Examples of rising and falling industries Beef chicken bagel stores smoothies video rental stores drive-in movies

Long Run vs. Short Run in an Industry Long run for an industry –Firms have either entered or exited the industry Short run for an industry –Firms have neither entered nor exited the industry Contrast: long run vs. short run for a firm –Long run: can adjust all inputs –Short run: can adjust some but not all inputs

The Long Run Competitive Equilibrium Model It’s Dynamic! It has three key ingredients – Two we have seen before –The third is new

(1) Each firm has the typical MC, ATC, AVC graph

(2) Each firm is competitive, and the Market demand curve is downward sloping

(3) Free entry and exit Firms can enter the industry or exit the industry –firms exit the industry if profits are negative (losses) –firms enter the industry if profits are positive Note that the definition of profits is economic profits –Opportunity costs are part of total costs

The Typical Firm and the Market

What happens if there is an increase in demand? First, look at short run effects Then, look at what happens over time as firms enter or exit Finally, check out the new long run equilibrium

Now let’s do it by hand to see how the curves change over time

Using the Model to explain the real world. Consider an example:

Now consider a decrease in demand –Short run effects –dynamics over time –new long run equilibrium

Another nice feature of competitive markets Since profits are zero in long run equilibrium, P = ATC Thus, in long run industry equilibrium ATC is at a minimum In other words, cost per unit is a low as you can go

What if there is a shift in costs? Shift down both the ATC and the MC curves Watch what happens

External Economies of Scale When a whole industry expands, the firms’ costs may shift down even though the scale at each firm does not expand Contrast with (internal) economies of scale at a single firm

To illustrate external economies of scale shift both the demand curve and the cost curves. Let’s look at a hand sketch again:

Look more carefully at market supply and demand

Can also have external diseconomies of scale