Download chapter 10 - Oregon State University

LONG RUN
A period of time over which the number of firms in an industry
can change their production facilities. In the long run, firms
can enter or leave an industry, and existing firms can modify
their facilities or build new facilities.
• The time required for a firm to build a production facility and
start producing output.
• The long run varies across industries.
LONG-RUN SUPPLY CURVE
• Shows the relationship between
price and quantity supplied over
a period of time long enough
that firms can enter or leave the
market and firms can modify
their production facilities.
Chair Industry Output and
Average Production Cost
Number Industry
of firms Output
25
50
75
500
1,000
1,500
Chairs
per
Firm
20
20
20
Total
Cost for
Firm
$400
$480
$560
Average
Cost Per
Chair
$20
$24
$28
The average cost of chair industry
increases as the industry grows for
two reasons:
Reasons Average Cost
Grows As Industry Grows
• Increasing Input Prices
As an industry grows, it competes with other
industries for limited amounts of various inputs;
this competition drives up the prices of these
inputs.
• Less Productive Inputs
A small industry only uses the most productive
inputs, but as the industry grows, firms may be
forced to use less productive inputs.
Drawing the long-run supply
curve
Market
Price
Initial
Short-Run
Supply
Firm
SMC
New 9.0
0
Short-Run
9.00
MR2
SATC2
Profit
Supply
6.00
5.00
SATC1
MR3
6.00
5.00
Long-Run
Supply
MR1
New
Demand
Initial
Demand
10
14
22
Quantity (thousands)
10 11 14
Quantity
The Long-Run Market
Supply Curve
• How much output produced at each
price.
• Determine the total output of the
industry by multiplying the output per
firm by the number of firms in the
industry.
Determining Number of
Firms in an Industry
• Whenever opportunity to make profit price exceeds average cost - firms enter
market.
• Firms continue to enter until economic
profit is zero.
• To find number of firms in the market,
find the quantity of chairs at which
average cost equals market price.
The Long-Run Market Supply
Curve
28
Price
of 24
Chairs
20
$
i
h
e
500
1,000
Chairs Per Hour
1,500
The Long-Run Supply Curve
The preceding long-run supply curve:
• Is positively sloped.
• The higher the price of chairs, the larger
the quantity supplied.
• An increase in the price of chairs makes
chair production more profitable, so
• firms enter the market,
• increasing the total output of the
industry.
Increasing-Cost Industry
An industry with a positively-sloped long-run
supply curve.
• Indicates average cost of production increases
as industry grows.
• Supply curve will be relatively steep if average
cost increases rapidly as industry grows.
• With rapidly increasing average cost, a
relatively large increase in price is needed to
get firms to produce more output.
The Long-Run Market Supply Curve For
a
Constant-Cost
Industry
Price
of
Taxi
Service
$
per mile
TAXI
TAXI
TAXI
3
Long-Run Supply Curve
1,000
2,000
Miles of Taxi Service Per Hour
Constant-Cost Industries
An industry with a horizontal long-run supply
curve.
• Indicates average cost of production is
constant.
• It can continue to buy inputs at the same
prices, and these inputs are as productive as
inputs in the smaller industry.
• Industry must be small part of relative input
markets: industry does not affect the prices of
inputs.
Decreasing-Cost Industry
An industry with a negatively-sloped long-run
supply curve.
• The average cost of production decreases
as the industry expands.
Short-Run versus Long-Run
Supply Curves
• Long-run response to change in price is much
greater than short-run response.
• The long-run supply curve is much flatter than
the short run curve, meaning that the quantity
of chairs increases by a larger amount in the
long run.
• The short-run supply curve is much steeper
than the long-run supply curve because there
are diminishing returns in the short run.
Long-Run versus Short-Run Market Supply
Long-Run
Curve
Supply
Short-Run Supply Curve
Price 28
of
Chairs 24
$
PRICE
$24 $28
SHORT RUN
# of Firms
50
50
Chairs by 1 firm
20
22
Chairs by all firms 1,000 1,100
LONG RUN
# of Firms
50
75
Chairs by 1 firm
20
20
Chairs by all firms 1,000 1,500
j
Curve
i
h
1,000 1,100
Chairs Per Hour
1,500
Long-Run versus Short-Run Market
Supply Curve
•
•
•
•
•
Price elasticity of supply measures difference
between short-run and long-run responses to
change in price:
Change in price = 16.67% = 4/24
Short-run change in quantity = 10% = 100/1000
Short-run price elasticity of supply = 0.60
Long-run change in quantity = 50% = 500/1000
Long-run price elasticity of supply = 3.00
Effects of Increased Demand
• Increased demand results in rightward shift in
demand curve, causing a shortage at the original
price: quantity demand exceeds quantity supplied at
the original price.
In Short Run
• The number of firms is fixed,
• Supply curve is relatively steep,
• Price increases by large amount,
In Long Run
• Firms can enter market,
• Supply curve is relatively flat,
• Price increases by small amount .
