive Industry in the

February 15, 2003
Chapter 11
Economic Change in a Competitive Industry
in the Entrepreneurless Economy
The goal of this chapter is to show how to use the theory of demand and supply for the entrepreneurless
economy to represent change. To represent a change and its effects, we begin by assuming that there is a
general economic equilibrium, as described at the end of Chapter Nine. Then we introduce some change,
such as a change in preferences or in the cond itions of supply. Nex t we trace the effects of the change. W e
do this by first showing how the change affects the demand and/or cost curves and then showing the short
run and long run adjustm ents to the change. In this chapter, we present two examples: a change in
preferences (part 1) and an innovation in technology (part 2).
1. THE EFFECTS OF A CHANGE IN PREFERENCES
The effects of a change can be divided into two classes: market effects and welfare effects. M arket effects
consist of (1) the change in prices and quantities of the various goods and (2) the change in the industry
structure (e.g., the number of firms in the various industries). W elfare effects consist of changes in w ell
being, as measured in money, of the various roles represented in the model. We begin by discussing the
market effects. Then w e turn to the welfare effects.
Market Effects
We described the long-run equilibrium for a competitive industry at the end of Chapter Ten. W e use this
as the starting point in figure 11-1 below. An increase in industry demand is represented by a rise in the
industry demand curve from D to D h in the right panel.
The Lon g-Run and Short-Run Industry Supply Curves
Before we can continue, we must distinguish between two kinds of industry supply curves: the long-run
curve and the short-run curve. The long-run industry supply curve shows the quantities of a good that all
firms together would supply at each price, given that new plant capital can be produced and that old plant
capital can be com pletely used up. The assumption that capital can be produced means that all of the firms
that want to enter or leave the industry can do so. The sh ort-run supply curve shows the quantities that all
firms together would supply at each price, given that new plant capital cannot be produced and, therefore,
that no new firms can enter an industry.
From a Change in Preferences to Changes in Demand
Preferences refer to consumer wants. In the model of the entrepreneurless economy, they are represented
by a shift of the industry demand curve. For example, we might assume that consumer preferences shift
so that consumers demand more vegetables and less meat at each price. Because wants are relative, an
increase in demand for one type of good must always be offset by a decrease in demand for at least one
other type of good.
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Figure 11-1
INCREASE IN INDUSTRY DEMAND
Figure 11-2
SHORT-RUN INDUSTRY EQUILIBRIUM
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Economic Change in a Competitive Industry in the No Entrepreneur Economy (11)
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In order to be brief in this chapter, we will examine in detail only the effects on an industry in which there
is an increase in demand. T he reader is advised to add to this by building a m odel of an industry in which
there is a decrease in demand. Such a model is the mirror image of the one presented here.
Equilibrium means that all existing firms have fully adjusted their choice of output to the behavior of the
other firms in an effort to maximize surplus or minimize the deficit. In short-run equilibrium, we assume
that they have adjusted only by increasing or decreasing their output; in long-run equilibrium, we assume
that they may have adjusted by changing their plant capital also.
Figure 11-2 contains two ind ustry demand curves, D 1 and D 2 , and two industry supply curves, SS and
LS. We begin by assuming that the industry is in both short run and long equilibrium. This is given at point
e, where both the SS and LS curve intersect the D1 curve. An increase in industry demand is represented
by a shift from the D 1 to the D 2 curve. The problem we face in this part is to show the effects of this change
in the short run and in the long run.
The technique of using both short and long run supply curves on the same graph enables us to represent
a two-stage adjustment to a change in demand or supply: (1) a short-run adjustment and (2) a long-run
adjustment. Our demonstration takes the following form. We begin by assuming a long-run equilibrium
price, quantity, con sumers’ surplus and economic rent. Then we introduce a change in industry demand
or supply. We go on to identify, in turn, both a short-run equilibrium and the new long-run equilibrium.
The Short-Run Adjustment to an Increase in Demand
We use the short-run industry supply to help us determine how much the price and quantity of the
consum ers’ good will rise in the short run as a result of the change in demand. Look at the right panel of
figure 11-3. Starting w ith a price of p 1 , the increase in demand causes a temporary shortage of Q d - Q 1 .
