competition and market equilibrium. perfect competition defining characteristic is lack of market...
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Competition and Market Equilibrium
Perfect Competition• Defining Characteristic is lack of market power
– Price Takers• How do we get there?
– Homogeneous output (or homogeneous enough)– Enough buyers and sellers that no one (or group
thereof acting together) can effect demand or supply enough to affect market price
– Perfect information (all participants know the market price)
– Free entry and exit in the long run (to ensure price = MC)
Supply and Demand
• The workhorse model of economics assumes perfectly competitive markets.
• Seems odd since so few markets satisfy all conditions, but predictive power holds for markets that are less competitive.
Why do economists like them so much
• With competitive markets, when all goods are private, there are no externalities and we don’t worry about income distribution…
• Markets– Produce goods at the lowest possible cost (technical
efficiency)– Commit all resources to their highest use (we produce
the mix of goods people want as cheaply as possible)– Goods and services are consumed by those who value
them most (maximize economic surplus, but not utility)
Technical Efficiency:Two Apple Growers of Many
$ $
q qq*q*
$1.00
$1.20
SMC
SMC
• Both farmers are producing at q* to start. Total cost of production can be lowered if Farmer Blue produces one fewer apple and Farmer Red produces one more.
• To minimize total cost of producing apples, the SMC of the last apple produced by every farmer must be the same.
• Perfectly competitive industries get this result.
Allocative EfficiencyRatio of market price = ratio of MC
Apples
Oranges
o o
a a
MC pSlope MRT
MC p
Qa
Qo
Wow!• Any and all units of a good or service that can be
produced at an opportunity cost below the value of the good to consumers will be produced (and should be produced).
• What coordinates all this magic? Price.• Price
– signals opportunity cost of resources to producers so they can minimize cost and know how much to produce and when to enter or exit production.
– Signals to consumers the value of the resources in production so that goods and services are consumed only by those whose value exceeds cost.
This IS the Invisible Hand
• Adam Smith:– Efficient Resource Allocation: Markets minimize the cost
of production (only the lowest cost producers produce)– Consumer Surplus Maximization: Markets maximize the
consumer surplus in consumption (highest value consumers consume)
– All and only units where benefit > cost will be produced– And not only in one market for one good, but for all
markets and all goods** except for those pesky market failures
Competition vs Non-competitive Markets
• While prices create technical efficiency and promote efficient rationing in less than competitive situations, allocative efficiency is lacking (monopolists underproduce)
• Only in perfect competition is economic surplus maximized.
• MB=MC for last unit produced, no deadweight loss.
Demand
• Demand is simply the horizontal sum of individual demand curves
• No short vs long run… although…• Demand becomes more elastic over time as
time allows individuals to find substitutes.
Market Demand
30
50
D
• Assume a market with 3 individuals:
x1 = 25 – 2px
x2 = 45 – 1.5px
x3 = 50 – 2.5px • The market demand curve is the horizontal sum
X = 120 – 6px (P = 20-.143X)
• Except for the kinks. This equation is for this line
4525
20
12.50
p
Q
Firm and Market Supply
• Very Short Run: Quantities of all inputs are fixed.
• Short Run: At least one input, but not all, are fixed.
• Long Run: Quantities of all inputs used are variable.
Market Adjustment in the Very Short Run
Q
P
When quantity is fixed in the very short run and demand increases, price will rise but quantity will not change as firms cannot increase production.
VSRS
D
D’
SRS
Demand for plywood increases as a hurricane approaches.
Market Adjustment in the Very Short Run
Q
P Similarly, there can be a supply shock(e.g. hurricane) that shifts supply back
S
D
S’
Market Adjustment in the Very Short Run
Q
P Gasoline: Price rises with supply shift.Assume an excise tax on gasoline.Politicians call for suspending the tax, but in the short run price will be unaffected as neither supply or demand would shift as a result.
