1. End of Perfect Competition Lecture 20
Dr. Jennifer P. Wissink
©2017 John M. Abowd and Jennifer P. Wissink, all rights reserved.
April 17, 2017

2. i>clicker question
Given the information, which size plant should Goldilocks build?
small
Medium
LARGE
Don’t know
atc-small
atc-Medium
atc-LARGE

3. 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

4. Ford, GM & Long Run Cost Curves

5. Internal Economies of Scale & Minimum Efficient Scale

6. 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-small K
q=35
q=50
q=150
q in tons

7. 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!

8. 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.

9. Long Run Equilibrium Position with Identical Firms
(1) Each firm is profit maximizing  mr = mc at q* for each firm.
(2) Zero profit required  P* = lratc at q* for each firm.
(3) Since the firm is perfectly competitive,  P* = mr at all values of q for the firm.
(4) Using (1) and (3), P* = mc at q*.
(5) Using (2) and (4), mc = lratc at q*.
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.

10. 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

11. 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.

12. What’s Not OK...

13. Long Run Market Supply in Perfect Competition
The long run market supply curve measures the quantities of a good or service offered for sale by all sellers--potential and actual--who could sell in the market.
The long run market supply curve represents the market relationship between P* and Q* when the market is in long run equilibrium.

14. 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*

15. Long Run Market Supply in a Perfectly Competitive Market
If input prices and/or technology does NOT change when firms enter and exit the market, then the LRSMARKET is horizontal at the “normal” long run competitive price.
At prices above P* incumbent firms are making positive economic profit and there will be entry.
At prices below P* incumbent firms are incurring losses and there will be exit. $
LRSMARKET P* Q

16. Long Run Market Supply in a Perfectly Competitive Market
Both points A and C in 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.
SRS w/N*
SRS
w/N** B P’ A C P*
LRS
LRS
Dnew
Dold Q* Q’
Q** Q

17. Long Run Market Supply in a Perfectly Competitive Market
The long run supply curve in the market is horizontal at the long run equilibrium price P*.
P* is sometimes called the “normal price.”
P* is the price consistent with the typical firm’s minimum long run average total cost.
Note: important assumption is that the position of the firm’s cost curve is unaffected by entry (or exit) of firms in the market. $
SRS w/N*
SRSw/N** B P’ A C
P**=P*
LRS
LRS
Dnew
Dold Q* Q’
Q** Q

18. External Economies and External Diseconomies
If the industry exhibits no external economies or diseconomies, then the industry long run supply curve is perfectly elastic (horizontal).
The industry grows by replicating firms at the efficient scale. Entry and exit leaves the position of cost curves intact. This is often called a constant cost industry.
If the industry exhibits external diseconomies, then the industry long run supply curve is upward sloping.
The minimum average total cost of all firms in the industry rises as the size of the market grows (and falls as it contracts). This is often called an increasing cost industry.
If the industry exhibits external economies, then the industry long run supply curve is downward sloping.
The minimum average total cost falls as the size of the industry grows (and rises as it contracts). This is often called a decreasing cost industry.
Note the difference between EXTERNAL economies/diseconomies and INTERNAL economies/diseconomies of scale

19. Long Run Market Supply with External Diseconomies$
SRSold
SRSnew
LRS B C A
Dnew
Dold Q

20. Long Run Perfectly Competitive Equilibrium - Performance
Two Efficiency Definitions
The market equilibrium quantity traded (Q) is Pareto/Allocatively Efficient(AE) if net social surplus in the market is maximized.
The firm is productively efficient(pe) if its output level (q) is such that the firm’s long-run average total costs are minimized.
Question: Do we get either... or both... under perfect competition?

21. Answer: 1st Fundamental Theorem of Welfare Economics In Pictures
THE MARKET
a typical firm $ $
lratc
SRS w/N* A a
mr=δ P* P* D Q* Q q* q

22. Long Run Perfectly Competitive Equilibrium - Performance
Equity: Is the outcome of the competitive process fair? Equitable? Just?
Good questions that we do not answer here and now.

23. RECALL…Various Market Structures Next Batter Up = Monopoly
Perfectly Competitive:
many firms
identical products
free entry and exit
full and symmetric information
Monopoly:
single firm
no close substitutes, only imperfect substitutes in related markets
barriers to entry and possibly exit
full and symmetric information, or possibly not

24. Sources of Monopoly Entry Barriers
Technical:
Natural monopoly
Vital input ownership
Technical secrets (the better mousetrap)
Legal:
Patents
Franchises
Licenses
Strategic:
Buy ‘em up
Blow ‘em up
Let’s make a deal