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Economics 2010 Lecture 12 Competition (II) Competition Output, Price, and Profit in the Short Run Output, Price, and Profit in the Long Run Changing Tastes and Advancing Technology Output, Price, and Profit in the Short Run In short-run equilibrium: The number of firms is fixed Each firm has a fixed amount of capital The quantity supplied equals the quantity demanded Short-Run Equilibrium In short-run equilibrium, firms might: earn an economic profit earn normal profit (break even) incur an economic loss The following figure shows three possible short-run equilibrium outcomes Short-Run Equilibrium The industry supply curve is S First, suppose the demand curve is D1. Short-Run Equilibrium If the demand curve is D1. The equilibrium price is $25 25 Short-Run Equilibrium At this price, the firm produces 9 sweaters a day and earns an economic profit Short-Run Equilibrium MC 30.00 ATC 25.00 AR=MR 20.33 15.00 9 Short-Run Equilibrium MC 30.00 ATC 25.00 20.33 AR=MR Total Profit 15.00 9 Short-Run Equilibrium Next, suppose the demand curve is D2 Short-Run Equilibrium If demand curve is D2 The equilibrium price is $20 20 Short-Run Equilibrium At this price of $20, the firm produces 8 sweaters a day and breaks even. It earns a zero economic profit Short-Run Equilibrium Finally, suppose the demand curve is D3 Short-Run Equilibrium If the demand curve is D3 The equilibrium price is $17 17 Short-Run Equilibrium At this price, the firm produces 7 sweaters a day and incurs an economic loss Output, Price, and Profit in the Long Run Long-run equilibrium occurs in a competitive industry when economic profits are zero Long-run equilibrium comes about because of entry and exit and because firms choose their least cost plant size Long-Run Equilibrium Profits and losses are signals for entry and exit Entry affects profits and losses Long-Run Equilibrium As new firms enter a competitive industry, the industry supply shifts rightward, price falls and quantity increases Long-Run Equilibrium This figure shows the effects of entry Initially, the industry supply curve is SA The price is $23 and firms are earning economic profits New firms enter the industry Long-Run Equilibrium As entry takes place, industry supply increases The supply curve shifts rightward toward S0 As supply increases, the quantity increases and the price falls When the price has fallen to $20, firms break even Long-Run Equilibrium At this point, entry ceases and the industry is in longrun equilibrium Long-Run Equilibrium Now let us show the effects of exit Initially, the industry supply curve is SB The price is $17 and firms are incurring economic losses Firms begin to exit the industry Long-Run Equilibrium As exit takes place, industry supply decreases The supply curve shifts leftward toward S0 As supply decreases, the quantity decreases and the price rises When the price has risen to $20, firms break even Long-Run Equilibrium At this point, exit ceases and the industry is in longrun equilibrium We will now learn more about the longrun equilibrium in a perfectly competitive industry Long-Run Equilibrium Changes in plant size Firms change plant size if they are not producing at least-cost In long-run equilibrium, each firm has chosen the plant size that minimizes cost Let us show the situation when the firm has made the plant changes necessary to minimize cost Long-Run Equilibrium When firms use their minimum cost plant, there is no further incentive either to expand or contract Changing Tastes and Advancing Technology When there is a permanent decrease in demand (e.g. as for typewriters and TV repairs), the following events take place: The industry demand curve shifts leftward The price falls Firms begin to incur economic losses Some firms exit the industry Permanent Decrease in Demand As exit takes place the supply shifts leftward and the price begins to increase Losses decline and the exit process slows down After a large enough number of firms have exited, the remaining ones make zero profit Permanent Decrease in Demand This shows the effect of a permanent decrease in demand. Demand decreases from D0 to D1 Permanent Decrease in Demand The price falls from P0 to P1 And the quantity decreases from Q0 to Q1 Permanent Decrease in Demand Each firm now incurs an economic loss Permanent Decrease in Demand So some firms exit the industry Permanent Decrease in Demand As they exit, supply decreases and the supply curve begins to shift leftward Permanent Decrease in Demand With a decrease in supply, the price begins to rise And the quantity keeps on decreasing Permanent Decrease in Demand But with a rising price, each remaining firm in the industry increases production Permanent Decrease in Demand When the process ends in a new longrun equilibrium, the price is back at P0 Permanent Decrease in Demand The quantity produced has decreased to Q2 And each remaining firm is producing q0, its initial quantity Permanent Decrease in Demand quantity has decreased to Q2 And each remaining firm is producing q0, its initial quantity So, we produce less overall, because we have less firms in the market, but the survivors produce the same as before External Economies and Diseconomies External economies are factors beyond the control of an individual firm that lower a firm’s costs as industry output expands Examples: growth of specialist support services in agriculture during the 19th century growth of technology support services today External Economies and Diseconomies External diseconomies are factors beyond the control of an individual firm that increase a firm’s costs as industry output expands Examples: highway congestion in trucking air traffic control congestion in air transportation services External Economies and Diseconomies In the absence of external economies and diseconomies, when industry output increases, price remains constant External Economies and Diseconomies In the face of external diseconomies, when industry output increases, price rises External Economies and Diseconomies In the presence of external economies, when industry output increases, price falls Technological Change Technological change is constantly decreasing costs and increasing supply in competitive industries Increases in supply lower prices. Firms that do not switch to the new technology incur losses and eventually exit