S
D
Tax
Tax
S’
Market Adjustment in the Very Short Run
Q
P Gasoline: Price rises with supply shift.Assume an excise tax on gasoline.Politicians call for suspending the tax, but in the short run price will be unaffected as neither supply or demand would shift as a result.
S
D
Tax
S’
Short Run/Long Run Model• The more usual analysis.• Short Run
– Firms produce where MR = SMC– Firms may shut down in the short run– Market supply is the horizontal sum of all firms in the
industry (no entry or exit in the short run)• Long Run
– Price driven to the break-even price as firms enter/exit to seek profits and avoid losses
– Profits = 0– Firm on expansion path– Capital at the level that minimizes SAC
Long and Short Run Cost Curves• Assume we start here.
$
q
AC
MCSMC
SAC
AVC
Short Run• Short Run supply is SMC at P > min(AVC)
– Yes, firms will produce at lower prices in SR than LR.
$
q
ACMCSMC
SAC
SAVC
Short Run Firm Supply (Algebra)SMC Above AVC
3 2
2 2
2
Shutdown priceQuantity where slope of AVC = 0
1 1VC q , AVC q
6 6dAVC 1
q 0 where q = 0dq 3
Or at q where AVC SMC1 1
q q6 21
q 0 where q = 03
3
2
2
Supply = Marginal Cost1
SC FC q6
SMC .5qFirm supply, SMC P
p .5q
q 2p
Short Run Market Supply (Algebra)
Supply = Marginal Cost (above AVC)Firm supply:
q 2pMarket supply with N firms:
Q=N* 2p
Short Run, Firm and Market• Assume we start here for short run.
$
q
SMC
SAC
SAVC
PSD
$
q
SRS
D
Q=N* 2Pq 2P
Long Run
• Assume IRS and then DRS (no CRS)$
q
AC
MCSMC
SAC
AVC
Firm Long Run Supply
• q where P = MC so long as π ≥0 (P> PBE)$
q
AC
MC
PBE
Firm LRS
Long Run Firm Supply (Algebra)MC above AC
2
Break-even price1 1 1
C q , AC q, MC q8 8 4
Quantity where slope of AC = 0dAC 1
0, at any qdq 8
Or at the quantity where AC MC1 1
q q8 41
q 0 where q = 04
2
Supply = Marginal Cost1
C q8
MC .25qFirm supply, MC PP .25qq 4p
Long Run Market Supply
• Long run firm supply: q=4P• So long run market supply: Q=N(4P)?• NO!!!
Long Run Firms Enter and Exit until profit = 0 and market price = PBE
• In long run: P →PBE and π →0$
q
ACMC
PBE
qLR
Long Run Market Supply• Firms enter and exit so that in the long run,
LRS = the quantity demanded at the pBE
P
q
SMC
SAC
AC
PSD
P
Q
S
D
LRS
MC
PBE
Assumes constant
cost industry, more to
come on that!
Shocks
• Change in demand• Change in FC• Change in VC
Change in Demand• Short Run: price up, Δ Q is n*Δq, π > 0
$
q
SMC
ATC
AVC
PBE
$
Q
D
D
q1 q2 Q1 Q2
SRS1
Change in Demand• Long run: Firms enter, π > 0
$
q
SMC
ATC
AVC
PBE
$
Q
SRS2
D
D
q1 q2 Q3Q2
SRS1
Change in Demand• Long Run Supply: If the PBE does not change, the
market will always supply the Qd at PBE . $
q
SMC
ATC
AVC
PBE
$
Q
SRS2
D
D
q1 Q3
LRS
Comparative Statics Analysis
• In the long run, the number of firms in the industry will vary from one long-run equilibrium to another
• Assume that we are examining a constant-cost industry
• Suppose that the initial long-run equilibrium industry output is Q0 and the typical firm’s output is q* (where AC is minimized)
• The equilibrium number of firms in the industry N1 = Q1/q1*
Comparative Statics Analysis• A shift in demand that changes the
equilibrium industry output to Q3 will change the equilibrium number of firms to
N3 = Q3/q1*
• The change in the number of firms is
• In a constant cost industry q*will not change, so only the size of the shift in demand will affect the change in n.
