Download Spring 2016

End of Perfect Competition
Lecture 20
Dr. Jennifer P. Wissink
©2017 John M. Abowd and Jennifer P. Wissink, all rights reserved.
April 17, 2017
i>clicker question
Given the information,
which size plant should
Goldilocks build?
A.
B.
C.
D.
small
Medium
LARGE
Don’t know
atcsmall
atcMedium
atcLARGE
Internal Economies of Scale &
Minimum Efficient Scale

When the lratc curve
is falling it is said to
exhibit internal
economies of scale.

When the lratc curve
is rising it is said to
exhibit internal
diseconomies of
scale.

MES is the smallest
quantity at which the
lratc curve attains its
minimum value.
Internal economies
of scale
q-MES
Internal
diseconomies of
scale
Ford, GM & Long Run Cost
Curves
Internal Economies of Scale &
Minimum Efficient Scale
Long Run ATC Curve in Relationship
to Short Run ATC Curves


When you are optimally
designed, short run and
long run cost values will
coincide.
As you deviate from what
you planned for in the long
run analysis, either
producing more OR less
than you optimally
designed for, your short
run costs will exceed your
long run costs.
$
sratcsmall K
q=35
q=50
q=150
lratc
q in
tons
Rules for Profit () Maximization in the
Long Run (pretty much the same)
 If
q* maximizes  , then
– mr(q*) = lrmc(q*)
–  (q*) is a maximum and not a minimum
– at q* it is worth operating:  at q*  0
 Could
get a long run supply curve for the
firm, but it’s never used, so let’s not and
say we did!
Long Run Equilibrium in
Perfectly Competitive Markets





All the short run equilibrium properties hold.
But also add… no firms wish to exit the market nor do
firms want to enter.
Given: market demand, factor prices and technology
Get: (P*, Q*, q*, N*)
Note: For there to be neither entry or exit, need economic
profit to be zero. This is a long run equilibrium
requirement. Otherwise the number of firms in the market
will still be in flux.
– Short run profit invites entry.
– Short run losses suggest exit.
– If firms ARE NOT identical, then it’s really that the
marginal firm has zero profit.
Long Run Equilibrium Position
with Identical Firms





(1) Each firm is profit maximizing  mr = mc at q* for
each firm.
(2) Zero profit required  P* = lratc at q* for each firm.
(3) Since the firm is perfectly competitive,  P* = mr at all
values of q for the firm.
(4) Using (1) and (3), P* = mc at q*.
(5) Using (2) and (4), mc = lratc at q*.
– Therefore, q* is at the minimum of the typical firm’s lratc curve.
So... q* is at MES.
– P* must be the price consistent with the minimum value on the
typical firm’s lratc curve.
– N* and Q* get determined by position of market demand.
A Long Run Equilibrium Picture
Note: Q* = N* times q*
$
$
lratc
SRS w/N*
P*
A
P*
a
mr=δ
D
Q*
MARKET
Q
q*
typical firm
q
Steps to Draw the Picture?
 Doesn’t
matter how you draw it, as long
as you draw it correctly in the end.
 Draw-a-person tests.
What’s Not OK...
Long Run Market Supply in
Perfect Competition

The long run market supply curve measures the
quantities of a good or service offered for sale by
all sellers--potential and actual--who could sell in
the market.

The long run market supply curve represents the
market relationship between P* and Q* when the
market is in long run equilibrium.
Finding the Long Run Market
Supply Curve (with identical firms)
THE MARKET
a typical firm
$
$
lratc
600
SRS0 w/N0*
P0*
A
P0*
a
mr0=δ0
DN
D0
Q0*
300,000
Note: Q0* = N0* times q0*
Q
q0*
500
q
Long Run Market Supply in a
Perfectly Competitive Market



If input prices and/or
technology does NOT
change when firms enter
and exit the market, then
the LRSMARKET is
horizontal at the
“normal” long run
competitive price.
At prices above P*
incumbent firms are
making positive
economic profit and
there will be entry.
At prices below P*
incumbent firms are
incurring losses and
there will be exit.
$
P*
LRSMARKET
Q
Long Run Market Supply in a
Perfectly Competitive Market



Both points A and C
in the previous picture
are long run
equilibrium points.
Point B is a temporary
short run equilibrium
point.
If you connect all
points like A and C
you get the market
long run supply curve
in a perfectly
competitive market.
SRS w/N*
B
P’
P*
SRS
w/N**
A
C
LRS
LRS
Dnew
Dold
Q*
Q’
Q** Q
Long Run Market Supply in a
Perfectly Competitive Market




The long run supply
curve in the market is
horizontal at the long run
equilibrium price P*.
P* is sometimes called
the “normal price.”
P* is the price consistent
with the typical firm’s
minimum long run
average total cost.
Note: important
assumption is that the
position of the firm’s cost
curve is unaffected by
entry (or exit) of firms in
the market.
$
SRS w/N*
SRSw/N**
B
P’
P**=P*
A
C
LRS
LRS
Dnew
Dold
Q*
Q’
Q**
Q
External Economies and
External Diseconomies

If the industry exhibits no external economies or diseconomies, then
the industry long run supply curve is perfectly elastic (horizontal).
– The industry grows by replicating firms at the efficient scale. Entry and exit leaves
the position of cost curves intact. This is often called a constant cost industry.

If the industry exhibits external diseconomies, then the industry long
run supply curve is upward sloping.
– The minimum average total cost of all firms in the industry rises as the size of the
market grows (and falls as it contracts). This is often called an increasing cost
industry.

If the industry exhibits external economies, then the industry long run
supply curve is downward sloping.
– The minimum average total cost falls as the size of the industry grows (and rises as
it contracts). This is often called a decreasing cost industry.

Note the difference between EXTERNAL economies/diseconomies
and INTERNAL economies/diseconomies of scale
Long Run Market Supply with
External Diseconomies
$
SRSold
SRSnew
B
C
A
Dnew
Dold
Q
LRS
Long Run Perfectly Competitive
Equilibrium - Performance
 Two
Efficiency Definitions
– The market equilibrium quantity traded (Q) is
Pareto/Allocatively Efficient(AE)
if net social surplus in the market is maximized.
– The firm is productively efficient(pe) if its output
level (q) is such that the firm’s long-run average
total costs are minimized.
 Question:
Do we get either... or both...
under perfect competition?
Answer: 1st Fundamental Theorem
of Welfare Economics In Pictures
a typical firm
THE MARKET
$
$
lratc
SRS w/N*
A
P*
P*
a
mr=δ
D
Q*
Q
q*
q
Long Run Perfectly Competitive
Equilibrium - Performance
Equity:
Is the outcome of the
competitive process fair? Equitable?
Just?
– Good questions that we do not answer
here and now.
RECALL…Various Market Structures
Next Batter Up = Monopoly

Perfectly Competitive:
–
–
–
–

many firms
identical products
free entry and exit
full and symmetric information
Monopoly:
– single firm
– no close substitutes, only
imperfect substitutes in related
markets
– barriers to entry and possibly
exit
– full and symmetric information,
or possibly not
Sources of Monopoly Entry
Barriers

Technical:
– Natural monopoly
– Vital input ownership
– Technical secrets
(the better
mousetrap)

Legal:
– Patents
– Franchises
– Licenses

Strategic:
– Buy ‘em up
– Blow ‘em up
– Let’s make a deal