End of Perfect Competition Lecture 20 Dr. Jennifer P. Wissink ©2017 John M. Abowd and Jennifer P. Wissink, all rights reserved. April 17, 2017

i>clicker question Given the information, which size plant should Goldilocks build? small Medium LARGE Don’t know atc-small atc-Medium atc-LARGE

Internal Economies of Scale & Minimum Efficient Scale When the lratc curve is falling it is said to exhibit internal economies of scale. When the lratc curve is rising it is said to exhibit internal diseconomies of scale. MES is the smallest quantity at which the lratc curve attains its minimum value. Internal diseconomies of scale Internal economies of scale q-MES

Ford, GM & Long Run Cost Curves

Internal Economies of Scale & Minimum Efficient Scale

Long Run ATC Curve in Relationship to Short Run ATC Curves When you are optimally designed, short run and long run cost values will coincide. As you deviate from what you planned for in the long run analysis, either producing more OR less than you optimally designed for, your short run costs will exceed your long run costs. $ lratc sratc-small K q=35 q=50 q=150 q in tons

Rules for Profit () Maximization in the Long Run (pretty much the same) If q* maximizes  , then mr(q*) = lrmc(q*)  (q*) is a maximum and not a minimum at q* it is worth operating:  at q*  0 Could get a long run supply curve for the firm, but it’s never used, so let’s not and say we did!

Long Run Equilibrium in Perfectly Competitive Markets All the short run equilibrium properties hold. But also add… no firms wish to exit the market nor do firms want to enter. Given: market demand, factor prices and technology Get: (P*, Q*, q*, N*) Note: For there to be neither entry or exit, need economic profit to be zero. This is a long run equilibrium requirement. Otherwise the number of firms in the market will still be in flux. Short run profit invites entry. Short run losses suggest exit. If firms ARE NOT identical, then it’s really that the marginal firm has zero profit.

Long Run Equilibrium Position with Identical Firms (1) Each firm is profit maximizing  mr = mc at q* for each firm. (2) Zero profit required  P* = lratc at q* for each firm. (3) Since the firm is perfectly competitive,  P* = mr at all values of q for the firm. (4) Using (1) and (3), P* = mc at q*. (5) Using (2) and (4), mc = lratc at q*. Therefore, q* is at the minimum of the typical firm’s lratc curve. So... q* is at MES. P* must be the price consistent with the minimum value on the typical firm’s lratc curve. N* and Q* get determined by position of market demand.

A Long Run Equilibrium Picture Note: Q* = N* times q* $ $ lratc SRS w/N* A a mr=δ P* P* D Q* Q q* q MARKET typical firm

Steps to Draw the Picture? Doesn’t matter how you draw it, as long as you draw it correctly in the end. Draw-a-person tests.

What’s Not OK...

Long Run Market Supply in Perfect Competition The long run market supply curve measures the quantities of a good or service offered for sale by all sellers--potential and actual--who could sell in the market. The long run market supply curve represents the market relationship between P* and Q* when the market is in long run equilibrium.

Finding the Long Run Market Supply Curve (with identical firms) THE MARKET a typical firm $ $ lratc 600 SRS0 w/N0* A a P0* P0* mr0=δ0 DN D0 Q0* Q q0* q 300,000 500 Note: Q0* = N0* times q0*

Long Run Market Supply in a Perfectly Competitive Market If input prices and/or technology does NOT change when firms enter and exit the market, then the LRSMARKET is horizontal at the “normal” long run competitive price. At prices above P* incumbent firms are making positive economic profit and there will be entry. At prices below P* incumbent firms are incurring losses and there will be exit. $ LRSMARKET P* Q

Long Run Market Supply in a Perfectly Competitive Market Both points A and C in the previous picture are long run equilibrium points. Point B is a temporary short run equilibrium point. If you connect all points like A and C you get the market long run supply curve in a perfectly competitive market. SRS w/N* SRS w/N** B P’ A C P* LRS LRS Dnew Dold Q* Q’ Q** Q

Long Run Market Supply in a Perfectly Competitive Market The long run supply curve in the market is horizontal at the long run equilibrium price P*. P* is sometimes called the “normal price.” P* is the price consistent with the typical firm’s minimum long run average total cost. Note: important assumption is that the position of the firm’s cost curve is unaffected by entry (or exit) of firms in the market. $ SRS w/N* SRSw/N** B P’ A C P**=P* LRS LRS Dnew Dold Q* Q’ Q** Q

External Economies and External Diseconomies If the industry exhibits no external economies or diseconomies, then the industry long run supply curve is perfectly elastic (horizontal). The industry grows by replicating firms at the efficient scale. Entry and exit leaves the position of cost curves intact. This is often called a constant cost industry. If the industry exhibits external diseconomies, then the industry long run supply curve is upward sloping. The minimum average total cost of all firms in the industry rises as the size of the market grows (and falls as it contracts). This is often called an increasing cost industry. If the industry exhibits external economies, then the industry long run supply curve is downward sloping. The minimum average total cost falls as the size of the industry grows (and rises as it contracts). This is often called a decreasing cost industry. Note the difference between EXTERNAL economies/diseconomies and INTERNAL economies/diseconomies of scale

Long Run Market Supply with External Diseconomies $ SRSold SRSnew LRS B C A Dnew Dold Q

Long Run Perfectly Competitive Equilibrium - Performance Two Efficiency Definitions The market equilibrium quantity traded (Q) is Pareto/Allocatively Efficient(AE) if net social surplus in the market is maximized. The firm is productively efficient(pe) if its output level (q) is such that the firm’s long-run average total costs are minimized. Question: Do we get either... or both... under perfect competition?

Answer: 1st Fundamental Theorem of Welfare Economics In Pictures THE MARKET a typical firm $ $ lratc SRS w/N* A a mr=δ P* P* D Q* Q q* q

Long Run Perfectly Competitive Equilibrium - Performance Equity: Is the outcome of the competitive process fair? Equitable? Just? Good questions that we do not answer here and now.

RECALL…Various Market Structures Next Batter Up = Monopoly Perfectly Competitive: many firms identical products free entry and exit full and symmetric information Monopoly: single firm no close substitutes, only imperfect substitutes in related markets barriers to entry and possibly exit full and symmetric information, or possibly not

Sources of Monopoly Entry Barriers Technical: Natural monopoly Vital input ownership Technical secrets (the better mousetrap) Legal: Patents Franchises Licenses Strategic: Buy ‘em up Blow ‘em up Let’s make a deal