3 13 1
Q QN N
q*
Change in FC• Short Run: MC is unaffected, so qs is unaffected,
so PM is unaffected. But firms suffer losses.$
q
SMC
ATC
AVC
PBE
$
Q
D
q1 Q1
SRS1
Change in FC• Long run: Firms exit until the PM = the new PBE . • With higher price of K, firms use less.• Change in firm level of output is unknown.
$
q
SMC’ATC’
AVC’
PBE1
$
Q
D
q3 Q1
SRS1
PBE2
Change in FC• Long run: Firms exit until the PM = the new PBE.
$
q
SMC’
SAC’
AVC’
PBE1
$
Q
D
Q1
SRS1
LRS1
LRS2PBE2
Q3q3
Change in VC• Short Run: MC is affected, so qs is affected, as is
PM . Firms suffer losses, as the higher price does not cover the higher cost.
$
q
SMC
ATC
AVC
PBE
$
Q
D
q1 Q1
SRS1
If AVC > P, firms will shut down.
Change in VC• While firm supply decreases, qs is unknown as
we don’t know the change in price. However, change in MC > change in P.
$
q
SMC
ATC
AVC
PBE
$
Q
D
q1 Q1
SRS1
If AVC > P, firms will shut down.
SRS2
Q2
Change in VC• Again, with higher costs, and PBE, the LRS curve
will shift upwards. The new q* (and optimal K) could be higher or lower.
$
q
SMC
ATC
PBE1
$
Q
D
q3 Q1
SRS1
SRS2
LRS1
LRS2
Q3
AVCPBE2
SRS3
Comparative Statics Analysis
• The effect of a change in input prices – we need to know how much minimum average
cost is affected– we need to know how an increase in long-run
equilibrium price will affect quantity demanded
Comparative Statics Analysis• The optimal level of output for each firm may
also be affected• Therefore, the change in the number of firms
becomes
• And the relative changes in Q and q* will determine the change in N.
3 13 1
3 1* *
Q QN N
q q
Comparative Statics, change in q*
A
A
C
t q*, where AC(v,w,q*(v,w,p)) MC(v,w,q*(v,w,p))the change in AC = the change in MC, that is:
AC q* MC MC q*w w w q* w
And at q* where AC=MC,
AC MCq* w w ,
q*AC
0q
, 0, depending MCwq
*
*
AC MCon , ,
w w
If AC rises more than MC, q* will rise and vice versa.
Supply and Demand• Basis is the competitive model
– Usually, competitive market in the short run.– Sometimes used to depict competitive market in the
long run with increasing cost industry assumption.• Treatment
– Algebra (to get equilibrium)– Calculus (comparative statics)
• Demand shifters• Supply shifters• Sales and Excise taxes
As in Intermediate Micro• Inverse Demand: P = 1,500 - .5Qd• Inverse Supply: P = 600 + Qs• Solution is Q = 600, P = 1,200
P
Q
1,200
600
S
D
1,500
600
3,000
Sales Tax, Comparative Statics• Intermediate
– Add Sales Tax = $150• Inverse Demand: P = 1500 - tax - .5Qd• Inverse Supply: P = 600 + Qs• Solution is Q = 500, P = 1100 (consumer cost = P + t = $1250)• Just by comparing outcomes,
0 0dP* dQ *
, dt dt
MarketPrice
P
Q
P*=1,100
S
DDt
PD=1,250
500
Excise Tax, Comparative Statics• Intermediate
– Add Excise Tax = $150• Inverse Demand: P = 1500 - .5Qd• Inverse Supply: P = 600 + tax + Qs• Solution is Q = 500, P = 1250 (producer keeps = P – t = $1100)• Just by comparing outcomes, dP* dQ *
