Download COMPETITIVE FIRM IN LONG RUN SLIDES

ADJUSTMENT IN LONG-RUN
ADJUSTMENT IN THE LONGRUN
RISE IN DEMAND CAUSES
INDUSTRY EXPANSION
LONG RUN ADJUSTMENT AFTER
A PERMANENT RISE IN DEMAND
LONG RUN EQUILIBRIUM
EFFICIENCY
• PRODUCTIVE EFFICIENCY.
– In the long run the industry always returns to
the equilibrium at which price equals minimum
ATC, so costs are as low as possible.
• ALLOCATIVE EFFICIENCY
– Price (willingness to give up) always equals
MC (what is necessary to give up).
ONE FIRM DEVELOPS A LOWER
COST TECHNIQUE
Adjustment to technological change
• If other firms do not have access to the
technology because the technique is patented,
the innovating firm can continue to make profits.
However, the firm would likely make still more
money selling the new technology to the other
firms.
• If other firms have access to the new technology,
firms will adopt it in order to also make the extra
profits.
• As firms adopt the new technology they expand
production and firms enter the industry because
profits are possible with the new technology.
Adjustment if new technology is
made available
RETURN TO LONG RUN
EQUILIBRIUM
Long run adjustment to
technological change
• When the economy adjusts to the lower
costs of the new technology, all firms in
the industry are forced to use it.
• If they fail to adopt the new technology,
their costs will be too high and they will
make losses. In the long-run they will go
out of business.
SUMMATION OF ADVANTAGES
• In a perfectly competitive industry, the right mix
of goods are produced at the lowest possible
price.
• Firms earn all they need to stay in business, and
no more.
• Strong incentives exist to respond to changes in
demand and to changes in technology.
• Industry is dynamic and has a strong bias
towards improving productivity
SUMMATION OF
DISADVANTAGES
• Only the costs that are paid by the firms
are minimized. If the lowest cost technique
causes harm to the environment, animals
or workers, firms will be forced to adopt
the technique or go out of business.
• Benefits of the product not enjoyed by the
consumer will also be ignored by the
market.
Life is tough in competitive
industries
• Note that firms in competitive industries have to work
hard to survive. They must always be on their toes.
• In industries that hold a declining share of our economy –
agriculture, for example – competitive markets will
steadily force firms out of the industry.
• Demand will tend to fall, relative prices will tend to fall,
and firms will always be struggling, with many losing the
battle.
• Farmers have fallen from 40% to 2% of our population.
They have been driven out of the market by falling
relative prices.
• The public benefits because now farmers kids and grand
kids are the factory workers, computer technicians,
doctors, lawyers, school teachers who produce goods we
need more than we need more food. The farmers forced
out of business are often pretty unhappy about it at the
time.
Farmers have good press
• Note that many farmers control very valuable
land and capital. Some lose it through
bankruptcy. Many others see that alternative
opportunities are more attractive, sell their
assets, and have a nice nest egg for starting a
new life.
• When we regulate industries such as dairy farms
to give farmers a good income, we are often
helping people with hundreds of thousands of
dollars in assets while forcing the poor to pay
much more for their kids’ milk than it costs to
produce.
REGULATION OF DAIRY
INDUSTRY
Regulation of the dairy industry
• Canada imposes quotas on dairy
production. Each farmer must own a quota
to be able to produce milk.
• The Dairy industry regulates the price of
milk, so that the quantity demanded
equals the quantity produced under quota.
Results for Farmers
• Quotas can be bought and sold on unregulated
markets. They are an artificial form of property.
That is, they are an asset, like the farmer’s land
or herd of cows, but they add nothing to the
physical ability to produce milk.
• In order to start farming, farmers must acquire
quota. If they buy quota on the open market,
they will find that the price is bid up until it
reduces the profits created by regulation to zero.
• These farmers will just break even, as if the
industry was unregulated.
End Result
• Many farmers have borrowed to acquire quota,
or regard quota as an asset they will sell to
provide an income in their retirement.
• If the industry is deregulated (as the World Trade
Organization or other pressures to free trade
may require) quotas will have no value.
• Farmers will either suffer severe economic loss,
or the government will have to step in to buy up
the quota, at a substantial cost to the tax payers.