Chapter 13 (3)

Question 1

SHORT-RUN SUPPLY

Answer 1

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

Question 2

LONG-RUN SUPPLY

Answer 2

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

Question 3

the difference between ACCOUNTING PROFIT & ECONOMIC PROFIT

Answer 3

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

Question 4

the existence of economic profits in a market signals that there is $$$ to be made…

Answer 4

–> How will others respond to this again?

–> They will enter the market to take advantage of the profit-making opportunity

Question 5

but as more firms enter the roasted-plantain market, what happens?

Answer 5

• The total quantity offered for sale at any given price increases

Question 6

What does the new equilibrium imply for the profits made by firms in the market?

Answer 6

–> Remember that profits are revenues minus costs

–> As the equilibrium market price falls, revenue falls –> and so do profits

Question 7

If positive economic profits exist:

Answer 7

–> 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.

Question 8

when we understand that ATC also includes opportunity cost

Answer 8

we can understand better why firms = decide to make the opposite decision–to exit a market

Question 9

If negative economic profits exist:

Answer 9

–>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

Question 10

If negative economic profits exist (cont)

Answer 10

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.

Question 11

N THE LONG RUN IN A PERFECTLY COMPETITIVE MARKET:

Answer 11

1. Firms earn zero economic profit
2. Firms operate at an efficient scale
3. Supply is perfectly elastic

Question 12

FIRMS EARN ZERO ECONOMIC PROFIT

Answer 12

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

Question 13

EFFICIENT SCALE

Answer 13

is the quantity that minimizes average total cost

Question 14

We put the three rules together:

Answer 14

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

Question 15

MC = ATC at the minimum of ATC

Answer 15

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

Question 16

SUPPLY IS PERFECLTY ELASTIC

Answer 16

• -> 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

Question 17

HORIZONTAL CURVE

Answer 17

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

Question 18

WHY THE LONG-RUN MARKET SUPPLY CURVE SHOULDN’T SLOPE UPWARD, BUT DOES

Answer 18

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

Question 19

the main tweak removes the assumption that ALL firms = have the same cost structure

Answer 19

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

Question 20

WHY THE LONG-RUN MARKET SUPPLY CURVE SHOULDN’T SLOPE UPWARD, BUT DOES
cont.

Answer 20

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