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LONG RUN A period of time over which the number of firms in an industry can change their production facilities. In the long run, firms can enter or leave.

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Presentation on theme: "LONG RUN A period of time over which the number of firms in an industry can change their production facilities. In the long run, firms can enter or leave."— Presentation transcript:

1 LONG RUN A period of time over which the number of firms in an industry can change their production facilities. In the long run, firms can enter or leave an industry, and existing firms can modify their facilities or build new facilities. The time required for a firm to build a production facility and start producing output. The long run varies across industries. A period of time over which the number of firms in an industry can change their production facilities. In the long run, firms can enter or leave an industry, and existing firms can modify their facilities or build new facilities. The time required for a firm to build a production facility and start producing output. The long run varies across industries.

2 LONG-RUN SUPPLY CURVE Shows the relationship between price and quantity supplied over a period of time long enough that firms can enter or leave the market and firms can modify their production facilities.

3 Chair Industry Output and Average Production Cost NumberIndustryChairsTotalAverage of firms OutputperCost forCost Per FirmFirmChair $400 $20 501,00020$480 $24 751,50020$560 $28 The average cost of chair industry increases as the industry grows for two reasons: NumberIndustryChairsTotalAverage of firms OutputperCost forCost Per FirmFirmChair $400 $20 501,00020$480 $24 751,50020$560 $28 The average cost of chair industry increases as the industry grows for two reasons:

4 Reasons Average Cost Grows As Industry Grows Increasing Input Prices As an industry grows, it competes with other industries for limited amounts of various inputs; this competition drives up the prices of these inputs. Less Productive Inputs A small industry only uses the most productive inputs, but as the industry grows, firms may be forced to use less productive inputs. Increasing Input Prices As an industry grows, it competes with other industries for limited amounts of various inputs; this competition drives up the prices of these inputs. Less Productive Inputs A small industry only uses the most productive inputs, but as the industry grows, firms may be forced to use less productive inputs.

5 Drawing the long-run supply curve Price Initial Demand New Demand Quantity (thousands) Initial Short-Run Supply Quantity SMC 6.00 SATC 1 MR MR 2 MR 3 SATC 2 Market Firm Long-Run Supply New Short-Run Supply Profit 11

6 The Long-Run Market Supply Curve How much output produced at each price. Determine the total output of the industry by multiplying the output per firm by the number of firms in the industry. How much output produced at each price. Determine the total output of the industry by multiplying the output per firm by the number of firms in the industry.

7 Determining Number of Firms in an Industry Whenever opportunity to make profit - price exceeds average cost - firms enter market. Firms continue to enter until economic profit is zero. To find number of firms in the market, find the quantity of chairs at which average cost equals market price. Whenever opportunity to make profit - price exceeds average cost - firms enter market. Firms continue to enter until economic profit is zero. To find number of firms in the market, find the quantity of chairs at which average cost equals market price.

8 Price of Chairs $ 5001,0001,500 Chairs Per Hour The Long-Run Market Supply Curve e h i

9 The Long-Run Supply Curve The preceding long-run supply curve: Is positively sloped. The higher the price of chairs, the larger the quantity supplied. An increase in the price of chairs makes chair production more profitable, so firms enter the market, increasing the total output of the industry. The preceding long-run supply curve: Is positively sloped. The higher the price of chairs, the larger the quantity supplied. An increase in the price of chairs makes chair production more profitable, so firms enter the market, increasing the total output of the industry.

10 Increasing-Cost Industry An industry with a positively-sloped long-run supply curve. Indicates average cost of production increases as industry grows. Supply curve will be relatively steep if average cost increases rapidly as industry grows. With rapidly increasing average cost, a relatively large increase in price is needed to get firms to produce more output. An industry with a positively-sloped long-run supply curve. Indicates average cost of production increases as industry grows. Supply curve will be relatively steep if average cost increases rapidly as industry grows. With rapidly increasing average cost, a relatively large increase in price is needed to get firms to produce more output.

11 3 Price of Taxi Service $ per mile 1,0002,000 Miles of Taxi Service Per Hour The Long-Run Market Supply Curve For a Constant-Cost Industry Long-Run Supply Curve TAXI

12 Constant-Cost Industries An industry with a horizontal long-run supply curve. Indicates average cost of production is constant. It can continue to buy inputs at the same prices, and these inputs are as productive as inputs in the smaller industry. Industry must be small part of relative input markets: industry does not affect the prices of inputs. An industry with a horizontal long-run supply curve. Indicates average cost of production is constant. It can continue to buy inputs at the same prices, and these inputs are as productive as inputs in the smaller industry. Industry must be small part of relative input markets: industry does not affect the prices of inputs.

