1. Perfect Competition: Short Run and Long Run

2. Perfectly Competitive Market
A perfectly competitive market is a market with four features:
There are many firms.
The product is standardized or homogeneous.
Firms can freely enter or leave the market in the long run.
Each firm takes the market price as given.
Is this realistic? Why not?
Individual firms do have some control over price, and can increase or decrease it to a certain extent

3. The Short-Run Output Decision
The firm’s objective is to maximize its profit, equal to revenue minus cost.
Total revenue is the money the firm gets by selling its product; equal to the price times the quantity sold.
Economic profit equals total revenue minus total economic cost.
There are two ways to calculate profit. What are they?
Total approach (profit = total revenue – total costs
Marginal approach (profit is when marginal revenue = marginal cost)

4. Total Approach
Profit = total revenue – total costs
Choose the quantity of output that generates the largest vertical difference between the total revenue curve and total cost curve.

5. Marginal Approach
Marginal revenue is the change in total revenue that results from selling one more unit of output.
= to the price of the product
choose the quantity at which marginal revenue equals marginal cost

6. The Shut-Down Decision
The firm should continue to operate if the benefit of operating (total revenue) exceeds the cost of operating, or total variable cost
Remember: Variable costs are…
When the fixed costs are very high, it is sometimes better to continue operating at a slight loss, rather then shut-down completely and have to pay the fixed costs in full
Why don’t we continue operating when profit sinks below the variable costs?
Example: if the fixed cost of the facility and physical capital was 100 million, and you stop operating, you have to pay that price.
Lets say if per minute, your fixed cost works out to be $36
If you operating at a profit of -$16 per minute, then you lose less money by continuing to operate until fixed costs are paid in full.
You wont have enough money to pay for all the variable inputs such as worker wages

7. The Shut-down Decision
At point z, the marginal revenue (price) is lower then the average total cost (therefore operating at a profit)
However, this point is still higher then the average variable cost (point u) therefore don’t shut down
The factory should shut down at which price? (point s)

8. Short-Run Supply Curves
The firm’s short-run supply curve shows the relationship between the price of a product and the quantity of output supplied by a firm in the short run.
The firm’s short-run supply curve is the part of the firm’s short-run marginal cost curve above the shut-down price.

9. The Short-Run Supply Curve of the Firm
short-run supply curve shows the relationship between the price of a product and the quantity of output supplied (in the short run)
= the part of the firm’s short-run marginal cost curve above the shut-down price.
What do we mean by “in the short run”?
when one of the factors of production is fixed (usually physical capital)

10. Short-Run Market Supply Curve
For the market, simply a sum of all individual suppliers

11. A Market in Long-Run Equilibrium
A market reaches a long-run equilibrium when three conditions hold:
The quantity of the product supplied equals the quantity demanded
Each firm in the market maximizes its profit, given the market price
Each firm in the market earns zero economic profit, so there is no incentive for other firms to enter the market
The first two are the same as the conditions for market equilibrium in the short-run
Therefore the only difference is that in the long-run there is no economic profit
if there was profit being made by any firm, then there would be incentive for other firms to enter the market
In addition to the conditions above, in long-run equilibrium the typical firm earns zero economic profit so there is no further incentive for firms to enter the market.

12. A Market in Long-run Equilibrium
Remember: profit = revenue – costs
Marginal revenue = price, and costs are the average total cost
In long-run equilibrium, price equals marginal cost (the profit-maximizing rule), and price equals short-run average total cost (zero economic profit).

13. Production Costs and the Size of the Industry in the Long Run
Industry Output and Average Production Cost
Number of Firms
Industry Output
Rakes per Firm
Typical Cost for Typical Firm
Average Cost per Rake 50
350 7
$70
$10
100
700 84 12
150
1,050 96 14
This table shows that as more firms enter a market, the price of the same product increases
Why might this be true?
(input costs increase as more firms need more of the special inputs)
(as more inputs are needed for production, less desirable inputs must be used)
The rake industry is an increasing-cost industry because the average cost of production increases as the total output of the industry increases.

14. The Long-Run Supply Curve for an Increasing-Cost Industry
An increasing-cost industry is an industry in which the average cost of production increases as the total output of the industry increases. The long-run supply curve is positively sloped.
The average cost increases as the industry grows for two reasons:
Increasing input prices
Less productive inputs

15. Drawing the Long-run Market Supply Curve
Each point on the long-run supply curve shows the quantity of rakes supplied at a particular price (i.e., at a price of $12, 100 firms produce 700 rakes).
The long-run industry supply curve is positively sloped for an increasing cost industry.
As price increases, supply increases
You can use the supply curve to calculate how many firms should enter the market (assuming a fixed output)
For example, at a price of $12, assuming each firm can achieve a standard output of 7 rakes per minute (i.e. all firms have the same inputs and factors of production – identical firms) there will be 100 firm.
How many firms would exist if output of each firm is only 1 rake per minute?
(700)
Turn to page 200 in text and read examples together. (Wolfram and sugar)

16. Market Equilibrium Revisited
An increase in demand increases the market price to $17, causing the typical firm to produce 8 rakes instead of 7. Price exceeds the short-run average total cost, so economic profit is positive. Firms will enter the market.

17. The Long-Run Effects of an Increase in Demand
In the short-run, firms respond to the increase in demand by adjusting output in their existing production facilities, and the price adjusts from $12 to $17.
Use our knowledge of market equilibrium to see what happens in the short-run and long-run when there is a change in demand
At the original equilibrium (e) average total costs = the market price (no profit)
When the demand increases, the firms that were already producing are now making a profit
increase output to match demand
they can charge a price of $17, which is higher then there average total costs ($12)
Why is this considered a short-run equilibrium?
(economic profit is not zero)
What is the fix?
More firms enter the market until the price is driven down (to match average total cost)

18. The Long-Run Effects of an Increase in Demand
In the long run, after new firms enter, equilibrium settles at $14.
The new price is a higher price than the price before the increase in demand (increasing cost industry).
How do we know what that price will be?
use the long-run supply curve
where it intersects the demand is our new equilibrium price
How do we know this is a long-run equilibrium?
At this point economic profit is zero

19. Long-Run Supply for a Constant-Cost Industry
In a constant-cost industry, firms continue to buy inputs at the same prices.
The long-run supply curve is horizontal at the constant average cost of production.
After the industry expands, the industry settles at the same long-run equilibrium price as before.
When the price of the inputs doesn’t change, regardless of how much all the firms in a market buy
Example: taxis
inputs are gasoline, cars, and labor
because the taxi industry uses a very small percentage of all these inputs, it won’t influence their prices
costs remain the same regardless of how much is supplied