0, 0dt dt
MarketPrice
Q
PS=1,100
S
D
St
P*=1,250
500
P
Linear Supply and Demand, Equilibrium• General linear functions specified
– Inverse Demand: P = a – bQd (a > 0, b > 0)
– Inverse Supply: P = c + dQs (c > 0, d > 0)
– Equilibrium condition: Qs = Qd (and Ps = Pd)
• Reduced form solution (only in terms of a, b, c, d) ad bc
P*b da c
Q*b d
P
Q
P*
Q*
S
D
a
cslope = -b
slope = d
Shifts in Supply or Demand, Comparative Statics
• Solution
• Comparative Statics
2 2
2 2
dP* d dQ * 10, 0
da b d da b dd c a c adP* dQ *
0, 0db dbb d b d
dP* b dQ * 10, 0
dc b d dc b da c c adP* dQ *
0, 0dd ddb d b d
ad bc a cP* , Q*
b d b d
So long as a>c
P
P*
S
D
a
c
slope = -b
slope = d
QQ*
Note, “b” rising means demand must be getting steeper.
Sales Tax• Market Model (sales tax)
– Inverse Demand: P = a - t – bQd (a > 0, b > 0)
– Inverse Supply: P = c + dQs (c > 0, d > 0)
– Equilibrium condition: Qs = Qd
• Reduced form solution (only in terms of a, b, c, d, t)
*t
*t
* *D t
ad td bcP
b da t c
Qb d
P P t
P
QQt* Q*
S
D
a
c
a-t
Dt
PD*
P*
Pt*
Sales Tax, Comparative Statics• Solution
• Comparative Statics
*
*
*D
dP d0
dt b ddQ 1
0dt b d
dP d d1 0 as 1 0
dt b d b d
* * * *tt D t
ad td bc a t cP , Q , P P t
b d b d
P
QQt* Q*
S
D
a
c
a-t
Dt
PD*
P*
Pt*
Supply and Demand with General Form Equations
• All we assume is:
• And that at equilibrium (Q*, P*):
• First assume only a is changing and then only b.
dd
ss
dQD(P;a) Q , 0 and "a" is a parameter that shifts demand
dPdQ
S(P;b) Q , 0 and "b" is a parameter that shifts supplydp
D(P*;a) Q*, or D(P*;a) Q* 0S(P*;b) Q*, or S(P*;b) Q* 0
• Start withFD = D(P*, a) – Q* = 0FS = S(P*) – Q* = 0
• Substitute in:P*=P*(a), and Q*=Q*(a)
• To getFD = D(P*(a), a) – Q* (a)= 0FS = S(P*(a)) – Q*(a) = 0
• Take the total derivative with respect to a:
Comparative Statics of a Demand Shift
(see 8.41 in Chiang)
*
* *
*
*
*dP dQda da
DP
dP
D
dQda d
SaP
0a
0
(see 8.40 in Chiang), Implicit function theorem tells us equations P* and Q* must exist to solve these equations simultaneously.
• From above
• Matrix Notation
Demand Shifting
*
*
*
*dPda
dQda
D DP a
0
1
S1
P
*
*
*
*
*
*dP dQda dadP dQda d
Da
0
PSP a
D
Slope of demand curveso dQd/dP
Slope of supply curvedQs/dP
Change in equilibrium quantity when a changes
Change in demand when a changes(Holding P constant, how does Qd change with a).
Change in equilibrium price when a changes
• Cramer’s Rule
• If a is income and the good is normal, then Da > 0 and equilibrium price will rise with a.
• If a is price of a complimentary good, then Da < 0 and equilibrium price will fall with a.
Demand Shifting and Change in P*
* *
*
a
P
*
P* *
*
Da D
0 DaS D
1
1dD
1PS
1
SaP
d D
P
P
P
> 0
• Cramer’s Rule
• If a is income and the good is normal, then Da > 0 and equilibrium quantity will rise with a.
