1. Short Run Equilibrium In Perfect Competition Lecture 19
Dr. Jennifer P. Wissink
©2017 John M. Abowd and Jennifer P. Wissink, all rights reserved.
April 12, 2017

2. Jonathan’s Profit Maximizing Move When Market Price P=$528
Recall: If q* maximizes  , then
(1) mr(q*) = srmc(q*)
(2)  (q*) is a maximum and not a minimum.
(3) at q* it is worth operating:  (q*>0)   (q=0)
Jonathan's Apple Farm Costs (detail)
Apples
(tons/year)
$Land
$Hired
Labor
$Proprietor's
time
$Total Cost
$Average
Cost
$Marginal
larger delta method
200
12,400
54,400
13,200
80,000
400
210
58,560
84,160
401
440
220
63,200
88,800
404
484
230
68,240
93,840
408
528
240
73,760
99,360
414
588
250
105,600
422
632
260
86,400
112,000
431

3. Using The Cost Graph to Derive Jonathan’s Short Run Supply Curveq*

4. END OF MATERIAL FOR PRELIM 2
Thank goodness!

5. Jonathan’s Short Run Supply Curve
So, for a perfectly competitive firm, the srsfirm = srmc for all points where srmc ≥ sravc (this assumes that all fixed costs are sunk).
Note that we have confirmed the “law of supply”!

6. i>clicker question
An improvement in production technology will shift the marginal cost curve
downward and decrease quantity supplied at each price.
upward and increase quantity supplied at each price.
upward and decrease quantity supplied at each price.
downward and increase quantity supplied at each price.
downward with no effect on market supply.

7. The Perfectly Competitive Short Run Market Supply Curve
The market supply curve is the horizontal sum of the quantities supplied by each seller at each market price.
Market supply, thus reflects the marginal costs of each of the producers in the market.

8. Reprise: The Short Run Market Supply
How does our scratch supply curve compare to the one we bought off the shelf?
Recall the supply function for X = mini speakers: QS = g(PX, Pfop, Poc, S&T, N) Where: QS = maximum quantity that producers are willing and able to sell PX = X’s price Pfop = the price of factors of production Poc = the opportunity costs S&T = science and technology N = number of firms in the market

9. Individual Producer’s Surplus
Recall: Producer’s Surplus measures the gain to the firm from selling all units at the market price.
Recall
PS on q units = Total Revenue – Variable Costs
We now know
Profit = Total Revenue – Variable Costs – Fixed Costs
Rearranging we get:
Variable Costs = Total Revenue – Fixed Costs – Profit
Plugging this expression for Variable Costs into PS we get:
PS on q units = Total Revenue – Total Revenue + Fixed Costs + Profit
So Producer’s Surplus can also be written as
PS on q units = Fixed Costs + Profit
An alternative interesting way to think of producer’s surplus
On the graph, Producer’s Surplus is
the area above the short run firm supply curve and below the market price

10. Jonathan’s Producer’s Surplus
Jonathan’s individual producer’s surplus when the market price is $528, is…
…the sum of his economic profits ($27,600) and his fixed costs ($25,600) = $53,200…
… or alternatively it is total revenue ($121,440) minus variable costs ($68,240) = $53,200.
srs-firm
≈$250

11. SO: The Market & The Firm in Short Run Equilibrium
Given:
Market Demand
Firms’ Technologies (including some fixed inputs)
Factor Prices
The Number of Firms
Need:
Each firm is profit maximizing
Market Demand = Short Run Market Supply
Solve For: Q* q* P*
profit*

12. SO: The Market & The Firm In Short Run Equilibrium$ $
Dmkt
sratc
srmc A a
mr*=δ* P* P*
SRSmkt w/N Q* q* Q q
MARKET
typical firm

13. Market Net Social Surplus
The market equilibrium occurs at P* & Q*
Consumers’ surplus is the blue shaded area
Producers’ surplus is the red shaded area
Net social surplus is the blue and red shaded area P
Short Run Supply=MC P*
Demand=MB Q*
Quantity

14. Next: Long Run Firm & Market Conduct
First, we are going to examine the long run cost curves of a single business.
Next, we will make precise the relation between the firm’s short run and long run supply decisions.
Then, we will consider the market in long run equilibrium.
So: Consider the following… q = f(K, L) where q is firm output, K is firm capital and L is firm labor and where PK is the unit price of capital and PL is the unit price of labor.

15. (Only) Three Long Run Cost Curves
There are three long run cost curves for the firm:
long run total cost lrtc = PLL*(q) + PKK*(q)
long run average total cost lratc = lrtc/q
long run marginal cost lrmc = lrtc/q
The most important is the lratc curve.

16. Goldilocks: Getting the Long Run Average Total Cost Curve for Three Different Levels of K
small
atc-small
atc-Medium
Medium
atc-LARGE
LARGE

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

18. 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

19. Ford, GM & Long Run Cost Curves

20. Internal Economies of Scale & Minimum Efficient Scale

21. 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

22. 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!

23. 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.

24. Why Are There Zero Economic Profits in the Long Run?
Zero economic profits means that all factors used in production make exactly their opportunity cost.
Purchased factors receive their market price, which is equal to their opportunity cost.
Owned factors receive the same compensation that they would receive in their next best use, which is also equal to their opportunity cost.
Thus, no firm wants to enter the market because it cannot make any more money than it is currently making.
Similarly, no firm wants to leave the market because it cannot make any more money in any other business.

25. 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.

26. 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

27. 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.

28. What’s Not OK...