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5.2 Long Run and Violations of Assumptions

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1 5.2 Long Run and Violations of Assumptions
5.2.1 Long run Industry Supply 5.2.2 Violations of Assumptions 5.2.3 Summary of Perfect Competition

2 Application “Days of cheap food are over say suppliers as ingredients costs soar” The Guardian 5th September 2007 Rapidly rising commodity prices due to Chinese and Indian growth Soft commodities affected too including grains Corn is used as a food stuff but also a feed for animals such as pigs and as a bi-fuel Producers of bread, pasta and tortillas around the world seeing huge increases in costs that they struggle to pass on

3 5.2.1 Long Run Industry Supply Curve
The key to understanding here is the input industries into the perfectly competitive market Will the costs of these inputs rise/fall or remain the same as the PC industry adjusts to a change in long-run equilibrium? These outcomes are reflected in the costs curves for the PC firms

4 Begin with the same basic scenario:
We are in long –run equilibrium in a PC market All firms make normal profits Equilibrium is disturbed by a shift in demand due, for example, to a change in tastes, a change in income or a change in the prices of substitute/complementary goods Question: how does this affect equilibrium and how can we find out the long-run supply curve from this? Answer: it depends on the costs of inputs to answer both

5 A) Constant Cost Industry
Firm Market S1 MC S2 P2 ATC P1 LRSC D2 D1 q1 q2 Q1 Q2 Q3

6 Market S1 MC S2 ATC1 P2 LRSC ATC P3 P1 D2 D1 q2 Q1 Q2 Q3 q1
B) Increasing Cost Industry Firm Market MC1 S1 MC S2 ATC1 P2 LRSC ATC P3 P1 D2 D1 q2 Q1 Q2 Q3 q1

7 C) Decreasing Cost Industry
Firm Market S1 MC MC1 P2 S2 ATC ATC1 P1 P3 LRSC D2 D1 Q1 Q2 Q3 q1 q2

8 5.2.2 Violations of Assumptions
What happens when perfect foresight is relaxed? S P Convergent cobweb p2 p3 Elasticities are key p1 D q3 q2 Q q1

9 Divergent cobweb D S p2 P p1 Q q1

10 Two key questions to ponder on violations:
What happens if the goods are not homogeneous? What happens if economies of scale/size exist? Both would lead to outcomes of imperfect competition but to differing degrees

11 5.2.3 Summary of Perfect Competition
Perfect competition is the ideal form of market where economies of size do not exist It must be viewed as a benchmark and not necessarily a representation of what actually happens in markets Remember the vital role of the assumptions The nature of the long run industry supply curve depends entirely on the nature of the cost of inputs


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