• If a is price of a complimentary good, then Da < 0 and equilibrium price will fall with a.
*
* *
* * a P
P P* *
*
*
*
*
*
DPSP
D1
PS
1
Da
D S0 D Sa PS
dQda D S D
P P
P
> 0
Demand Shifting and Change in Q*
• Start withFD = D(P*) – Q* = 0FS = S(P*, b) – Q* = 0
• Substitute in:P*=P*(b), and Q*=Q*(b)
• To getFD = D(P*(b)) – Q* (b)= 0FS = S(P*(b), b) – Q*(b) = 0
• Take the total derivative with respect to b:
Supply Shifting
(see 8.41 in Chiang)
(see 8.40 in Chiang), Implicit function theorem tells us equations P* and Q* must exist to solve these equations simultaneously.
* *
* *
*
*
dP dQdb dbdP dQdb db
0
S0
b
DPSP
• From above
• Matrix Notation
Supply Shifting
*
*
*
*dPdb
dQdb
DP
P
0Sb
1
S1
*
* *
*
*
*
0
S
DPS
dP dQd
b
b dbd
PP dQ
db db
Slope of demand curveso dQd/dP
Slope of supply curveso dQs/dP Change in
equilibrium price when b changes
Change in equilibrium quantity when b changes
Change in supply when b changes (holding P constant, how does Qs change with a).
• Cramer’s Rule
• If b is technology, then Sb > 0 and equilibrium price will fall with b.
• If b is wages, then Sb < 0 and equilibrium price will rise with b.
Supply Shifting and the Change in P*
* *
*
b
P P*
*
*
*
1
1
D1
0S
PS
1P
dPd
SSb b
S D DP
b SP
< 0
• Cramer’s Rule
• If b is technology, then Sb > 0 and equilibrium quantity will rise with b.
• If b is wages, then Sb < 0 and equilibrium quantity will fall with b.
* * * *
*P* b P* b
P P P P*
*
*
*
*
*
*
0
S D SD S D Sb P b
S
DPSP
D1
P
dQdb D
S1
P
S D D SP P
< 0
Supply Shifting and the Change in P*
• We can convert our analysis to elasticities
bP,b
P P
SdP b bdb P S D P
1
1S d
b S,bbP,b
P P Q ,P Q ,PP P
b(S )(S ) b Q Q(S D ) P P PS DQ QQ
Results in Elasticities
aP,a
P P
DdP a ada P S D P
1
1S d
a D,aaP,a
P P Q ,P Q ,PP P
a(D )(D ) a Q Q(S D ) P P PS DQ QQ
• Assume D,M = .5, S,p = .75, D,p = -1.25
S D
D,MP,M
Q ,P Q ,P
.5.75 1.25
.25
.5% S
D’.25%
.1875%
1% increase in income .5% inc. in demand.5% increase in
demand .25% inc. in price
.25 increase in price .1875% inc. in quantity:
%ΔQs/%ΔP =.75 %ΔQs/.25 =.75 %ΔQs =.1875
D
Effect of a 1% increase in income on demand for a normal good
P
Q
• Assume S,w = -.60, Qs,p = .80, Qd,p = -.70
P
Q
.6% S
S’
.40%
-.28%
1% increase in income for a .6% dec. in supply.6% decrease in
supply .40% inc. in price
.40% increase in price .28% dec. in quantity:%ΔQd/%ΔP =-.70 %ΔQd/.40 =-.70
%ΔQs =-.28
D
s d
S,wP,w
Q ,P Q ,P
.60.80 .70
.40
Effect of a 1% increase in wages
• Start withFD = D(P*+t) – Q* = 0FS = S(P*) – Q* = 0