Firms respond to the shortage by raising price. How much will they be able to raise price? In order to find
out the short-run industry eq uilibrium price, we must find the intersection of the new industry demand
curve, D 2 , and the short-run industry supply curve. This is given at the price p2 and quantity Q 2 .
Now consider the effect on the firm's choice of output. This is shown in the left panel of figure 11-3. As
the price rises in the industry, the price also rises for each firm. The higher short-run equilibrium price
faced by the firm is shown in the left panel by an upward shift of the firm’s demand curve from D 1 to D 2 .
Assuming that there is no effect on costs, the rising price changes the surplus maximizing output from q1
to q 2 , where the new demand line faced by the firm crosses the marginal cost line. The rising price creates
a gap between the price and average total cost, enabling the firm to earn surplus.
The Long Run Adjustment to an Increase in Demand
W e now turn to the long-run adjustm ent. T he short-run equilibrium su rplus earned by firms in this
industry implies that there are deficits in other industries. If firms elsewhere shift into this industry, they
can earn a surplus. By definition, in the long-run, firms enter the surplus earning industry until the surplus
is driven down to zero. As new firms enter, the industry short run supply curve shifts out to the right. This
is because each new entrant adds a marginal cost curve to the ex isting curves. In the right panel of figure
11-4, new firms continue to enter. This causes the supply curve, SS 1 , to shift to the right. With the increase
in short-run industry su pply, price must fall. Otherwise, there would be a surplus of the good in the
industry. The price falls until the money surplus earned by the firm is driven back to zero. The long-run
industry equilibrium situation is shown in the right panel of figure 11-4, where we see that the initial SS
curve (SS1 ) has shifted to the right until it ultimately equals the intersection of the new demand curve and
the long run supply curve (SS 2 = LS = D 2 ). The long-run equilibrium price is p 3 and the long-run
equilibrium quantity for the industry is Q 3 . Notice in the left panel that the mc and ac curves have shifted
upward from ac 1 and mc 1 to ac3 and mc 3 . This reflects the higher costs due to the entry of new firms.
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Figure 11-4
LONG-RUN INDUSTRY EQUILIBRIUM
We have assumed that the change in costs leads the firm to prod uce the same quantity as before the
change. This assumption is made for the sake of convenience. We also assume that the industry is an
increasing cost industry. We can explain this by assuming that as new firms enter, their competition for
resources causes existing firms' costs to rise. The long run industry supply curve is upsloping. We could
have assumed a decreasing cost industry or a constant cost industry. In a decreasing cost industry, the ac 3
curve would lie below the ac1 curve and the LS curve would be downsloping. In a constant cost industry,
the ac3 curve would be the same as the ac1 curve and the LS curve would be a horizontal line.
Other Industries
In our discussion, we represented the effects of an increase in demand. In at least one other industry, there
would be a decrease in demand. To complete our analysis, we should represent that also. We should show
how this change leads firms to face deficits in the short run, which would lead some of them to leave the
industry in the long run. As firms left, the dem and curve faced by each remaining firm would shift up and,
assuming an increasing cost industry, the cost curves would shift down. In the industry, the exit of firms
would lead the short-run industry supply curve to shift back to the left. The end result would again be a
zero money surplus model of the firm and an industry model in which the new demand equals the long-run
supply and the short-run supply. To show this in figure 11-4, we would only have to change the labels on
the curves.
Welfare Effects of the Increase in Demand
In order to find the welfare effects, w e must consider changes in the well being, as m easured in m oney,
of three roles: producers (firms), consumers, and suppliers of the specialized resources. In Chapter Nine,
we showed how consum ers benefit from exchange. They receive consumers’ surplus. We can determine
the effects of an increase in demand on consum ers by comparing the consumers’ surplus before and after
the increase. Finding the benefits to producers and the owners of resources is more complicated. Th e first
step is to distinguish between short run and long run gains. In the short run model, firms can earn surplus
Economic Change in a Competitive Industry in the No Entrepreneur Economy (11)
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and incur deficits. We can regard the surplus (deficit) as a gain (deficit) to producers. However, we have
seen that in the long run, econom ic surplus is zero. Therefore producers’ surplus m ust be zero in the long
run.
