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PPA 723: Managerial Economics Lecture 13: Competition in the Long Run.

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Presentation on theme: "PPA 723: Managerial Economics Lecture 13: Competition in the Long Run."— Presentation transcript:

1 PPA 723: Managerial Economics Lecture 13: Competition in the Long Run

2 Managerial Economics, Lecture 13: Competition in Long Run Outline  Profit Maximization in the Long Run  The Long-Run Supply Curve  Characteristics of Long-Run Equilibrium in a Competitive Market

3 Managerial Economics, Lecture 13: Competition in Long Run LR Competitive Profit Maximization  In competitive markets, firms are still price takers in the long run.  So the long-run output decision is to set output at the q* where p = LRMC(q*)

4 Managerial Economics, Lecture 13: Competition in Long Run Long-Run Shut-Down Decision  In the long run, a firm operates only if revenue  variable cost.  All costs are variable in the long run, so the shut-down rule in the long run is to  operate only if revenue  cost  i.e., if p  minimum of AC curve.

5 Managerial Economics, Lecture 13: Competition in Long Run Short Run vs. Long Run  In the short run, a firm compares its revenue only to its avoidable (variable) cost, It ignores sunk fixed costs.  In the long run, all costs are avoidable.  A firm can eliminate them by shutting down.  So a firm shuts down if LR profit is negative: i.e., if  < 0

6 Managerial Economics, Lecture 13: Competition in Long Run Long-Run Firm Supply Curve  Because all costs are variable in the long run, the long-run firm supply curve equals the long-run MC curve above the minimum of the long-run AC curve.  A firm chooses its capital in the long- run, so the long-run supply curve may differ from the short-run supply curve.

7 Managerial Economics, Lecture 13: Competition in Long Run Figure 8.11 The Short-Run and Long-Run Supply Curves p, $ per unit 50110q, Units per year p SRAC LRMC LRAC SRMC SRAVC B A S SR S LR

8 Managerial Economics, Lecture 13: Competition in Long Run LR Market Supply Curve  The market supply curve = the horizontal sum of firms' supply curves in both the long-run and the short-run.  The market supply curve differs in the long-run and the short-run because of differences in number of firms and, perhaps, in input prices.

9 Managerial Economics, Lecture 13: Competition in Long Run Number of Firms  In the short run, each firm can produce more or less, but the number of firms, n, is fixed.  In the long run, firms can produce more or less and firms can enter or exit the market.  Firms enter a market in response to profits and exit in response to losses.

10 Managerial Economics, Lecture 13: Competition in Long Run p p, $ per unit 150 LRAC LRMC (a) Firm q, Hundred metric tons of oil per year 10 S 1 0 p, $ per unit (b) Market Q, Hundred metric tons of oil per year Long-run market supply before entry 10 0 p1p1 Profit p1p1 Entry S1S1 S2S2 D

11 Managerial Economics, Lecture 13: Competition in Long Run Long-Run Market Supply  The long-run market supply curve is flat at the minimum long-run average cost if  There is free entry and exit.  An unlimited number of firms have identical costs.  Input prices are constant as the number of firms changes.

12 Managerial Economics, Lecture 13: Competition in Long Run p p, $ per unit 150 LRAC LRMC (a) Firm q, Hundred metric tons of oil per year 10 S 1 0 p, $ per unit (b) Market Q, Hundred metric tons of oil per year Long-run market supply curve with entry 10 0

13 Managerial Economics, Lecture 13: Competition in Long Run Why Long-Run Market Supply Curve Sometimes Slopes  Factors that lead to a long-run supply curve that is not flat include  Barriers to entry  Variation in costs across firms  Input prices that vary with market output.

14 Managerial Economics, Lecture 13: Competition in Long Run Figure 8.13 Long-Run Market Supply in an Increasing- Input-Cost Market p, $ per unit q 1 q 2 Q 1 =n 1 q 1 Q 2 =n 2 q 2 q, Units per yearQ p 1 p 2 e 2 e 1 E 2 S E 1 p, $ per unit (a) Firm (b) Market AC 2 MC 2 1 AC 1

15 Managerial Economics, Lecture 13: Competition in Long Run Figure 8.14 Long-Run Market Supply in an Decreasing- Input-Cost Market p, $ per unit q 1 q 2 Q 1 =n 1 q 1 Q 2 =n 2 q 2 q, Units per yearQ p 1 p 2 e 2 e 1 E 2 S E 1 p, $ per unit (a) Firm (b) Market AC 2 MC 2 1 AC 1

16 Managerial Economics, Lecture 13: Competition in Long Run Long-Run Competitive Equilibrium  The intersection of the long-run market supply and demand curves determines long- run competitive equilibrium  With identical firms, constant input prices, and free entry and exit,  The long-run market supply curve is horizontal at minimum long-run AC  The equilibrium price = minimum long-run AC  A shift in the demand curve affects only equilibrium quantity and not equilibrium price.

17 Managerial Economics, Lecture 13: Competition in Long Run Figure 8.15 The Short-Run and Long-Run Equilibria for Vegetable Oil p, $ per ton e 1 f q, Hundred metric tons of oil per year MC AVC (a) Firm AC p, $ per ton F 1 E 1 F 2 E 2 1,50002,0003,3003,600 Q, Hundred metric tons of oil per year (b) Market D 1 S SR S LR D 2 f

18 Managerial Economics, Lecture 13: Competition in Long Run Characteristics of Long-Run Competitive Equilibrium  All firms earn zero economic profit (which means they earn the same business profit they could earn elsewhere).  All firms in market operate at minimum long-run AC; i.e, they produce the equilibrium quantity using the minimum possible resources.


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