• Substitute in:P*=P*(t), and Q*=Q*(t)
• To getFD = D(P*(t) + t) – Q*(t)= 0FS = S(P*(t)) – Q*(t) = 0
• Take the total derivative with respect to t:
Supply and Demand (Sales Tax)
** **
* *
*
*
*
*
dP dQdt dt
dP dQd
D dP dQ D1 0
P dt dt P
0t dt
DP
SP
P* is the market price, but the buyer pays PD = P*+t
• From above
• Matrix Notation
Supply and Demand (Sales Tax)
**
*
*
*
dPdt
d
D1
PS
1P
D
Qdt
P0
*
*
* *
*
*
*
dP dQdt dt
dP dQdt
DPSP
DP
dt0
Change in P* when t rises
*
* *
*
* *
*
*
*
*P
P P* *
P D
S DP P
*S D SD D
S D S D S D
D
D
*
*
*D
S
DP D
D0 P 0 , S D S DP P
PD Q 0
P
dPdt
dPdt
P P t
1
1D
1PS
dP
S DQ
dP1 1 0
dtdt
1P
P
Q
*dPdt
DdPdt
S
D
dt
Original Tax
Change in Q* when t rises
*
*D S
S D* **
*
*
* *
*
DPS S
dQdt
DP
PD0QP 0
S D PP P
P PD
1PS
1
Q
P
P
*dQdt
S
D
Original Tax
**
*
*
*
dPdt
d
D1
PS
1P
D
Qdt
P0
• Start withFD = D(P*) – Q* = 0FS = S(P*-t) – Q* = 0
• Substitute in:P*=P*(t), and Q*=Q*(t)
• To getFD = D(P*(t)) – Q*(t)= 0FS = S(P*(t) - t) – Q*(t) = 0
• Take the total derivative with respect to t:
Supply and Demand (Excise)
*
*
*
*
* ** *
* *
0
S dP dQ S1
dP dQd
0 0P dt dt P
t dtdP dQdt dt
DP
SP
P* is the market price, but the supplier keeps Ps = P*-t
• Matrix Notation
Supply and Demand (Excise Tax)
*
*
*
*
*
dPdt
d
D1
PS
1P
0
Qdt
SP
*
* *
*
*
* *
DPSP
dP dQdt dt
dP dQd
0
0Pt dtS
Change in P* when t rises
*
* *
*
* *
* *P
P P* *
S
*
*
P
S DP P
*S S S D D
S D S D S D S D
*
*
*S
S
0S S
SP P 0 S D S DP P
PS Q 0
PS DQ
P P t
dPdt
dP
dP1 1 0
d
1
1
D1
P
t
dt
S1
dPt
P
d
P
Q
SdPdt
dt
*dPdt
S
D
Original Tax
* * *
*
*
*
*
D S
S* *
*
D
0
S PD S
DPSPD
1PS
1
P QP P 0S
dQP
P P Q
P
dt D
*
* *
*
*
* *
DPSP
dP dQdt dt
dP dQd
0
0Pt dtS
P
Q
dt
*dQdt
S
D
Original Tax
Change in Q* when t rises
And FinallyS D
SD
S D S
S D D
S D
Note that for Sales tax, P*=P and for excise tax, P*= PFor either tax, the ratio of change in the demander price to the supplier price is as follows:
dPdt dPdt
Absolut
D
S
S D
S D
S D
e value of both sides to get:
dPdt dPdt
If , suppliers see the bigger change in price
If , demanders see the bigger change in price
S DIf 3 and 1, the price to demanders will rise 3x more than the price for suppliers will fall.That is, for a $4 tax, demanders willsee prices rise $3 and sellers will seetheir price fall $1.
Increasing Cost Industries and Decreasing Cost Industries
• What happens when the market expands or contracts.– For constant cost industries, expansion and
contraction of the market does not affect v and w so the break-even price remains constant.