13 Decreasing-Cost Industry An industry with a negatively-sloped long-run supply curve. The average cost of production decreases as the industry expands. An industry with a negatively-sloped long-run supply curve. The average cost of production decreases as the industry expands.

14 Short-Run versus Long-Run Supply Curves Long-run response to change in price is much greater than short-run response. The long-run supply curve is much flatter than the short run curve, meaning that the quantity of chairs increases by a larger amount in the long run. The short-run supply curve is much steeper than the long-run supply curve because there are diminishing returns in the short run. Long-run response to change in price is much greater than short-run response. The long-run supply curve is much flatter than the short run curve, meaning that the quantity of chairs increases by a larger amount in the long run. The short-run supply curve is much steeper than the long-run supply curve because there are diminishing returns in the short run.

15 24 28 Price of Chairs $ 1,0001,500 Chairs Per Hour Long-Run versus Short-Run Market Supply Curve h i j Short-Run Supply Curve Long-Run Supply Curve PRICE $24$28 SHORT RUN # of Firms Chairs by 1 firm Chairs by all firms 1,000 1,100 LONG RUN # of Firms Chairs by 1 firm Chairs by all firms 1,000 1,500 1,100

16 Long-Run versus Short-Run Market Supply Curve Price elasticity of supply measures difference between short-run and long-run responses to change in price: Change in price = 16.67% = 4/24 Short-run change in quantity = 10% = 100/1000 Short-run price elasticity of supply = 0.60 Long-run change in quantity = 50% = 500/1000 Long-run price elasticity of supply = 3.00 Price elasticity of supply measures difference between short-run and long-run responses to change in price: Change in price = 16.67% = 4/24 Short-run change in quantity = 10% = 100/1000 Short-run price elasticity of supply = 0.60 Long-run change in quantity = 50% = 500/1000 Long-run price elasticity of supply = 3.00

17 Effects of Increased Demand Increased demand results in rightward shift in demand curve, causing a shortage at the original price: quantity demand exceeds quantity supplied at the original price. In Short Run The number of firms is fixed, Supply curve is relatively steep, Price increases by large amount, In Long Run Firms can enter market, Supply curve is relatively flat, Price increases by small amount. Increased demand results in rightward shift in demand curve, causing a shortage at the original price: quantity demand exceeds quantity supplied at the original price. In Short Run The number of firms is fixed, Supply curve is relatively steep, Price increases by large amount, In Long Run Firms can enter market, Supply curve is relatively flat, Price increases by small amount.

18 Price of Video Rentals $ Per Night i s Initial Demand New Demand Quantity: Thousands of Video Rentals per Day Short-Run Supply f Long-Run Supply Price Quantity Short Run Change Long Run Change $ $ $ Short-Run and Long-Run Effects of an Increased Demand for Video Rentals

19 Relationship between long- run and short-run cost curves Units of output Long-run average cost (LAC) Dollars per unit SATC 1 SATC 2 SMC SATC 3

20 Relationship between LAC and LMC Long-run marginal cost is the change in total cost resulting from producing an extra unit of output in the long-run. When LAC is downward-sloping, LMC must lie below LAC. When LAC is horizontal, LMC and LAC are equal. Long-run marginal cost is the change in total cost resulting from producing an extra unit of output in the long-run. When LAC is downward-sloping, LMC must lie below LAC. When LAC is horizontal, LMC and LAC are equal.

21 Relationship between long- run and short-run cost curves Units of output Long-run average cost (LAC) Dollars per unit 300 Long-run marginal cost (LMC)

22 MONOPOLYMONOPOLY An industry served by a single firm. Occurs when some barrier to entry exists, preventing other firms from entering the market. PATENT -- Granted by the government, giving an inventor exclusive right to sell a new product for some period of time. Government implicitly grants monopoly power. For example, government permits major league baseball to restrict the number and location of teams. An industry served by a single firm. Occurs when some barrier to entry exists, preventing other firms from entering the market. PATENT -- Granted by the government, giving an inventor exclusive right to sell a new product for some period of time. Government implicitly grants monopoly power. For example, government permits major league baseball to restrict the number and location of teams.