Ordinarily, when econ omists measure the welfare effects of a change, they are interested in long run
effects. As a result, they disregard any short run surplus or deficits to producers on the grounds that they
are temporary. Instead, they assume that all surpluses go to the owners of specialized resources. Following
this convention, we assume that all of what we called “suppliers’ gain” in Chapter Nine consists of surplus
to owners of specialized resources. W e call this surplus economic rent. Economic rent refers to the surplus
that owners of specialized resources receive, after deducting opportunity costs, because producers have
a derived demand for their services. We now discuss this concept in greater detail.
Economic Rent
To elucidate the concept of econ omic rent, imagine an economy in which there are only two extreme
classes of resources: purely specialized resources and purely non-specific resource. We defined these
resources in Chapter Nine. We illustrate economic rent by referring to figure 11-5. If the demand for the
good prod uced with your specialized resource is low, then the demand for your resource will also be low.
The amoun t of money that is paid to all of the owners of that resource will be low. In the graph, if demand
for the good is D 1 , the total economic rent received by all of owners of the specialized resources is only
efg. If the demand for the good is a higher D 2 , total economic rent is a higher cdg. If the demand is higher
still, at D 3 , total economic rent is abg.
The typical good is produced with many types of resources of varying degrees of specialization. This
simple model helps us see that the more specialized resources receive increases in economic rent when
there is an increase in market demand. Of course, they are also exposed to decreases in economic rent if
there is a fall in market demand. Moreover, if a resource can be produced, like plant capital can be; when
the economic rent rises high enough, copies of the resource will be made and the owners of specialized
resources will face greater competition.
Figure 11-5
ECONOMIC RENT
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The Ricardian Theory of Land Rent
In the last subsection, we described the idea that the rent on a specialized resource that is limited in
sup ply rises as more of it is em ployed. This idea was first described by the classical economist David
Ricardo in the early part of the 18 th century. He presented a simple model like that of figure 11-6. In that
model, we assume that the amount of land is fixed at L. If the demand for that land is D 1 , its equilibrium
price is a low P1 . If the dem and is D 2 , equilibrium price is P 2 , and so on. Suppose that you lived for many
years in a growing city. If you owned land in the city, you would realize that as the popu lation and wealth
of the city increased, the dem and for land w ould also increase. The price of your land would rise to many
times its original price.
Ricardo extended this analysis by distinguishing between land of different degrees of fertility. He argued
that as the demand for farm land increased, less and less fertile land would be settled and brou ght into use
to prod uce food. As this happened the rent on the more fertile land would rise. This theory is called the
theory of differential rent. It maintains that, other things equal, superior resources of a specialized type are
used first. As demand for the resources increases, (1) resources that are less superior are brought into use
and (2) the more superior resources earn a rent that is higher than the less superior ones. The land at the
margin – or marginal land – is less fertile than all of the other land. Its price would be zero, whild all of
the other land would have a positive price.
The demand for a resource is sometimes called a derived demand. The demand is derived from the
demand for consumers’ goods in the sense that if the demand for consumers’ goods rises, firms increase
their demands for resources. Thus a higher price in an industry is follow ed by higher prices in the markets
for the specialized resources necessary to produce the good.
Figure 11-6
DEMAND AN D LAND PRICES
The Surplus from Exchange in Long-Run Equilibrium
Recalling the idea of consumers’ surplus, we are now in a position to show, step-by-step the long-run
equilibrium gains from exchange to the consumer and resource owner role. Refer to figure 11-7, which
Economic Change in a Competitive Industry in the No Entrepreneur Economy (11)
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shows a supply curve and demand curve in the A industry. Consider the first unit q 1 . Suppose for some
reason that firms decided to produce only one unit and that the unit is produced by the lowest-cost firm.
