End of Perfect Competition Lecture 21 Dr. Jennifer P. Wissink ©2018 John M. Abowd and Jennifer P. Wissink, all rights reserved. April 16, 2018

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) lrtc = PLL*(q) + PKK*(q) long run average total cost (lratc) lratc = lrtc/q long run marginal cost (lrmc) lrmc = lrtc/q The one we will see/use most is the lratc curve.

Goldilocks: Getting the Long Run Average Total Cost Curve for Three Different Levels of K Ksmall atc-Ksmall atc-KMedium KMedium atc-KLARGE K LARGE

i>clicker question Given the information in the graph, which size plant should Goldilocks build? small Medium LARGE Don’t know One of each 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-Ksmall 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 Each firm is profit maximizing  mr = mc at q* for each firm. (1) Zero profit required  P* = lratc at q* for each firm. (2) Perfectly competitive firm  P* = mr at all values of q. (3) Sub (3) into (1)  P* = mc at q* for each firm. (4) Using (2) and (4)  mc = lratc at q* for each firm. 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...

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 (assuming a “constant cost” industry) Both points A and C from 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. assumes tech doesn’t change with entry and exit assumes input prices don’t change with entry and exit P* called the “normal” price. SRS w/N* SRS w/N** B P’ A C P* LRS LRS Dnew Dold Q* Q’ Q** Q

Short Run versus Long Run Market Supply Curves: Recap Along the short run market supply curve the number of firms in the industry is fixed, along with any fixed factors of production for the firm. Along the long run market supply curve all firms operate at the point where marginal cost equals average cost. The number of firms adjusts to vary the supply. Remember, all firms are assumed to be identical. Remember, an assumption of perfectly competitive markets is that firms can freely enter and exit. SRS w/N* SRS w/N** B P’ A C P* LRS LRS Dnew Dold Q* Q’ Q** Q