Today

1
Today

• LR industry supply
• Constant cost
• Increasing cost
• Implications of LR equilibrium

2
Industry Supply in the Long Run

• The Key to understanding the long run is firm
  entry and exit.

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
Q
SR price rises. Firms earn profits. Why isnt
this a new LR equilibrium?
6
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
Q
LR Firms enter until no more profits can be
made. Given our assumption, that is when price
falls to its original level. Second LR
equilibrium.
7
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.

8
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
9
Significance of Result

• For these industries, growing demand (ceteris
  paribus) will not result in higher (or lower)
  prices.
• Remember LRS is not predicting how prices change
  over time.
• For these industries, there is a constant
  opportunity cost of producing this good.

10
Case 2 Increasing Cost Industry

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

11
Case 2 LR Industry Supply
P
P
Typical Firm
Industry or Market
SRS
SRS
LRATC (Q1)
LRS
LRATC(Q0)
P
D
D
q
Q
Q0
Q1
Case 2 Upward-sloping Long-Run Supply Curve
12
Significance of Case 2

• Growing demand for milk forces up the price of
  milk.
• Less productive land is converted to dairy
  farming.
• Opportunity 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.

13
Profits for New Dairy Farms

• Consider the dairy farms that have opened because
  of higher milk prices.
• Do they make profits, losses, or break even in
  the long run? How do you know?

14
Profits for Old Dairy Farms.

• Consider the dairy farms that were in business
  prior to the increase in demand.
• Will they make profits, losses, or break even in
  the new long run equilibrium?
• What about dairy farmers who rent their land?
• What about dairy farmers who buy land that has
  always been used for dairy farming?
• What about dairy farmers who already owned dairy
  farms?

15
Coming Up

• Prepare for second midterm exam.

16
Group Work

• Profits for Coal Mines

17
Coal Mining

• Assume the coal mining industry is perfectly
  competitive.
• Consider two mines
• Alpha mine has rich, easily accessible deposits.
• Beta mine has less desirable deposits. Its
  marginal cost of producing coal is everywhere
  twice as high as for Alpha.

18
Profits for Alpha Beta Mines

• Assume the price of coal is high enough that Beta
  mine is actively mining coal.
• Will Beta mine make economic profits, economic
  losses or break even in the long run?
• Suppose the total coal deposits in the two mines
  are equal. What can you say about the likely
  price of Alpha mine compared to Beta mine?

19
Profits for Alpha Beta Mines, Contd.

• Will the two mines have the same fixed costs?
• Will Alpha mine make economic profits, economic
  losses or break even in the long run? How do you
  know?