Microeconomics Chapter 11 Notes
Microeconomics Chapter 11 Notes ECON 1010
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This 4 page Class Notes was uploaded by Danyn Notetaker on Saturday April 9, 2016. The Class Notes belongs to ECON 1010 at Tulane University taught by Armine Shahoyan in Summer 2015. Since its upload, it has received 11 views. For similar materials see Microeconomics in Economcs at Tulane University.
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Date Created: 04/09/16
Learning Objectives - Explain how Long Run differs from Short Run in pure competition - Describe how proﬁts and losses drive long-run adjustment process of pure competition - Explain the difference between constant, increasing, and decreasing cost industries - Show how long run equilibrium in pure competition produces an efﬁcient allocation of resources - Discuss creative destruction and proﬁt incentives for innovation The Long Run in Pure Competition - In short run ﬁrms can shut down, but here is insufﬁcient time to go out of business - In the long run there is enough time for ﬁrms to liquidate and get out of the business - There’s no speciﬁc time period that makes up the long run as it differs by industry - The key concept of long run is how proﬁts or losses in combination with free entry and exit steer industry to use resources efﬁciently - Proﬁt maximization in Long Run • Several assumptions are made - Entry and exit of ﬁrms are the only long run adjustment - Firms in the industry have identical cost curves - The industry is a constant-cost industry, meaning entry and exit of ﬁrm won’t affect resource prices or location of unit-cost schedule for individual ﬁrms The Long Run Adjustment Process in Pure Competition - After long run equilibrium is achieved, product price will be equal to, and production will occur at, each ﬁrm’s minimum Average Total Cost • Firms seek proﬁt and shun loss • Under competition, ﬁrms may enter and exit industries freely • If short run losses occur, ﬁrms leave; if proﬁtable, ﬁrms enter - The model is one of zero economic proﬁts this allows for a normal proﬁt to be made in the long run: Normal Proﬁt=Cost that is incorporated in the cost curves • If economic proﬁts are being made, ﬁrms enter, upping market supply, lowering product price to equilibrium where no economic proﬁts are made • These graphs show temporary proﬁts and the re-establishment of long-run equilibrium in a representative ﬁrm and the industry. • A favorable shift in demand (D1 to D2) will upset the original industry equilibrium and produce economic proﬁts. • As a result, those proﬁts will entice new ﬁrms to enter the industry, increasing supply (S1 to S2) and lowering product price until economic proﬁts are once again zero. • In other words, an increase in demand temporarily raises price. Higher prices draw in new competitors. Increased supply returns price to equilibrium. • If losses occur in the short run. ﬁrms will leave; this decreases market supply, causing the price to rise until normal proﬁts are earned - Temporary losses and establishment of long run equilibrium is a single ﬁrm and in the industry - A decrease in demand temporarily lowers price, price drives away competitors, lowering the supply, which returns price back to equilibrium Long Run Supply - Long run supply for a constant-cost industry will be perfectly elastic; level of output doesn’t affect price • In a constant-cost industry, expansion or contraction doesn’t affect resource price • Exit and entry of ﬁrms will affect quantity of output, but always bring price back to equilibrium - Long run Supply for an Increasing-cost industry will be upward sloping as industry expands • Average cost curves shift upward as industry expands and downwards when it contracts • A two-way proﬁt squeeze will occur as demand increases because costs will rise as ﬁrms enter, and new equilibrium price must increase if the level of proﬁt is to be maintained at a normal level - In an Increasing-cost industry, the entry of new ﬁrms in response to an increase in demand will bid up resource prices - As a result, an increased industry output will be forthcoming only at a higher price - Long run supply for a decreasing-cost industry will be downward sloping • Average cost increases when industry contracts - Long run supply curve for a decreasing-cost industry is down-sloping - In a decreasing-cost industry, the entry of new ﬁrms in response to an increase in demand will lead to decreased input price Pure Competition and Efﬁciency - Whether the industry is one of constant or increasing costs the ﬁnal long run equilibrium will have the same basic characteristics • Productive efﬁciency occurs when P=minimum Average Total Cost; at this point ﬁrms must use the least-cost technique or they won’t survive • Allocative efﬁciency occurs where P=Marginal Cost, because price is society’s measure of relative worth of a product at the margin or its marginal beneﬁt - And the MC of producing X measures the relative worth of other goods that the resources used in producing X could have otherwise produced - Price measures the beneﬁt that society gets from additional units of X, and the MC of this unit measures the sacriﬁce or cost to society of other goods given to produce X - If price is greater than the MC, then society values more unites of X than alternative products - Until Qe, demand lies above supply implying the Marginal Beneﬁt of those units exceeds the MC so procession creates net beneﬁts - If price is less than the MC, then society values other goods more than X, and resources are over allocated to X - Beyond Qe, supply lies above demand implying that society would prefer a reduction in the production of the good and fewer resources allocated to the production of this good - Allocative efﬁciency implies maximum consumer and producer surplus • Consumer surplus is the beneﬁt buyers receive by have the market price being less than the maximum price they are willing and able to pay • Producer surplus is the beneﬁt sellers receive by having the market price less greater than their minimum acceptable price • Combined consumer and producer surplus is at its maximum at equilibrium • Any quantity greater than the equilibrium would reduce both consumer and producer surplus • Any quantity greater than equilibrium would occur with an efﬁciency loss that would subtract from combined consumer and producer surplus - Dynamic adjustments will occur automatically in pure competition when changes in demand, or in resource supplies, or in technology occur Dis equilibrium will cause expansion/contraction of the industry until new equilibrium at • P=MC occurs - ‘The Invisible Hand” works in a competitive market system since no explicit orders are given to the industry to achieve P=MC Technology Advance and Competition - So far in the long run analysis of pure competition, assumed that entry/exit of ﬁrms is merely a reaction to price and that all ﬁrms are the exact same - The heart of competition is in creation of new goods and production technology - There is always an attempt to somehow gain more than a normal proﬁt - Since ﬁrms in pure competition lack the ability to change the market price, they seek to improve production technology, lower costs, and increase proﬁt - A ﬁrm can create a new, popular good as the only producer of the food the ﬁrm will have control over price and make more than a normal proﬁt - No matter how the ﬁrm manages to increase proﬁts, usually these are only temporary beneﬁts - Creative destruction • Creation of new good and production techniques that destroys market shares of ﬁrms committed to old goods and old business methods - The mere threat of new good and technology can cause existing ﬁrms to abandon old ways - There are many examples of creative destruction in transportation, entertainment, music, postal service, and retail - As creative destruction evolves an industry, individuals will likely become unemployed so there are costs even though the beneﬁts are greater A Patent Failure? - Patents give inventors the sole legal right to market and sell their new ideas for a period of 20 years - This allows ﬁrms to recoup their initial investment cost - Without patents new research, inventions, and innovations may not occur - The patent system also gives ability to stiﬂe creative abilities of others - Some Companies may buy up patents in hopes of suing for royalties
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