Then, in a competitive market for resources, the money a firm would have to pay for the specialized
resources needed to supply the first unit would be as low as possible, at mr. If that unit was given for free
to the consumer who is willing to pay the highest price for it, the total consumer surplus in terms of money
would be br. It follows that the net surplus would be bm. The distance mr represents the opportunity cost
to the suppliers of the specialized resources. T his is the money that they could earn if their resources were
used to produce some other good. Sup pose that the consum er must pay a price of p. Then his surp lus
would be be. If we assume that firms earn no surplus, then the money, em, would go to the owners of the
specialized resources in the form of econ omic rent.
Now suppose, in addition, that the second unit, q 2 , is also produced at the lowest cost by the lowest cost
producer and given for free to the consumer who is willing to pay the highest price for it. The net surplus
from the second unit is ck. If the price is p, the consumer who buys the secon d unit gains cf, while the
owners of the specialized resources needed to produce it receive a gain fk. The opportunity cost of
supplying the second unit is kt. The surplus from the third unit is dh.
The consu mer of the second unit receives less surplus than the consumer of the first unit because he
values it less yet must pay the same price. The owners of specialized resources needed to produce the
second unit also receive less surplus than the owners of the resources needed to produce the first unit. The
reason for this is that their opportunity cost is higher. The higher opportunity cost may be due to the lower
productivity of the resources that are used to produce the second unit of the good. For example, the
resources might be inferior grade rice land. A ssum ing that all grades of rice land have the same alternative
use value, lower-grade land would be used only after the superior land. B ecause superior land is m ore
productive, less of it would be needed and rice growers would bid the price per hectare higher than inferior
land with the same alternative use. Thus the owner of the superior land would receive higher rent than the
owner of the inferior land.
Figure 11-7
LONG RUN SURPLUS FROM EXCHANGE
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Assuming that the market for good A is in equilibrium, the price would be p and the quantity of the good
exchanged would be q. Th e surplus to consumers, or consum ers’ surplus, would be apg. The economic
rent would be pgn.
Classifying the Welfare Effects of an Increase in Demand
We now show the long-run welfare effects of an increase in demand. We do this by com parin g
consum ers’ surplus and economic rent of the industry in long-run equilibrium before the increase in
demand with consumers' surplus and economic rent afterwards. Con sider figure 11-8. Consumers' surplus
has risen from def to abc. Because abc is greater than def, consumers, taken as a whole, have gained in
term s of m oney.
Some consum ers are likely to lose as a result of the higher demand. You can see this by putting yourself
in the shoes of an original demander before the increase in demand. Sup pose that the increase in demand
is due to the other people deciding that this product yields more utility than previously. You, however,
experience no change in your demand. Since the increase in demand drives up the price from p 1 to p2 , you
may decide to shift some of your purchases to some other good. U nless there is a corresponding fall in the
prices of the other goods you buy, you will be a loser. In this kin d of m odel, there is likely to be a fall in
the prices of other goods, since the shift of firms from other industries into this one will have reduced
specialized resource prices in those industries. If we just consider the industry in question, how ever, it is
clear that you lose because of the higher price.
Figure 11-8
WELFARE EFFECTS OF AN INCREASE IN DEMAND
Economic Change in a Competitive Industry in the No Entrepreneur Economy (11)
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Figure 11-9
WELFA RE EFFEC TS OF AN INCREASE IN DEMAND (2)
Now consider the owners of specialized resources. Before the increase in demand they received a total
of efg in economic rent. In the new long-run equilibrium, they receive bcg. They have gained bcef, as
shown by the shad ed area in figure 11-8. The total gain in consumers’ and resource suppliers’ surplus
(economic rent) is aced.
It is possible, though unlikely, that the new consumers’ surplus after a change in demand would be less
than the old consumers’ surplus. Suppose that the new demand curve has a shap e like that drawn in figure
11-9. The consum ers’s surplus after the increase in deman d, abc, wou ld be less than the area of consumers’
surplus before the increase in dem and, def.
