Today

1
Today

• LR industry supply
• Constant cost,
• increasing cost, and
• decreasing cost industries
• Market efficiency in perfect competition

2
Industry Supply in the Long Run

• Three Cases

3
Case 1 Constant Cost Industry

• Assumes that firms costs are independent of the
  size of the market. Expanding or contracting
  demand yields the same price in the long run.
• Firms cost curves do not shift as industry
  output changes.
• Leads to a horizontal long-run industry supply
  curve.

4
Initial LR Equilibrium
P
P
Typical Firm
Industry or Market
SRS
MC
ATC
LRATC
P
D
q
Q
Q
q
Thought experiment What happens to the industry
LR equilibrium as market demand expands?
5
SR Response to Increase in Demand
P
P
Typical Firm
Industry or Market
SRS
MC
ATC
LRATC
P
D
D
q
Q
Q
q
Q
SR price rises. Firms earn profits. Why isnt
this a new LR equilibrium?
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LR Response to Increase in Demand
P
P
Typical Firm
Industry or Market
SRS
MC
ATC
SRS
1
1
LRATC
2
0
0
P
2
D
D
q
Q
q
Q
Q
LR Firms enter until no more profits can be
made. Given our assumption, that is when price
falls original level. Second LR equilibrium.
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LR Response to Increase in Demand
P
P
Typical Firm
Industry or Market
SRS
MC
ATC
SRS
LRATC
P
D
D
q
Q
q
Q
Q
LR Firms enter until no more profits can be
made. For case 1, that is when price falls
original level. Second LR equilibrium.
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LR Industry Response to an Increase in Demand

• Assuming that firms costs do not depend on the
  size of the industry, and
• Beginning in LR equilibrium and increasing
  demand
• in the SR, price rises, firms profits and
  outputs rise.
• In the LR, price returns to original level, firms
  earn zero profits, each firm makes same q as
  before, but market output is higher.

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LR Response to Increase in Demand
P
P
Typical Firm
Industry or Market
MC
ATC
LRATC
LRS
P
D
D
q
Q
q
Q
Q
Case 1 Horizontal Long-Run Supply Curve
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Significance of Result

• For these industries, growing demand will not
  result in higher (or lower) prices. (Ceterus
  Paribus)
• Remember LRS is not predicting prices over time.

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Case 2 Increasing Cost Industry

• Assumes factor prices rise as industry (or
  market) output expands, causing firms costs to
  rise.
• Ex market for milk price of dairy land
• Results in an upward-sloping long-run industry
  supply curve

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Case 2 LR Industry Supply
P
P
Typical Firm
Industry or Market
SRS
LRATC (Q1)
LRS
LRATC(Q0)
P
D
D
q
Q
Q0
Q1
Case 2 Upward-sloping Long-Run Supply Curve
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Significance of Case 2

• Growing demand for milk forces up the prices of
  dairy land.
• Cost of producing milk rises.
• Price of milk rises in the long run, even though
  there are more milk farms.
• Result comes from the underlying scarcity of
  dairy land.

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Case 3 Decreasing Cost Industry

• Assumes costs fall as industry (or market) output
  expands.
• Results in an downward-sloping long-run industry
  supply curve

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Ex Software Production

• Its less costly to produce software as the
  industry grows because of a larger pool of
  possible programmers in the same area
• Dont need to relocate programmers to your area,
  cheaper.
• Programmers informally spread new ideas, reducing
  costs.
• The price of software falls as the industry
  expands.

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Economic Efficiency
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Definition

• Economic Efficiency When goods are produced in
  the least costly manner and distributed to those
  who value them most.
• Requires
• Productive Efficiency
• Allocative Efficiency

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Productive Efficiency

• There is no way to re-direct production among
  firms to increase total output.

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Perfect Comp and Productive Efficiency

• In LR firms produce at lowest possible LRAC.
• There is no way to cut costs by changing plant
  size.
• Since all firms take the same price, all firms
  have same MC (why?)
• There is no way to re-direct production to other
  firms and get lower marginal costs.
• Productive efficiency holds.

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Allocative Efficiency

• Goods are consumed by those who most value them.
• There is no alternative comb. of goods that could
  be produced that would increase societys
  well-being.

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Measuring Allocative Efficiency

• The sum of consumers surplus and producers
  surplus.

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Recall Consumers Surplus

• The difference between what a consumer is willing
  to pay what he does pay.

/unit
8
A
6
B
4
D
2
units
1
3
4
5
2
6
7
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Producers Surplus-SR perspective

• The difference between the amount of revenue the
  firm earns and the minimum amount necessary to
  get the firm to produce that quantity of the good
  in the short run.
• Revenue - total variable costs.

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Producers Surplus-Market

• Selling 4 units _at_6/unit.
• Total revenue B C.
• TVC for all firms is represented by the area
  under the SRS curve (why?) C
• B producers surplus

/unit
SRS
8
6
B
4
C
D
2
units
1
3
4
5
2
6
7
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Allocative Efficiency

• A B The sum of consumers and producers
  surplus.
• Vertical distance between D and S is the
  difference between value to consumer and MC to
  producer.
• What Q maximizes CSPS?

/unit
SRS
8
A
6
B
4
C
D
2
units
1
3
4
5
2
6
7
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Allocative Efficiency Perfect Competition

• Perfectly competitive markets provide the
  allocatively efficient quantity of a good.

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Perfect Comp and Econ Efficiency

• Conclusion Perfectly competitive markets are
  economically efficient!
• This is one reason why we use them as a benchmark
  for our study of other market structures.

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Coming Up

• Begin Monopoly
• Second midterm exam is 1 week from today!
• We will use Mondays class to review for the
  exam. Bring your copy of the study guide.

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Group Work

• Thought problem on perfect competition.
• Graph of Case 3 Downward-sloping LR industry
  supply.

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Profits and Perfect Competition

• Assume dairy production is a perfectly
  competitive, increasing cost industry (case 2 in
  our notes).
• Suppose demand for dairy products is growing.
• Some farmers have really good land for grazing,
  others have land that is rather poor.

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Questions about Dairy Example

• Which farmer earns the most profits? Explain in
  full.
• Hint Dont forget, this is a perfectly
  competitive industry.
• Hint Dont forget opportunity costs.

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Case 3 LR Industry Supply

• On the following graph, derive the LR Industry
  supply curve. Assume that firms costs decrease
  as the industry grows.

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Case 3 LR Industry Supply
P
P
Typical Firm
Industry or Market
SRS
LRATC(Q0)
P
D
D
q
Q
Q0
Case 3 Downward-sloping Long-Run Supply Curve