ATC AVC MC Average-Cost and Marginal-Cost Curves Short-Run: Some Fixed Costs Competitive Firm, Monopoly, Whatever $0.00 $0.50 $1.00 $1.50 $2.00 $2.50 $3.00 $ Quantity of Output Costs AFC

Supply Demand Price Quantity Competitive Industry Supply and Demand $ Equilibrium

The Competitive Firm’s Short-Run Supply Curve: (The Competitive Firm is a Price-Taker) Produce where MC = MR = Price > AVC Quantity ATC AVC 0 Costs MC If P < AVC, shut down. If P > AVC, keep producing in the short run. If P > ATC, keep producing at a profit. Firm’s short-run supply curve.

The Short Run: Market Supply with a Fixed Number of Firms... (a) Individual Firm Supply Quantity (firm) 0 Price (b) Market Supply Quantity (market) Price 0 Supply MC 1.00 $ $ ,000200,000

Industry Supply: Some Examples 1.50 firms, each with TC(x) = 2x +.01 x 2 Each firm’s supply Industry supply 2.50 firms with TC(x) = 2x +.01 x 2 and 50 firms with TC(x) = 3x x 2 Each firm’s supply Industry supply firms with TC(x) = x +.01 x 2, x > 0 ; but TC(0) = 0, i.e., avoidable fixed cost Each firm’s supply Industry supply

Competitive Firm’s Supply Curve Long Run: No Fixed Costs Quantity MC = Long-run S ATC 0 Costs Firm enters if P > ATC Firm exits if P < ATC

The Long Run: Market Supply with Entry and Exit... (a) Firm’s Zero-Profit Condition Quantity (firm) 0 Price P = minimum ATC (b) Market Supply Quantity (market) Price 0 Supply MC ATC

Response to Increase in Demand Short - Run, Medium - Run, Long - Run Initial equilibrium: existing firms operating at efficient scale and earning zero profit Short – run: fixed number of existing firms –Price rises  each firm expands output along its MC curve  MC = Price > AC  PROFITS Intermediate – run: additional firms enter –Industry supply shifts outward  Price declines  Reduced profits Long – run: additional firms continue to enter, industry supply continues to shift increase, and price continues to drop  Return to zero profit equilibrium

The Long Run: Competitive Market Supply Is long – run supply truly horizontal (flat)? Are long – run profits truly zero? All firms are not created equal … some are endowed with lower costs –More and less fertile land  Rents –Better and worse management  Quasi – rents As less and less efficient firms enter, industry supply curve slopes upward Industry expansion  higher input prices  higher costs for all firms As industry expands, each firm’s minimum cost increases  industry supply curve slopes upward

Monopolistic Competition: Many Firms with Differentiated Products Short-Run: Firm Makes a Profit Quantity 0 Price Demand MR ATC Profit MC Profit- maximizing quantity Price Average total cost

A Monopolistic Competitor in the Long Run…P > MC … but Zero Profit Quantity Price 0 Demand MR ATC MC Profit-maximizing quantity P=ATC

Consumer Surplus and Producer Surplus: Benefits they get from trading in the market Price Equilibrium price 0Quantity Equilibrium quantity A Supply C B Demand D E Producer surplus Consumer surplus

Q2Q2 P2P2 Price And Consumer Surplus... Consumers benefit from price < what they’re willing to pay, whether they face competitive firm or monopolist Quantity Price 0 Demand Copyright © 2001 by Harcourt, Inc. All rights reserved Initial consumer surplus Additional consumer surplus to initial consumers Consumer surplus to “new” consumers Q1Q1 P1P1 DE F B C A

P2P2 Q2Q2 How Price Affects Producer Surplus... Quantity Price 0 Supply Q1Q1 P1P1 A B C Initial Producer surplus Additional producer surplus to initial producers D E F Producer surplus to new producers

Price 0 Quantity Equilibrium quantity Supply Demand Cost to sellers Value to buyers Cost to sellers Value to buyers is greater than cost to sellers. Value to buyers is less than cost to sellers. Static Efficiency of Competitive Market Equilibrium

Insights About Market Outcomes uFree markets allocate the supply of goods to the buyers who value them most highly. With money-left-over utility function, MU x /p x = 1 or MU x = p x  same for all buyers uFree markets allocate the demand for goods to the sellers who produce them at least cost  MC x = p x  same for all sellers = p x = MU x uFree markets produce the quantity of goods that maximizes the sum of consumer and producer surplus. But promise of monopoly profits drives innovation

Price 0 Quantity Supply Demand Tax The Tax Wedge and Deadweight Loss Price Rec’d Price Paid Consumer Surplus Producer Surplus Tax Revenue