2. THE EFFECTS OF INNOVATION
There are two types of innovation: (1) the discovery and use of a new and superior good and (2) the
discovery and use of a new and superior method of production. The models we have been using are mainly
useful for discussing the second type, since they assume that the number of goods in an economy is fixed.
So we shall restrict our discussion to this type. We first describe the market effects and then the welfare
effects.
Market Effects
Suppose that a firm discovers a new and superior method of production. Immediately after its discovery,
its cost curves shift downw ard. For simplicity, suppose that they shift in a way that is shown in figure 1110. The average and marginal cost curves shift from ac1 and mc 1 , respectively, to ac 2 and mc 2 . This means
that the innovating firm w ill want to sell a larger quantity than before and that it can earn a surplus by
doing so. In the example, the firm maximizes surplus by increasing output to q 2 . Its surplus is abdc (total
10 Knowledge and Entrepreneurship (11)
revenue abe0 - total cost cde0). Although it increases output, we assume that the firm is so small that its
greater output has no effect on industry price.
Some innovations of this type could be copied by other firms in the industry, even in the short run.
However, to simplify our analysis, we assume that copying requires the production of new plant capital,
which cannot occur in the short run. In the long run, the methods of production will be copied by the
existing firm s in the industry and by outsiders w ho enter the industry.
In the long ru n, the plant capital needed for copying can be produced. The copying reduces surp lus to
the innovators in two ways. First, the increase in industry supply causes the market price to fall, thus
reducing the revenue to the innovating producer. This is represented by a downward shift of the demand
curve faced by the firm. In the left panel of figure 11-11, it shifts down from D 1 to D 2 . Second, the
increased bids by copiers for the resources that are specialized in using the new method of production raise
the costs of production to each firm. This is shown on the same panel of figure 11-11 by an upward shift
of the cost curves from ac2 and mc 2 to ac 3 and mc 3 . In our example, the innovator’s money surplus returns
to zero and he produces the same output as before.
Let us summarize the market effects from the innovating firm’s point of view. At first, the innovation
enables the firm to earn short run surplus. In the long run, new plant capital is produced and new firms
enter the industry. As this occurs, the firm's demand falls and costs rise. This is due to the competition that
results from copying by existing firms and the entry of new firms. The increased competition bids down
the price of the good and it bids up the p rice of the specialized resources. The end result is that the
innovating firm is no better off in the long run than it was in the first place. In the new long run
equilibrium, it makes zero surplus.
Now let us look at this sequence of events from the stand point of the industry in the long run. The
innovation, combined with its later adoption by all firms, causes the long run supply curve to shift out from
LS 1 to LS 2, as shown in the right panel of figure 11-11. This causes the long-run equilibrium price in the
industry to fall from p 1 to p2 .
Economic Change in a Competitive Industry in the No Entrepreneur Economy (11)
Figure 11-10
SURPLUS-MAXIMIZING POSITION OF AN INNOVATING FIRM
Figure 11-11
LONG RUN EQUILIBRIUM AFTER AN INNOVATION
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In the example, we have assumed that the new long-run surplus maximizing quantity for the firm is the
same as the old long-run surplus maximizing quantity. This need not be the case. However, if we make
this assumption, then there will be more firms in the industry after the adjustment to the innovation. W e
know this because the quantity produced by all firms together is high er (Q 2 > Q 1 ), yet the quantity
produced by each firm (q 1 ) is the same as before.
Welfare Effects
Most of the short run gains from a successful innovation go to the innovating firm in the form of higher
surplus. The innovatin g firm may also em ploy additional specialized resources, thereby benefitting their
owners, although it is also possible that the innovation will reduce the demand for resources (or for some
kinds of resources). All discoveries of a new and superior method of production save on resources needed
to produce a given quantity of the good. Thus an innovation reduces the demand for the resources needed
to prod uce a given ou tput. H owever, the amount of output produced in the industry rises. Whether
suppliers of specialized resources in this industry gain in the short run depends on whether the reduced
demand for specialized resources due to the innovation offsets the increased demand for resources due to
the desire to produce a higher output. If it does, then the suppliers of specialized resources, as a group,
lose. If it does not, they gain.
