Economics 2010 Lecture 12 Competition (II)

Competition  Output, Price, and Profit in the Short Run  Output, Price, and Profit in the Long Run  Changing Tastes and Advancing Technology

Output, Price, and Profit in the Short Run  In short-run equilibrium: £ The number of firms is fixed £ Each firm has a fixed amount of capital £ The quantity supplied equals the quantity demanded

Short-Run Equilibrium  In short-run equilibrium, firms might: £ earn an economic profit £ earn normal profit (break even) £ incur an economic loss  The following figure shows three possible short-run equilibrium outcomes

Short-Run Equilibrium  The industry supply curve is S  First, suppose the demand curve is D 1.

Short-Run Equilibrium  If the demand curve is D 1.  The equilibrium price is $25 25

Short-Run Equilibrium  At this price, the firm produces 9 sweaters a day and earns an economic profit

Short-Run Equilibrium AR=MR MC ATC

Short-Run Equilibrium AR=MR MC ATC Total Profit

Short-Run Equilibrium  Next, suppose the demand curve is D 2

Short-Run Equilibrium  If demand curve is D 2  The equilibrium price is $20 20

Short-Run Equilibrium  At this price of $20, the firm produces 8 sweaters a day and breaks even. It earns a zero economic profit

Short-Run Equilibrium  Finally, suppose the demand curve is D 3

Short-Run Equilibrium  If the demand curve is D 3  The equilibrium price is $17 17

Short-Run Equilibrium  At this price, the firm produces 7 sweaters a day and incurs an economic loss

 Long-run equilibrium occurs in a competitive industry when economic profits are zero  Long-run equilibrium comes about because of entry and exit and because firms choose their least cost plant size Output, Price, and Profit in the Long Run

Long-Run Equilibrium  Profits and losses are signals for entry and exit  Entry affects profits and losses

Long-Run Equilibrium  As new firms enter a competitive industry, the industry supply shifts rightward, price falls and quantity increases

 This figure shows the effects of entry  Initially, the industry supply curve is S A  The price is $23 and firms are earning economic profits  New firms enter the industry Long-Run Equilibrium

 As entry takes place, industry supply increases  The supply curve shifts rightward toward S 0  As supply increases, the quantity increases and the price falls  When the price has fallen to $20, firms break even Long-Run Equilibrium

 At this point, entry ceases and the industry is in long- run equilibrium Long-Run Equilibrium

 Now let us show the effects of exit  Initially, the industry supply curve is S B  The price is $17 and firms are incurring economic losses  Firms begin to exit the industry Long-Run Equilibrium

 As exit takes place, industry supply decreases  The supply curve shifts leftward toward S 0  As supply decreases, the quantity decreases and the price rises  When the price has risen to $20, firms break even Long-Run Equilibrium

 At this point, exit ceases and the industry is in long- run equilibrium Long-Run Equilibrium

 We will now learn more about the long- run equilibrium in a perfectly competitive industry

Long-Run Equilibrium  Changes in plant size  Firms change plant size if they are not producing at least-cost  In long-run equilibrium, each firm has chosen the plant size that minimizes cost  Let us show the situation when the firm has made the plant changes necessary to minimize cost

Long-Run Equilibrium  When firms use their minimum cost plant, there is no further incentive either to expand or contract

Changing Tastes and Advancing Technology  When there is a permanent decrease in demand (e.g. as for typewriters and TV repairs), the following events take place: £ The industry demand curve shifts leftward £ The price falls £ Firms begin to incur economic losses £ Some firms exit the industry

Permanent Decrease in Demand  As exit takes place the supply shifts leftward and the price begins to increase  Losses decline and the exit process slows down  After a large enough number of firms have exited, the remaining ones make zero profit

Permanent Decrease in Demand  This shows the effect of a permanent decrease in demand.  Demand decreases from D 0 to D 1

Permanent Decrease in Demand  The price falls from P 0 to P 1  And the quantity decreases from Q 0 to Q 1

Permanent Decrease in Demand  Each firm now incurs an economic loss

Permanent Decrease in Demand  So some firms exit the industry

Permanent Decrease in Demand  As they exit, supply decreases and the supply curve begins to shift leftward

Permanent Decrease in Demand  With a decrease in supply, the price begins to rise  And the quantity keeps on decreasing

Permanent Decrease in Demand  But with a rising price, each remaining firm in the industry increases production

Permanent Decrease in Demand  When the process ends in a new long- run equilibrium, the price is back at P 0

Permanent Decrease in Demand  The quantity produced has decreased to Q 2  And each remaining firm is producing q 0, its initial quantity

Permanent Decrease in Demand  quantity has decreased to Q 2  And each remaining firm is producing q 0, its initial quantity  So, we produce less overall, because we have less firms in the market, but the survivors produce the same as before

External Economies and Diseconomies  External economies are factors beyond the control of an individual firm that lower a firm’s costs as industry output expands  Examples: £ growth of specialist support services in agriculture during the 19th century £ growth of technology support services today

External Economies and Diseconomies  External diseconomies are factors beyond the control of an individual firm that increase a firm’s costs as industry output expands  Examples: £ highway congestion in trucking £ air traffic control congestion in air transportation services

External Economies and Diseconomies  In the absence of external economies and diseconomies, when industry output increases, price remains constant

External Economies and Diseconomies  In the face of external diseconomies, when industry output increases, price rises

External Economies and Diseconomies  In the presence of external economies, when industry output increases, price falls

Technological Change  Technological change is constantly decreasing costs and increasing supply in competitive industries  Increases in supply lower prices.  Firms that do not switch to the new technology incur losses and eventually exit