Today SR market equilibrium Changes in equilibrium LR equilibrium Print out slides #26 & 28 full-sized to have more room to work.

Short-Run Market Equilibrium The price must clear the market (Q D = Q S ). Every firm must be profit-maximizing, given its costs and the market price. Firms may be making profits or losses.

Graph of SR Market Equilibrium qQ D SRS PPTypical FirmIndustry or Market Does this firm produce in the short run? If so, how much? Q* P* MC AVC ATC

Graph of SR Market Equilibrium qQ D SRS PPTypical FirmIndustry or Market Does this firm make profits in the short run? If so, how much? Q* P* =MR MC AVC ATC q*

Graph of SR Market Equilibrium qQ D SRS PPTypical FirmIndustry or Market P - ATC = profit per unit. Does the rectangle go to the bottom of ATC? Q* P* =MR MC AVC ATC q*

Decrease in Demand qQ D SRS PPTypical FirmIndustry or Market ATC - P = loss per unit. Does the rectangle go to the bottom of ATC? Q* P* P’=MR MC AVC ATC q* D’ Q’ q’

Results of Decrease in Demand Market price falls. Firm responds by cutting its output. This firm makes losses but still produces in the short run. (Why?) Market quantity falls.

Further Decrease in Demand qQ D SRS PPTypical FirmIndustry or Market Q* P* P’’= MR MC AVC ATC q* Q’ q’ Q’’ q’’ What does this firm do in the short run? Why? D’ D’’

Firm Supply in the Long Run If price is less than ATC, a firm makes losses in the short run. Such a firm will shut down in the long run. Therefore, the firm’s long-run supply curve is its marginal cost curve above ATC.

Graphing the Firm’s Supply Curve q P MC P0P0 P1P1 P2P2 P3P3 AVC SRS ATC LRS

Long-Run Equilibrium The key to understanding the LR is firm entry and exit.

The Key Profits are a signal for resources to flow into the industry: new firms enter. Losses are a signal for resources to leave the industry: firms exit.

Conditions for Long Run Equilibrium The market price clears the market. Firms must max. profits, given their SR constraints. Firms do not make profits or losses. Firms must be at their lowest SRAC, given their level of production. –The assumption “room for many firms” implies firms produce at the lowest level of their LRAC curve.

Adjustment to LR Equilibrium qQ D SRS PPTypical FirmIndustry or Market What do you expect will happen in the long run? Q* P* MC ATC

Adjustment to LR Equilibrium qQ D SRS PPTypical FirmIndustry or Market Profits attract entry. Price falls. Firm’s output falls, market output rises (why?). What happens to the firm’s profits? Is this LR equilibrium? Q* P* MC ATC SRS’ P’

Adjustment to LR Equilibrium qQ D SRS PPTypical FirmIndustry or Market Entry continues until the firm no longer earns profits. Is this LR equilibrium? Q* P* MC ATC SRS’ SRS’’ P” Q” q”

LR Equilibrium qQ D PPTypical FirmIndustry or Market In long run equilibrium, firms in a perfectly competitive market will operate at the lowest point on their LRAC curves. Q* MC ATC SRS’’ P” Q” q” LRATC

Adjustment to LR equilibrium: Case of Initial Profits Profits attract new firms into the market, increasing market supply. Market price falls. All firms must cut back output and see lower profits. Market quantity rises, though, due to larger number of firms. Process continues until profits fall to zero.

Initial Losses qQ SRS PPTypical FirmIndustry or Market Why is this not LR equilibrium? What will happen in the LR? Q* P* P=MR MC AVC ATC D q*

Firm Exit If a firm is making losses, then it will get out of business as soon as possible –expiration of lease, sale of property, etc. Exception: if it expects market conditions to improve soon enough, it may decide to wait it out. –May wait for others to exit first, or demand to increase. Note this could be quite costly. We usually ignore this possibility.

Initial Losses qQ SRS PPTypical FirmIndustry or Market Firms exit. Market price rises. Remaining firms produce more. Losses shrink. Market output falls. Is this a LR equilibrium? Q* P* P=MR MC AVC ATC D q* SRS’ P’=MR’

Initial Losses qQ SRS PPTypical FirmIndustry or Market Firms exit until none make losses. Is this a LR equilibrium? Q* P* P=MR MC AVC ATC D q* SRS’ P”=MR” SRS” Q” q”

Coming Up: LR Industry Supply—3 Cases Market Efficiency

Group Work LR supply SR industry equilibrium

The Firm’s LR Supply Curve In the long run, if the market price is $3, what quantity will the firm produce? _____ In the long run, if the market price is $5.25, what quantity will the firm produce? _____ In the long run, if the market price is $7.50, what quantity will the firm produce? _____ Trace out the firm's long-run supply curve. How does this compare to the SR supply curve from the last lecture’s problem?

Firm’s LR Supply Curve

Short Run Market Equilibrium Indicate all of the following answers on the graph for the short run. –Equilibrium market price (P*) –Equilibrium market quantity(Q*) –Firm's output (q*) –Price firm charges (p*) –Demand for firm's output (d) –Firm's marginal revenue (MR) –Firm's average revenue (AR) –Firm's average profit/loss per unit –Firm's total profit/loss.

SR Industry Equilibrium