Figure 11-12
LONG-RUN GAINS DUE TO INNOVATION
It is also possible that an innovation in the production of a good will make a resource ob solete with
respect to producing that good. If this happens, suppliers of the obsolete resource will lose the opportunity
to earn economic rent in the innovating industry. If the owner of such a resource has no other rent-earning
possibilities, the resource will become a non-resource.
Now consider the long-run. No firms, including the innovating firm, make surplus in the long-run. If the
innovator does not gain in the long run from the technological change he causes, who does? Figure 11-12
shows part of the answer. The technological change shifts the long-run supply from LS 1 to LS 2 . First
Economic Change in a Competitive Industry in the No Entrepreneur Economy (11)
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consider the increase in consum ers' surplus. Because consumers buy the larger quantity q 2 at the lower
price p2 , they gain a surplus of bcfd. Thus consumers definitely gain.
The graph shows an additional change. The economic rent changes from bcg to dfh. There is a gain of
gefh but a loss of bced. It is not evident w hich is larger. W e could draw a set of demand and supply curves
for which the gain in economic rent would be greater than the loss. But we could also draw a set for which
the surplus would be less than the loss. Thinking of the resources as a whole, we simp ly cann ot be certain
whether individuals in their role as owners of specialized resources will gain in the long run.
In the long run, the benefits from an innovation are received not by the innovator or by copiers but by
consu mers and possibly by some suppliers of specialized resources. The additional surplus, whether it is
consumers' surplus or rent to specialized resources, is gcfh. Thus, we say that innovation benefits either
the innovator and possibly the owners of certain specialized resources in the short-run. In the long-run, the
innovation benefits consumers and possibly the suppliers of some specialized resources. Although we
cannot be certain about the change in econom ic rent, there is no doubt that the innovation raises the sum
of the consumers’ surplus and economic rent.
3. SIGNALING AND CONSUMER SOVEREIGNTY
Signaling
Having completed our presentation of the short run-long run model, we now return to the issue of how
the model is useful. In C hapter Ten, we pointed out that on e use of the model is to help us id entify and
describe an economy-wide signaling function of prices. Consider first the signaling that occurs as a result
of the increase in demand. The change in dem and leads surplus-maximizing firms to change their bids for
resources. In the short run, the changes in bids signal owners to shift their variable resources into the
industry. The changes also signal the producers to shift resources into the production of plant capital for
the exp and ing industry an d aw ay from the typical other industry. In the long ru n, new plant capital is
produced and firms enter the industry. The entry decreases industry price. This decrease signals firms
already in the industry to reduce output by hiring fewer variable resources. It also signals outside firms to
stop entering.
Now consider signaling in the model of a change in technology. The su rplus that can be earned by a firm
that copies the new, lower cost method s of produ ction acts as a signal to firms in the industry an d to
outsiders to bid for some resources and plant capital to take advantage of the new methods. Their bids
signal the producers of plant capital to shift their resources toward the production of the kind of plant
capital that will enable the firms to adopt the new methods and away from the typical other kinds of plant
capital. As firms copy the technology, they bid up the prices of the resources needed to take advantage of
the new method s and they bid down the prices of the product. Both of these factors squeeze the surplus
to zero, thereb y sending a signal to outsiders to stop entering the industry.
Consumer Sovereignty
The model also helps us demon strate consu mer sovereignty. Con sumer sovereignty refers to the idea that
all choices in the market economy are carried out with the goal of producing goods for consum ers.
Choices are not made according to the directions of a central planner, or individual sovereign (king).
Consumers, as a group, are the sovereigns. In the model of an increase in industry demand, firms and
resource suppliers respond instantly to changes in consumer demand by causing resources to be shifted into
those industries where consumer demand has risen and out of those industries where demand has fallen.
And they cause new plant capital to be produced as soon as possible in order to take advantage of surplusearning opportunities. The result is that the initially high price to consumers falls to one that is as low as
possible, given that firms need a normal surplus to continue to operate and that resources have to be paid
amoun ts at least equal their opp ortunity costs to keep them in their current uses. Comp eting firms singlemindedly aim to maximize surplus and they can do so only by catering to every change in consumer
demand that is expressed.
