Chapter Nine The Rise and Fall of Industries

Copyright © by Houghton Mifflin Company, Inc. All rights reserved9 - 2 Markets and Industries Industry: Group of firms producing a similar product. –Sometimes called a “market”. For example, cosmetics market Manufacturing is the making of goods by mechanical or chemical processes. –Industry doesn’t just mean manufacturing. Also includes services. –Most large firms are now international.

Copyright © by Houghton Mifflin Company, Inc. All rights reserved9 - 3 Long-Run Competitive Equilibrium Model of an Industry All firms make choices to MAXIMIZE PROFITS. –Still considering a competitive market Long-run Competitive Equilibrium Model: A model of firms in an industry in which free entry and exit produce an equilibrium such that price equals the minimum of ATC. –Just a model, not exact. Some firms adhere more than others

Copyright © by Houghton Mifflin Company, Inc. All rights reserved9 - 4 Figure 9.2: How a Competitive Firm Sees Demand in the Market

Copyright © by Houghton Mifflin Company, Inc. All rights reserved9 - 5 Entry and Exit Free Entry and Exit: Movement of firms into and out of an industry that is not blocked by regulation, other firms, or any other barriers. –Characteristic of competitive markets –Based on profits: If earning profits, there is incentive to enter. If profits are negative, there is incentive to exit. When profits are zero, no incentive to do either. –When firms enter or exit, the entire supply curve is affected.

Copyright © by Houghton Mifflin Company, Inc. All rights reserved9 - 6 Figure 9.3: Long-Run Equilibrium in a Competitive Market

Copyright © by Houghton Mifflin Company, Inc. All rights reserved9 - 7 About the LR Equilibrium in a Competitive Market Price line represents current market price, which is determined by the intersection of the supply and demand curve Vertical axes have the same scale ($) Horizontal axes have different scale (Q) Quantity demanded equals the quantity supplied in the market AND profits are zero. Long-run Equilibrium: Situation in which entry and exit in an industry are complete and economic profits are zero with price equal to ATC.

Copyright © by Houghton Mifflin Company, Inc. All rights reserved9 - 8 Figure 9.4: The Rise of an Industry after a Shift in Demand

Copyright © by Houghton Mifflin Company, Inc. All rights reserved9 - 9 Figure 9.4: The Rise of an Industry after a Shift in Demand (cont’d)

Copyright © by Houghton Mifflin Company, Inc. All rights reserved Economic Profits versus Accounting Profits Accounting Profits: TR-TC, not including implicit opportunity costs Economic Profits: TR-TC, including all opportunity costs –Use economic profits because they measure the incentive the owner of the firm has to stay in business versus doing something else.

Copyright © by Houghton Mifflin Company, Inc. All rights reserved Figure 9.5: The Decline of an Industry after a Shift in Demand

Copyright © by Houghton Mifflin Company, Inc. All rights reserved Figure 9.5: The Decline of an Industry after a Shift in Demand (cont’d)

Copyright © by Houghton Mifflin Company, Inc. All rights reserved Figure 9.6: Effect of a Reduction in Costs

Copyright © by Houghton Mifflin Company, Inc. All rights reserved Figure 9.6: Effect of a Reduction in Costs (cont’d)

Copyright © by Houghton Mifflin Company, Inc. All rights reserved Minimum Costs per Unit and the Efficient Allocation of Capital In the Long-Run Equilibrium, ATC is as low as technology permits. –Firms produce at minimum ATC (Where MC = ATC)

Copyright © by Houghton Mifflin Company, Inc. All rights reserved External Economies and Diseconomies of Scale A firm whose LR ATC declines as the firm expands has economies of scale. A firm whose LR ATC increases as the firm expands has diseconomies of scale.

Copyright © by Houghton Mifflin Company, Inc. All rights reserved Figure 9.9: External Diseconomies of Scale

Copyright © by Houghton Mifflin Company, Inc. All rights reserved Figure 9.10: External Economies of Scale