Chapter 21: page 411-420 Profit Maximization in the long run -In the long run, firms already in an industry have sufficient time either to expand or to contract their plant capacities. -the number of firms in the industry may either increase or decrease as new firms enter or existing firms leave. Assumptions (how these long run adjustments modify our conclusions concerning short-run output and price determination. 1. Entry and Exit Only: The only long run adjustment is the entry or exit of firms. We ignore all short run adjustments in order to concentrate in effects of the long run adjustments. 2. Identical costs: All firms in the industry have identical cost curves. cause all firms are affected by any long run adjustments that occur, we can assume that there is an average or representative firm 3. Constant-cost industry: the industry is a constant industry, where the entry and exit of firms does not affect resource prices or the locations of the average, total cost curves of individual firms. goal of analysis: -After all long-run adjustments are completed, product price will be exactly equal to, and the production will occur at, each firm's min avg. total cost. follows 2 basic facts: 1. firms seek profits and shun losses 2. under pure competition, firms are free to enter and leave and industry. -if marginal price initially exceeds avg total costs, the resulting economic profits will attract new firms to the industry. -industry expansion will increase supply until price is brought back down to equality with min avg total cost. -if price initially is less than avg total cost, resulting losses will cause firms to leave the industry. -total supply will decline, bringing price back up to equality with min. avg. total cost. Long-run equilibrium. - if avg firm is in a purely competitive industry that is initially in LR equilibrium. -MR=MC -price and min avg cost are equal -economic profit is 0 -the industry is in equilibrium or at rest because there is no tendency for firms to enter or to leave. existing firms are earning normal profits. -PG 414 Entry Eliminates economic profits -if change in consumer taste increases demand... -price will rise -firm’s marginal rev. curve will shift upward. -there is an economic profit, which will lure new firms into the industry as firm enters... -market supply of the product increases. -market price falls -price and min avg total cost are back to equal. -economic profit caused by the boost in demand has been ELIMINATED. -previous incentive for more firms to enter the industry has disappeared. -long run equilibrium has been restored. Exit eliminated losses: -assume that consumer demand declines.... -market price and marginal revenue drop, production unprofitable -is at Minimum ATC -induces firms to leave the industry -some firms will go out of business -industry supply will decreases, pushing price up! -more firms leave, losses eliminated and long run equilibrium is restored -firms with less production labor forces will be higher cost producers and likely candidates to quit an industry when demand decreases. ****proven that competition, reflected in the entry and exit of firms, eliminates economic profits or losses by adjusting price to equal min. long-run avg. total cost. -this competition forces firms to select output levels at which avg. total cost is minimized. Long-Run supply for a constant cost industry -character of long run supply curve: it is the effect that changes in the number of firms in the industry will have on costs of the individual firms in the industry. -constant-cost industry; industry is under discussion, that industry expansion or contraction will not affect resource prices and therefore production costs. -entry or exit does not affect the long-run atc curves in individual firms. -it is when the industry's demand for resources is small in relation to the total demand for those resources. Then the industry can expand or contract without significantly affecting resource prices and costs. -Curve of a long-run supply curve of a constant cost industry -long run supply curve of a constant cost industry is perfectly elastic -figure on pg 415. Long run supply for an increasing cost industry -most industries are increasing cost industries, in which firm’s ATC curve shift upwards as the industry expands and downwards as the industry contract. -higher resource prices result in higher long-run avg. costs for all firms in the industry. -higher costs cause upward shifts in each firm’s long-run ATC curve -increase in product demand results in economic profits and attracts new firms to an increasingcost industry, a two way squeeze works to eliminate those profits. -now, ATC shifts upward, the overall result is higher than original equilibrium price. -the long-run supply curve for an increasing cost industry is upsloping. Long-Run Supply for a decreasing cost industry -firms experience lower costs as the industry expands. exp: personal computer industry. -as demand increases, new manufactures of computers entered for the industry and greatly increased the resource demand for the components used to build them (exp: microchips, hard drives, etc.) -expand productions enable producers of those items to achieve substantial economies of scale -the decreased production costs of the components reduced their prices which greatly lowered the computer manufacturer’s average costs of production. -supply of personal computers increased by more than demand and the price of personal computers declined. -it is a downsloping curve Pure competition and efficiency: - whether it is a constant cost industry or an increasing cost industry, the final long run equilibrium positions of all firms have the same basic efficiency. - price will settle where it is min avg. total cost. P= Min ATC - margina l cost and average total cost are equal. MC=min ATC - in long-term, triple equality occurs: P = MC=Min ATC - it will earn only a normal profit by producing in accordance with MR=MC -idealized purely comp economy leads to an efficient use of society’s scarce resources. Product efficiency: P=min ATC -productive efficiency: requires that goods be produced in the least costly way. -in long run, pure comp. forces firms to produce at a mina avg. total cost of production and to charge a price that is just consistent with that cost. - min amount of resources will be used to produce any particular output. Allocative efficiency P=MC -requires resources be apportioned among firms and industries to yield the mix of products and services that is most wanted by society. Least cost production must be used to provide society with the right goods -two elements that are critical 1. the money price of any product in society’s measure of relative worth of an additional unit of that product, for exp: cucumbers. so the price of a unit of cucumbers is the marginal benefit derived from that unit of the product 2. marginal cost of an additional unit of product measures the value, or relative worth, of the other goods sacrificed to obtain it. to produce cucumbers, resources are drawn away from producing other goods.. marginal cost of producing a unit of cucumbers measures society's sacrifice of those other products. -producing cucumbers beyond the P=MC point world sacrifice alternative goods whose value to society exceeds that of the extra cucumbers -producing cucumbers short of P=MC point would sacrifice cucumbers that society values more than the alternative goods its resources could produce. Max consumer and producer surplus: consumer surplus: difference between the max prices that consumers are willing to pay for a product and the market price of that product. producer surplus is the difference between the min prices that producers are willing to accept for a product and the market price of the product. it is the vertical distances between the equilibrium price and the supply curve. pg 418. -pure comp. produces allocative efficien cy where P=MC=min ATC -a change in consumer tastes resource supplies or tech will automatically set in motion the appropriate realignments of resources. invisible hand: max profits for individual producers and creates a pattern or resource allocation that max consumer satisfaction. they mix private interest and society's interests.