Short-Run and Long-Run Effects of an
Increased Demand for Video Rentals
Price of
Video Rentals
$ Per Night
6.00
s
Initial
Demand
2.15
2.00
Short-Run
Supply
New
Demand
f
i
Long-Run Supply
Price Quantity
$2.00 10
Short Run
$6.00
Change
14
Long Run $2.15
Change
22
10
14
22
Quantity: Thousands of Video Rentals per Day
Relationship between longrun and short-run cost
curves
Dollars per unit
SATC1
SATC2
SMC1
SATC3
Long-run
average
cost (LAC)
11
10
100
150
Units of output
300
Relationship between LAC
and LMC
• Long-run marginal cost is the change in
total cost resulting from producing an
extra unit of output in the long-run.
• When LAC is downward-sloping, LMC
must lie below LAC.
• When LAC is horizontal, LMC and LAC
are equal.
Dollars per unit
Relationship between longrun and short-run cost
curves
Long-run
average
cost (LAC)
10
Long-run
marginal
cost (LMC)
100
150
Units of output
300
MONOPOLY
An industry served by a single firm.
Occurs when some barrier to entry exists, preventing other firms from
entering the market.
• PATENT -Granted by the government, giving an inventor exclusive right to sell a
new product for some period of time.
• Government implicitly grants monopoly power.
For example, government permits major league baseball to restrict the
number and location of teams.
BARRIERS TO ENTRY
•
FRANCHISE or LICENSING SCHEME -Government designates single firm to sell a particular good:
• Off-street parking;
• National Park Food Concessions;
• Radio and TV FCC licensing.
• NATURAL MONOPOLY -Economies of Scale
Single firm would be profitable; a pair of firms would lose money;
Second firm would make price less than average cost.
THE MONOPOLIST’S OUTPUT
DECISION
How much output to produce at what price.
Objective is to maximize profits:
The difference between total revenue and total
cost.
TOTAL AND MARGINAL
REVENUE
• Total Revenue --Price times the quantity sold.
• Marginal Revenue --The change in total revenue that results
from selling one more unit of output.
PRICE QUANTITY
SOLD
$16
0
TOTAL REVENUE
$35
$30
$25
$20
$15
$10
$5
$14
1
$12
2
$10
3
$0
1
2
3
4
QUANTITY SOLD
5
6
$14
MARGINAL REVENUE
$12
$8
$10
4
QUANTITY SOLD
$8
$6
$4
$2
$6
5
$4
6
$0
($2)
1
2
3
4
5
($4)
6
($6)
QUANTITY SOLD
PRICE
$$
14
12
10
8
6
4
2
-2
-4
-6
TOTAL MARGINAL
REVENUE REVENUE
0
--$14
$14
$24
$10
$30
$6
$32
$2
$30
-$2
$24
-$6
DEMAND
1 2 3 4 5 6
QUANTITY SOLD
QUANTITY SOLD
MARGINAL REVENUE
DEMAND, TOTAL REVENUE AND MARGINAL REVENUE
PRICE QUANTITY SOLD TOTAL REVENUE
$16 0
MARGINAL REVENUE
0
---
$14 1
$14
$14
$12 2
$24
$10
$10 3
$30
$6
$8
4
$32
$2
$6
5
$30
-$2
$4
6
$24
-$6
PRICE
$$
b
14
c
12
d
10
h
MONOPOLIST’S DEMAND
( MARKET DEMAND )
e
8
f
6
i
g
4
2
MARGINAL REVENUE
0
-2
1
2
3
4
5
j
6
-4
-6
k
QUANTITY SOLD
THE MARGINAL PRINCIPLE
Increase the level of an activity if its marginal
benefit exceeds its marginal cost, but reduce
the level if the marginal cost exceeds the
marginal benefit. If possible, pick the level at
which the marginal benefit equals the marginal
cost.
MARGINAL REVENUE = MARGINAL COST
USING MARGINAL PRINCIPLE TO PICK
PRICE AND QUANTITY
PRICE QUANTITY
SOLD
$18
600
$17
700
$16
800
$15
900
$14
1,000
$13
1,100
$12
1,200
MARGINAL
REVENUE
$12
$10
$8
$6
$4
$2
$0
MARGINAL
COST
$6
$6
$6
$6
$6
$6
$6
USING MARGINAL PRINCIPLE TO PICK
PRICE AND QUANTITY
PRICE
$$
24
22
20
h
18
16
14
i
12
10
PROFIT = $8,100
8
6
4
2
m
n
LONG-RUN MARGINAL COST
EQUALS
LONG-RUN AVERAGE COST
MARKET DEMAND CURVE
MARGINAL REVENUE
200 400 600 800 1000 1200 1400 1600 1800 2000
DOSES OF DRUG PER HOUR
CALCULATING MARGINAL
REVENUE
• Marginal Revenue
= Current Total Revenue
Previous Total Revenue
= Initial Price - [ Initial Quantity *
Slope of Demand Curve ]
-
MONOPOLY VERSUS
PERFECT COMPETITION
PRICE
Market Demand
Curve
C
m
$15
M
$6
D
p
900
1,800
Doses of Drug per hour
Long-run average cost and
market supply curve
DEADWEIGHT LOSS
• Net loss associated with a monopoly (D).
• Monopoly is inefficient because it
generates less output than a perfectly
competitive market.