23 BARRIERS TO ENTRY FRANCHISE or LICENSING SCHEME -- Government designates single firm to sell a particular good: Off-street parking; National Park Food Concessions; Radio and TV FCC licensing. NATURAL MONOPOLY -- Economies of Scale Single firm would be profitable; a pair of firms would lose money; Second firm would make price less than average cost. FRANCHISE or LICENSING SCHEME -- Government designates single firm to sell a particular good: Off-street parking; National Park Food Concessions; Radio and TV FCC licensing. NATURAL MONOPOLY -- Economies of Scale Single firm would be profitable; a pair of firms would lose money; Second firm would make price less than average cost.

24 THE MONOPOLIST’S OUTPUT DECISION How much output to produce at what price. Objective is to maximize profits: The difference between total revenue and total cost. How much output to produce at what price. Objective is to maximize profits: The difference between total revenue and total cost.

25 TOTAL AND MARGINAL REVENUE Total Revenue --- Price times the quantity sold. Marginal Revenue --- The change in total revenue that results from selling one more unit of output. Total Revenue --- Price times the quantity sold. Marginal Revenue --- The change in total revenue that results from selling one more unit of output.

26 PRICEQUANTITYTOTALMARGINAL SOLD REVENUEREVENUE $ $14 1$14 $14 $12 2$24 $10 $10 3$30 $6 $8 4$32 $2 $6 5$30 -$2 $4 6$24 -$6 -$6 PRICE $$ QUANTITY SOLD DEMAND MARGINAL REVENUE QUANTITY SOLD

27 DEMAND, TOTAL REVENUE AND MARGINAL REVENUE PRICE QUANTITY SOLD TOTAL REVENUE MARGINAL REVENUE $ $141$14 $14 $122$24 $10 $103$30 $6 $84$32 $2 $65$30 -$2 $46$24 -$6 PRICE QUANTITY SOLD TOTAL REVENUE MARGINAL REVENUE $ $141$14 $14 $122$24 $10 $103$30 $6 $84$32 $2 $65$30 -$2 $46$24 -$6

28 PRICE$$ QUANTITY SOLD MONOPOLIST’S DEMAND ( MARKET DEMAND ) MARGINAL REVENUE b c d e f g h i j k 0

29 THE MARGINAL PRINCIPLE Increase the level of an activity if its marginal benefit exceeds its marginal cost, but reduce the level if the marginal cost exceeds the marginal benefit. If possible, pick the level at which the marginal benefit equals the marginal cost. MARGINAL REVENUE = MARGINAL COST Increase the level of an activity if its marginal benefit exceeds its marginal cost, but reduce the level if the marginal cost exceeds the marginal benefit. If possible, pick the level at which the marginal benefit equals the marginal cost. MARGINAL REVENUE = MARGINAL COST

30 USING MARGINAL PRINCIPLE TO PICK PRICE AND QUANTITY PRICEQUANTITYMARGINAL MARGINAL SOLDREVENUECOST $ $12 $6 $ $10 $6 $ $8 $6 $ $6 $6 $14 1,000 $4 $6 $13 1,100$2 $6 $12 1,200 $0 $6 PRICEQUANTITYMARGINAL MARGINAL SOLDREVENUECOST $ $12 $6 $ $10 $6 $ $8 $6 $ $6 $6 $14 1,000 $4 $6 $13 1,100$2 $6 $12 1,200 $0 $6

31 USING MARGINAL PRINCIPLE TO PICK PRICE AND QUANTITY PRICE$$ DOSES OF DRUG PER HOUR PROFIT = $8,100 h m i n MARKET DEMAND CURVE MARGINAL REVENUE LONG-RUN MARGINAL COST EQUALS LONG-RUN AVERAGE COST

32 CALCULATING MARGINAL REVENUE Marginal Revenue = Current Total Revenue - Previous Total Revenue = Initial Price - [ Initial Quantity * Slope of Demand Curve ] Marginal Revenue = Current Total Revenue - Previous Total Revenue = Initial Price - [ Initial Quantity * Slope of Demand Curve ]

33 MONOPOLY VERSUS PERFECT COMPETITION PRICE Doses of Drug per hour 9001,800 Long-run average cost and market supply curve Market Demand Curve C M D m p $15 $6

34 DEADWEIGHT LOSS Net loss associated with a monopoly (D). Monopoly is inefficient because it generates less output than a perfectly competitive market. Net loss associated with a monopoly (D). Monopoly is inefficient because it generates less output than a perfectly competitive market.


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