1. End of Perfect Competition Lecture 21
Dr. Jennifer P. Wissink
©2018 John M. Abowd and Jennifer P. Wissink, all rights reserved.
April 16, 2018

2. 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.

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

4. Goldilocks: Getting the Long Run Average Total Cost Curve for Three Different Levels of K
Ksmall
atc-Ksmall
atc-KMedium
KMedium
atc-KLARGE
K LARGE

5. i>clicker question
Given the information in the graph, which size plant should Goldilocks build?
small
Medium
LARGE
Don’t know
One of each
atc-small
atc-Medium
atc-LARGE

6. 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

7. Ford, GM & Long Run Cost Curves

8. Internal Economies of Scale & Minimum Efficient Scale

9. 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-Ksmall
q=35
q=50
q=150
q in tons

10. 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!

11. 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.

12. Long Run Equilibrium Position with Identical Firms
Each firm is profit maximizing  mr = mc at q* for each firm. (1)
Zero profit required  P* = lratc at q* for each firm. (2)
Perfectly competitive firm  P* = mr at all values of q. (3)
Sub (3) into (1)  P* = mc at q* for each firm. (4)
Using (2) and (4)  mc = lratc at q* for each firm.
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.

13. 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

14. 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.

15. What’s Not OK...

16. 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*

17. Long Run Market Supply in a Perfectly Competitive Market (assuming a “constant cost” industry)
Both points A and C from 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.
assumes tech doesn’t change with entry and exit
assumes input prices don’t change with entry and exit
P* called the “normal” price.
SRS w/N*
SRS
w/N** B P’ A C P*
LRS
LRS
Dnew
Dold Q* Q’
Q** Q

18. Short Run versus Long Run Market Supply Curves: Recap
Along the short run market supply curve the number of firms in the industry is fixed, along with any fixed factors of production for the firm.
Along the long run market supply curve all firms operate at the point where marginal cost equals average cost. The number of firms adjusts to vary the supply.
Remember, all firms are assumed to be identical.
Remember, an assumption of perfectly competitive markets is that firms can freely enter and exit.
SRS w/N*
SRS
w/N** B P’ A C P*
LRS
LRS
Dnew
Dold Q* Q’
Q** Q