Chapter 13 (3) Flashcards
SHORT-RUN SUPPLY
we assume that the # of firms on the market = fixed
–> The total quantity of a good that is supplied at a given price = therefore the sum of the quantities that each individual producer is willing to supply
LONG-RUN SUPPLY
The key difference between short-run and long-run supply is that firms are able to enter and exit the market in the long run.
–> The # of firms is NOT fixed –> but changes in response to changing circumstances
the difference between ACCOUNTING PROFIT & ECONOMIC PROFIT
IF firms are making an economic profit
–> their revenues are higher than their total costs
–>These total costs = includes opportunity costs (e.g., such as money they could have made if they had invested their resources in other business opportunities
–> understanding that the ATC curve = also includes opportunity costs help us understand what makes firms want to enter & exit a market
the existence of economic profits in a market signals that there is $$$ to be made…
–> How will others respond to this again?
–> They will enter the market to take advantage of the profit-making opportunity
but as more firms enter the roasted-plantain market, what happens?
• The total quantity offered for sale at any given price increases
What does the new equilibrium imply for the profits made by firms in the market?
–> Remember that profits are revenues minus costs
–> As the equilibrium market price falls, revenue falls –> and so do profits
If positive economic profits exist:
–> More firms still have an incentive to enter the market to take advantage of them
–>Thus, the process continues –> w/ firms entering the market & driving quantity up & price down
- ->Eventually, the price will be low enough that economic profits = reduced to zero– P = ATC
- —-> The market supply curve shifts outward until P = ATC.
when we understand that ATC also includes opportunity cost
we can understand better why firms = decide to make the opposite decision–to exit a market
If negative economic profits exist:
–>If price falls below ATC –> a firm = may be still making accounting profits
- ->It could be making more $$ by pursing other opportunities
- —–> It thus has an incentive to exit the market to invest its resource elsewhere
If negative economic profits exist (cont)
Therefore,
- The quantity supplied at any given price decreases
- -> the supply curve shifts to the left & and the new market equilibrium is at a lower quantity & higher price
-Price increases: profits also increases
- The process continues until economic profits are zero
- -> at which point no more firms exit the market
- -> they are indifferent between the roasted-plantain market & other business opportunities
- P < ATC.
The market supply curve shifts inward until P = ATC.
N THE LONG RUN IN A PERFECTLY COMPETITIVE MARKET:
- Firms earn zero economic profit
- Firms operate at an efficient scale
- Supply is perfectly elastic
FIRMS EARN ZERO ECONOMIC PROFIT
this doesn’t mean that a business = not earning ACCOUNTING PROFIT
–> Simply means that the firm could not earn greater accounting profit by choosing to operate in a different market, instead
EFFICIENT SCALE
is the quantity that minimizes average total cost
We put the three rules together:
P = MR = MC
MC = ATC at the minimum of ATC (at its lowest point) P = ATC
P = MC = ATC
–> all three lines intersect at only one point
MC = ATC at the minimum of ATC
When a firm produces at a point that satisfies this condition
–> it is necessarily producing the quantity that minimizes average total cost in the long run
–>In other words it is operating at its efficient scale
SUPPLY IS PERFECLTY ELASTIC
- -> We have established that economic profits are zero.
- For this to be true, price must be equal to the minimum of ATC
- -> IF anything causes the market equilibrium to move away from the price
- -> the resulting (+) or (-) profits will cause firms to enter or exit the market
- Such entry and exit = will increase / decrease the quantity supplied
- -> until price returns to the level that yields zero economic profits
- Thus in the long run –> price = the same at any quantity
-This causes the supply curve to be horizontal
HORIZONTAL CURVE
perfectly elastic, producers will supply any quantity at the market price
- ->In theory, therefore, in a competitive market
- -> the price of a good should never change in the long run
WHY THE LONG-RUN MARKET SUPPLY CURVE SHOULDN’T SLOPE UPWARD, BUT DOES
assuming that the price of good/service = never changes doesn’t seem very realistic
–>We’ll add a few nuances to the model to explain WHY the price doesn’t stay perfectly constant in the long run
the main tweak removes the assumption that ALL firms = have the same cost structure
In the real world –> this is hardly every true
–> Some firms = simply more efficient than others at converting inputs into outputs
–>The newer firms w/ higher costs = will enter only markets w/ higher prices
–>In practice, therefore, the long-run supply curve will slope upward –> b/c price has to rise to entice new firms to enter & increase the total quantity supplied
WHY THE LONG-RUN MARKET SUPPLY CURVE SHOULDN’T SLOPE UPWARD, BUT DOES
cont.
in reality, price is equal to the minimum of ATC for the least-efficient firm in the market
–> not for every firm currently in the market
–> Dropping the simplifying assumption that every firm’s cost = the same also overturns the surprising conclusion –> that firms in a perfectly competitive market earn zero economic profit
–>The last firm to enter the market = earns zero economic profit –> b/c its ATC is equal to price
- -> But more efficient firms w/ lower ATC
- -> are able to earn positive economic profit
