Chapter 24 Industry Supply Key Concept: SR industry supply is the horizontal sum of individual firm supply. LR industry supply is roughly flat.

Chapter 24 Industry Supply S(p)=1nSi(p). This is easy in the SR, we just horizontally sum the individual firm’s supply curve.

Fig. 23.1

What about the LR industry supply? Why is it ever a question? Why can’t we horizontally sum up like we did for the SR, so that S(p)=1nSi(p)?

S(p)=1nSi(p)? By free entry and free exit, we don’t know what n is. That is, we do not know how many firms there are in the industry.

Assume all firms have identical long-run cost function. Given the cost function, we can compute the level of output where average costs are minimized. Denote this minimal average cost by p*=miny AC(y).

Fig. 23.3

Let’s ask a slightly different question. What are the possible equilibria in the LR? If firms enter the industry when positive profits are made, then the relevant intersection is the lowest price consistent with nonnegative profits (p’).

Fig. 23.3

(1) Rule out all points that lie below p*. (2) Since demand is downward sloping, rule out points which if any downward sloping demand passes through, it would also intersect a supply associated with a larger number of firms (see point A).

Fig. 23.3

So every point on the one-firm supply curve that lies to the right of the intersection of the two-firm supply curve and the line determined by p* cannot be consistent with the LR equilibrium.

Fig. 23.4

These are where the LR equilibria can actually occur. As the number of firms gets larger, the segments becomes flatter.

Fig. 23.5

So we cannot be very far from p*. The LR supply curve will be approximately flat at p*. This is just like a CRS firm, but firms replicate by entry.

Consider taxation in an industry with free entry and exit. Initially before the tax, the industry is in the long run equilibrium where each firm is making zero profit. Moreover, the number of firms in this industry is endogenously determined.

In the SR, with a fixed number of firms, the supply curve of the industry is upward sloping whereas in the LR, with a variable number of firms, the supply curve is flat at price equals minimum average cost.

Now a quantity tax of t dollars is imposed Now a quantity tax of t dollars is imposed. Given the number of firms, the supply curve shifts upwards by t. Since demand is typically downward sloping, the equilibrium price rises less than t.

Some tax is born by the consumers and some by producers. However, since producers are making zero profit before, when the price rises less than t, firms are making losses. This results some firms in the industry to exit.

When this happens, the number of the firms in the industry decreases, so the industry supply moves to the left even further. When the supply moves to the left, the equilibrium price increases. This continues till the price rises by t so any firm is making 0 profit.

Fig. 23.6

π=0 doesn’t mean the industry disappears π=0 doesn’t mean the industry disappears. It just means it does not produce extra rewards to attract new entrants. All factors of production are being paid their market price, the same market price these factors could earn elsewhere. Owner of a firm is still collecting a payment for her labor time or for the money she invested in the firm.

Each factor is earning the same amount that it could earn elsewhere.

There are situations where some factors are fixed for the economy as a whole even in the LR. For example, there are only a fixed number of taxicab licenses. Does this mean there could be positive economic profit in the LR since entry is prevented by law?

Whenever there is some fixed factor that is preventing entry, there will be an equilibrium rental rate for that factor. The possibility of selling out is an opportunity cost of not doing so. Hence it should be counted as an opportunity cost or production cost. Hence the rental price of the license must be high to drive the profit to zero.

Chapter 24 Industry Supply Key Concept: SR industry supply is the horizontal sum of individual firm supply. LR industry supply is roughly flat.