14 Knowledge and Entrepreneurship (11)
Sim ilarly, competing firms and own ers of capital-producing resources respond to an improvement in
technology by causing reduced prices of the consumers’ goods produced with that technology. In the long
run, they cause plant capital to be produced to take advantage of the new techn ology. Th e result, as we
have seen, is that the main beneficiaries of a technological improvement are the consumers.
Consum er sovereignty does not mean that every consumer gains from every change in the market
economy. Like firms that compete for customers, consumers compete for goods. Some gain and some lose,
depending on how the prices of the goods they are inclined to bu y change. However, the model of a
competitive industry in an entrepreneurless economy enables us to show how consum ers, in general, gain
from competition among the surplus-maximizing suppliers of goods and resources.
Chapter 11
1. Define economic rent, purely specialized resource, non-specific resource, derived demand, consumer
sovereignty.
2. Assume a long run equilibrium in a competitive industry in the entrepreneurless economy. Draw the
equilibrium of the indu stry and firm side by side in two panels. Show how a decrease in industry
demand affects the firm in the short run. Be sure to explain your graph in words. Make sure that the
graphs for the firm are consistent with th e graph s for the industry.
3. Assume a long run equilibrium in a competitive industry in the entrepreneurless economy. Draw the
equilibrium of the industry and firm side by side in two panels. Show how an increase in industry
demand affects the firm in the short run. Be sure to explain your graph in words. Make sure that the
graphs for the firm are consistent with th e graph s for the industry.
4. Assume a long run equilibrium in a competitive industry in the entrepreneurless economy. Draw the
equilibrium of the industry and firm side by side in two panels. Show how an increase in industry
demand affects the firm in the long run. Be sure to explain your graph in words. Make sure that the
graphs for the firm are consistent with th e graph s for the industry.
5. Assume a long run equilibrium in a com petitive industry in the entrepreneurless economy. Draw the
equilibrium of the industry and firm side by side in two panels. Show how a decrease in industry
demand affects the firm in the long run . Be sure to explain your graph in words. Make sure that the
graphs for the firm are consistent with th e graph s for the industry.
6. In building the model of the surplus from exchange in long run equilibrium, we say that the owners of
the specialized resources needed to produce the second unit of a good receive less economic rent that
the owners of the resources needed to prod uce the first unit. What basis do we have for concluding this?
7. Describe the Ricardian theory of d ifferential rent.
8. Use a graph to show that the price of a purely specialized resource depends entirely on the height of
the demand for that resource. You may wish to use the example of land. Explain your graph in words.
9. Show graphically and describe in words the welfare effects of an increase in demand.
10. Show graphically and describe in words the welfare effects of a decrease in demand.
11. Show graphically and tell in words the m arket effects of an innovation. In other words show an d tell
the effects (1) on industry price and quantity and (2) on price, quantity, costs and revenues of the
innovating firm. A sensible approach would be to draw a graph containing two panels – one of the
firm and one of the industry.
12. Show graphically and tell in words the welfare effects of an innovation. In other words show an d tell
the effects on consumers’ surp lus and economic rent in the industry.
13. Our model of the effects of a change in demand in a competitive industry helps us demonstrate the
signaling function of prices. Explain. (In your explanation, you should begin by defining the signaling
function of prices.)
14. Our model of the effects of a change in dem and in a comp etitive industry helps us demonstrate
consumer sovereignty. Explain. (In your explanation, you should begin by defining consumer
sovereignty.)
Economic Change in a Competitive Industry in the No Entrepreneur Economy (11)
Gunning’s Address
J. Patrick Gunning
Professor of E cono mics/ College of B usiness
Feng C hia University
100 Wenhw a Rd, Taichung
Taiwan, R.O.C.
Please send feedba ck
Email: gunning@ fcu.edu.tw
Go to Pat Gunn ing's Pages
M irror Site of Pat Gunning's Pages
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