Short Run Equilibrium In Perfect Competition Lecture 19 Dr. Jennifer P. Wissink ©2017 John M. Abowd and Jennifer P. Wissink, all rights reserved. April 12, 2017

Jonathan’s Profit Maximizing Move When Market Price P=$528 Recall: If q* maximizes  , then (1) mr(q*) = srmc(q*) (2)  (q*) is a maximum and not a minimum. (3) at q* it is worth operating:  (q*>0)   (q=0) Jonathan's Apple Farm Costs (detail) Apples (tons/year) $Land $Hired Labor $Proprietor's time $Total Cost $Average Cost $Marginal larger delta method 200 12,400 54,400 13,200 80,000 400 210 58,560 84,160 401 440 220 63,200 88,800 404 484 230 68,240 93,840 408 528 240 73,760 99,360 414 588 250 105,600 422 632 260 86,400 112,000 431

Using The Cost Graph to Derive Jonathan’s Short Run Supply Curve q*

END OF MATERIAL FOR PRELIM 2 Thank goodness!

Jonathan’s Short Run Supply Curve So, for a perfectly competitive firm, the srsfirm = srmc for all points where srmc ≥ sravc (this assumes that all fixed costs are sunk). Note that we have confirmed the “law of supply”!

i>clicker question An improvement in production technology will shift the marginal cost curve downward and decrease quantity supplied at each price. upward and increase quantity supplied at each price. upward and decrease quantity supplied at each price. downward and increase quantity supplied at each price. downward with no effect on market supply.

The Perfectly Competitive Short Run Market Supply Curve The market supply curve is the horizontal sum of the quantities supplied by each seller at each market price. Market supply, thus reflects the marginal costs of each of the producers in the market.

Reprise: The Short Run Market Supply How does our scratch supply curve compare to the one we bought off the shelf? Recall the supply function for X = mini speakers: QS = g(PX, Pfop, Poc, S&T, N) Where: QS = maximum quantity that producers are willing and able to sell PX = X’s price Pfop = the price of factors of production Poc = the opportunity costs S&T = science and technology N = number of firms in the market

Individual Producer’s Surplus Recall: Producer’s Surplus measures the gain to the firm from selling all units at the market price. Recall PS on q units = Total Revenue – Variable Costs We now know Profit = Total Revenue – Variable Costs – Fixed Costs Rearranging we get: Variable Costs = Total Revenue – Fixed Costs – Profit Plugging this expression for Variable Costs into PS we get: PS on q units = Total Revenue – Total Revenue + Fixed Costs + Profit So Producer’s Surplus can also be written as PS on q units = Fixed Costs + Profit An alternative interesting way to think of producer’s surplus On the graph, Producer’s Surplus is the area above the short run firm supply curve and below the market price

Jonathan’s Producer’s Surplus Jonathan’s individual producer’s surplus when the market price is $528, is… …the sum of his economic profits ($27,600) and his fixed costs ($25,600) = $53,200… … or alternatively it is total revenue ($121,440) minus variable costs ($68,240) = $53,200. srs-firm ≈$250

SO: The Market & The Firm in Short Run Equilibrium Given: Market Demand Firms’ Technologies (including some fixed inputs) Factor Prices The Number of Firms Need: Each firm is profit maximizing Market Demand = Short Run Market Supply Solve For: Q* q* P* profit*

SO: The Market & The Firm In Short Run Equilibrium $ $ Dmkt sratc srmc A a mr*=δ* P* P* SRSmkt w/N Q* q* Q q MARKET typical firm

Market Net Social Surplus The market equilibrium occurs at P* & Q* Consumers’ surplus is the blue shaded area Producers’ surplus is the red shaded area Net social surplus is the blue and red shaded area P Short Run Supply=MC P* Demand=MB Q* Quantity

Next: Long Run Firm & Market Conduct First, we are going to examine the long run cost curves of a single business. Next, we will make precise the relation between the firm’s short run and long run supply decisions. Then, we will consider the market in long run equilibrium. So: Consider the following… q = f(K, L) where q is firm output, K is firm capital and L is firm labor and where PK is the unit price of capital and PL is the unit price of labor.

(Only) Three Long Run Cost Curves There are three long run cost curves for the firm: long run total cost lrtc = PLL*(q) + PKK*(q) long run average total cost lratc = lrtc/q long run marginal cost lrmc = lrtc/q The most important is the lratc curve.

Goldilocks: Getting the Long Run Average Total Cost Curve for Three Different Levels of K small atc-small atc-Medium Medium atc-LARGE LARGE

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.

Why Are There Zero Economic Profits in the Long Run? Zero economic profits means that all factors used in production make exactly their opportunity cost. Purchased factors receive their market price, which is equal to their opportunity cost. Owned factors receive the same compensation that they would receive in their next best use, which is also equal to their opportunity cost. Thus, no firm wants to enter the market because it cannot make any more money than it is currently making. Similarly, no firm wants to leave the market because it cannot make any more money in any other business.

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...