– For increasing cost industries:• Factor price effect: w, or v rise with Qe• Less efficient firm’s effect
– For decreasing cost industries:• Factor price effect: w, or v fall with Qe
Short Run• Assume we start here.
$
q
SMC
ATC
AVC
PBE
$ SRS
D
Q
• Demand Increases
$
q
SMC
PBE
$ SRS
D
D’
Q
Increasing Cost Industry:Factor Price effect
ATC
AVC
• Firms increase production in the short run
$
q
SMC
PBE
$ SRS
D
D’
Q
Increasing Cost Industry:Factor Price effect
ATC
AVC
Increasing Cost Industry:Factor Price effect
• If it is w that rises with an increased demand for labor, MC will rise with expansion.
$
q
SMC
PBE
$
Q
SRS
D
D’
SRS’
ATC
AVC
• Profits > 0, so firms still enter, but profit returns to zero before the price falls to its previous level.
$
q
SMC
PBE
$ SRS
D
D’
SRS’’SRS’
Q
Increasing Cost Industry:Factor Price effect
ATC
AVC
• Profits > 0, so firms still enter, but profit returns to zero before the price falls to its previous level.
$
q
SMC
PBE
$ SRS
D
D’
SRS’ SRS’’
LRS
PBE’
Q
Increasing Cost Industry:Factor Price effect
ATC
AVC
SR or LR effects
• Often, costs are assumed stable in SR, but increase only in the long run.
• Same result, easier math.
• Firms increase production in the short run
$
q
SMC
PBE
$ SRS
D
D’
Q
Increasing Cost Industry:Differential Productivity Effect
ATC
AVC
• New firms are less efficient, so entry stops before price returns to original level
$
q
SMC
PBE
$ SRS
D
D’
Q
Increasing Cost Industry:Differential Productivity Effect
SRS’
ATC
AVC
• New firms are less efficient, so entry stops before price returns to original level
$
q
SMC
PBE
$ SRS
D
D’
Q
Increasing Cost Industry:Differential Productivity Effect
SRS’
LRS
ATC
AVC
Why differential in efficiency?
• Better (lower cost) location? Rent should rise to compensate.
• Better managers at some firms? Wages should rise to equilibrate costs.
• Smarter entrepreneur? Should have higher opportunity cost.
• More fertile land (Ricardo’s original example)
Decreasing Cost Industry
• As a market expands, economies of scale in production of inputs causes input prices to fall.
• As the market expands, inputs prices fall and when firms enter, the price falls below its initial level before P = PBE.
• Reverse of factor price effect.• As demand for micro computers rose in the
1980s-90s, chip factories got bigger and prices fell (technological advances exacerbated the issue, but that is separate).
Producer Surplus• Remember the short run
$
q
SMC
PBE
$ SRS
D
Q
PS=π+FC
ATC
AVC
Long Run Producer Surplus• Long Run producer surplus is long run π• Zero producer surplus if constant cost industry.
$
q
SMC
PBE
$ SRS
D
Q
LRS
ATC
AVC
Producer Surplus• In an increasing cost industry, depends on the
source of the upward sloping LRS curve.$
q
SMC
PBE
$ SRS
D
Q
LRS
ATC
AVC
Producer Surplus• Factor price effect, the rising price needed to increase
supply of the input provides a surplus to lower cost suppliers
• However, individual firms have LR π=0 and PS=0.
$
q
$
D
Q
LRS
S
D
Factor MarketOutput Market
Producer Surplus• Differential Productivity Effect: if some firms
have a cost advantage, the firm that owns the source will benefit in the long run.
$
q
$
D
Q
LRS
SOutput Market
$
q
SMC
ATC
PBE
Long Run Producer Surplus• Farmer with the best land will earn an
increasing producer surplus (long run profit).– The excess future stream of long run profits will be
capitalized into the market price (value) of the land.
• Actors and Athletes who are really good earn a long run profit because there is no substitute. But now we are starting to talk about market power.
excess annual profitextra land value =
i
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