Krugman/Wells Microeconomics in Modules and Economics in Modules Third Edition Module 27 Long-Run Outcomes in Perfect Competition

What You Will Learn Why industries behave differently in the short run from the long run What determines the industry supply curve in both the short run and the long run 2 of

The Short-Run Individual Supply Curve 3 of $ MC ATC AVC C B A E Minimum average variable cost Short-run individual supply curve Shut- down price Price, cost of bushel Quantity of tomatoes (bushels) The short-run individual supply curve shows how an individual producer’s optimal output quantity depends on the market price, taking fixed cost as given. A firm will cease production in the short run if the market price falls below the shut- down price, which is equal to minimum average variable cost.

Industry Supply Curve The industry supply curve shows the relationship between the price of a good and the total output of the industry as a whole. The short-run industry supply curve shows how the quantity supplied by an industry depends on the market price, given a fixed number of producers. 4 of 14

Industry Supply Curve There is a short-run market equilibrium when the quantity supplied equals the quantity demanded, taking the number of producers as given. 5 of 14

The Short-Run Market Equilibrium 6 of $ D Short-run industry supply curve, S E MKT Shut- down price Price, cost of bushel Quantity of tomatoes (bushels) Market price The short-run industry supply curve shows how the quantity supplied by an industry depends on the market price given a fixed number of producers. There is a short-run market equilibrium when the quantity supplied equals the quantity demanded, taking the number of producers as given.

The Long-Run Industry Supply Curve A market is in long-run market equilibrium when the quantity supplied equals the quantity demanded, given that sufficient time has elapsed for entry into and exit from the industry to occur. 7 of 14

The Long-Run Market Equilibrium 8 of 14 A market is in long-run market equilibrium when the quantity supplied equals the quantity demanded, given that sufficient time has elapsed for entry into and exit from the industry. Quantity of tomatoes (bushels) $ , $ D E C D Y Z MC ATC A B (a) Market (b) Individual Firm E MKT D MKT C MKT S1S1 S3S3 S2S2 Price, cost of bushel Quantity of tomatoes (bushels) Price, cost of bushel Break- even price

The Effect of an Increase in Demand in the Short Run and the Long Run 9 of 14 MC ATC X Y 000 $18 14 Quantity MC ATC Z Y Price S1S1 D1D1 D2D2 S2S2 Y MKT X MKT Z MKT LRS QXQX QYQY QZQZ (a) Existing Firm Response to Increase in Demand (b) Short-Run and Long-Run Market Response to Increase in Demand (c) Existing Firm Response to New Entrants Price, cost Increase in output from new entrants. An increase in demand raises price and profit. Higher industry output from new entrants drives price and profit back down. Quantity The LRS shows how the quantity supplied responds to the price once producers have had time to enter or exit the industry.

Comparing the Short-Run and Long-Run Industry Supply Curves 10 of 14 The long-run industry supply curve is always flatter—more elastic—than the short-run industry supply curve. Short-run industry supply curve, S Long-run industry supply curve, LRS Price Quantity A higher price attracts new entrants in the long run, resulting in a rise in industry output and lower price. A fall in price induces producers to exit in the long run, generating a fall in industry output and a rise in price.

The Cost of Production and Efficiency in the Long-Run Equilibrium In a perfectly competitive industry in equilibrium, the value of marginal cost is the same for all firms. In a perfectly competitive industry with free entry and exit, each firm will have zero economic profits in long-run equilibrium. 11 of 14

The Cost of Production and Efficiency in the Long-Run Equilibrium The long-run market equilibrium of a perfectly competitive industry is efficient: no mutually beneficial transactions go unexploited. 12 of 14

Economics in Action Baling In, Bailing Out Cotton prices were soaring between early 2010 and early 2011, and farmers began planting more cotton. Increases in demand and decreases in supply caused the price increases. Will cotton production remain highly profitable? No, because a highly profitable industry will draw new producers, bringing prices down. 13 of 14

Summary 1.The industry supply curve depends on time. 2.The short-run industry supply curve is the industry supply curve given that the number of firms is fixed. 3.The short-run market equilibrium is given by the intersection of the short-run industry supply curve and the demand curve. 4.The long-run industry supply curve is the industry supply curve given sufficient time for entry and exit. 5.In long-run market equilibrium—the intersection of the long-run industry supply curve and the demand curve— no producer has an incentive to enter or exit. 14 of 14

Summary 6.The long-run industry supply curve is often horizontal. It may slope upward if there is limited supply of an input. It is always more elastic than the short-run industry supply curve. 7.In the long-run market equilibrium of a competitive industry, profit maximization leads each firm to produce at the same marginal cost, which is equal to market price. 8.Free entry and exit means that each firm earns zero economic profit—producing the output corresponding to its minimum average total cost. So the total cost of production of an industry’s output is minimized. 9.The outcome is efficient because every consumer who is willing to pay at least marginal cost gets the good. 15 of 14