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Perfect Competition Long Run Overheads

Perfect Competition Long Run Overheads. Review of short run equilibrium. The number of firms is fixed. The firm is operating on a short-run cost curve. Some inputs are fixed. The market or industry supply curve, Q S , is the horizontal summation of the individual firm supply curves.

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Perfect Competition Long Run Overheads

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  1. Perfect Competition Long Run Overheads

  2. Review of short run equilibrium The number of firms is fixed The firm is operating on a short-run cost curve Some inputs are fixed

  3. The market or industry supply curve, QS, is the horizontal summation of the individual firm supply curves

  4. Industry Supply-Demand Equilibrium Demand for Individual Firm $ $ S(p) p0 D(p) p0 D(p) Output Q0 Output

  5. AVC ATC MC P = 120 Short run equilibrium 300 $ 250 200 150 100 50 0 0 2 4 6 8 10 12 14 16 18 Output

  6. Competitive markets in the long run The number of firms in the industry can vary The firm is operating on its long run cost curve

  7. Conditions for a long run equilibrium 1. No individual firm wishes to change the amount of the good it is supplying to the market 2. No individual consumer wishes to change the amount of the good he or she is demanding 3. No individual firm in the market has an incentive to change the amount of any of the inputs it is using or to exit from the market 4. No firm outside the market has any incentive to enter it 5. The aggregate supply in the market equals the aggregate demand in the market

  8. Plant size adjustment by the firm with no change in the market price Assumptions for example problem P = Price = $292 The firm is operating a plant with a capacity rating of 5 Short run average and marginal costs as in the table

  9. SRAC SRMC SRAC SRMC SRAC SRMC SRAC SRMC y Price 5 5 9 9 15 15 18 18 0.00 292 1.00 292 851.00 103.00 2291.00 6251.00 9041.00 2.00 292 479.00 112.00 1079.00 2879.00 4184.00 4.00 292 303.50 148.00 483.50 1203.50 1766.00 5.00 292 275.00 175.00 371.00 875.00 1289.00 6.00 292 261.00 208.00 301.00 661.00 976.00 7.00 292 256.14 247.00 256.14 7.00 513.29 757.57 8.00 292 257.75 292.00 227.75 52.00 407.75 599.00 9.00 292 264.33 343.00 211.00 103.00 331.00 481.00 10.00 292 275.00 400.00 203.00 160.00 275.00 392.00 11.00 292 289.18 463.00 201.91 223.00 234.64 324.64 12.00 292 306.50 532.00 206.50 292.00 206.50 274.00 13.00 292 326.69 607.00 215.92 367.00 188.23 7.00 236.69 14.00 292 349.57 688.00 229.57 448.00 178.14 88.00 210.29 15.00 292 375.00 775.00 247.00 535.00 175.00 175.00 193.00 16.00 292 402.88 868.00 267.88 628.00 177.88 268.00 183.50 88.00 17.00 292 433.12 967.00 291.94 727.00 186.06 367.00 180.76 187.00 18.00 292 465.67 1072.00 319.00 832.00 199.00 472.00 184.00 292.00 19.00 292 500.47 1183.00 348.89 943.00 216.26 583.00 192.58 403.00 20.00 292 537.50 1300.00 381.50 1060.00 237.50 700.00 206.00 520.00 22.00 292 618.09 1552.00 454.45 1312.00 290.82 952.00 245.82 772.00 23.00 292 661.61 1687.00 494.65 1447.00 322.48 1087.00 271.61 907.00

  10. Conditions for short run equilibrium Price = MC Price  AVC

  11. SRAC SRMC SRAC SRMC SRAC SRMC SRAC SRMC y Price 5 5 9 9 15 15 18 18 0.00 292 1.00 292 851.00 103.00 2291.00 6251.00 9041.00 2.00 292 479.00 112.00 1079.00 2879.00 4184.00 4.00 292 303.50 148.00 483.50 1203.50 1766.00 5.00 292 275.00 175.00 371.00 875.00 1289.00 6.00 292 261.00 208.00 301.00 661.00 976.00 7.00 292 256.14 247.00 256.14 7.00 513.29 757.57 8.00 292 257.75 292.00 227.75 52.00 407.75 599.00 9.00 292 264.33 343.00 211.00 103.00 331.00 481.00 10.00 292 275.00 400.00 203.00 160.00 275.00 392.00 11.00 292 289.18 463.00 201.91 223.00 234.64 324.64 12.00 292 306.50 532.00 206.50 292.00 206.50 274.00 13.00 292 326.69 607.00 215.92 367.00 188.23 7.00 236.69 14.00 292 349.57 688.00 229.57 448.00 178.14 88.00 210.29 15.00 292 375.00 775.00 247.00 535.00 175.00 175.00 193.00 16.00 292 402.88 868.00 267.88 628.00 177.88 268.00 183.50 88.00 17.00 292 433.12 967.00 291.94 727.00 186.06 367.00 180.76 187.00 18.00 292 465.67 1072.00 319.00 832.00 199.00 472.00 184.00 292.00 19.00 292 500.47 1183.00 348.89 943.00 216.26 583.00 192.58 403.00 20.00 292 537.50 1300.00 381.50 1060.00 237.50 700.00 206.00 520.00 22.00 292 618.09 1552.00 454.45 1312.00 290.82 952.00 245.82 772.00 23.00 292 661.61 1687.00 494.65 1447.00 322.48 1087.00 271.61 907.00

  12. SRAC SRMC SRAC SRMC y Price 5 5 9 9 6.00 292 261.00 208.00 301.00 7.00 292 256.14 247.00 256.14 7.00 8.00 292 257.75 292.00 227.75 52.00 9.00 292 264.33 343.00 211.00 103.00 10.00 292 275.00 400.00 203.00 160.00 11.00 292 289.18 463.00 201.91 223.00 12.00 292 306.50 532.00 206.50 292.00

  13. P = 292 SRAC 5 SRMC 5 Short Run Equilibrium 1 500 Profit 274.00 450 400 350 300 250 200 150 100 50 0 0 5 10 15 20 25 30 35 MC = $292  y* = 8

  14. SRAC SRMC SRAC SRMC SRAC SRMC SRAC SRMC y Price 5 5 9 9 15 15 18 18 0.00 292 1.00 292 851.00 103.00 2291.00 6251.00 9041.00 2.00 292 479.00 112.00 1079.00 2879.00 4184.00 4.00 292 303.50 148.00 483.50 1203.50 1766.00 5.00 292 275.00 175.00 371.00 875.00 1289.00 6.00 292 261.00 208.00 301.00 661.00 976.00 7.00 292 256.14 247.00 256.14 7.00 513.29 757.57 8.00 292 257.75 292.00 227.75 52.00 407.75 599.00 9.00 292 264.33 343.00 211.00 103.00 331.00 481.00 10.00 292 275.00 400.00 203.00 160.00 275.00 392.00 11.00 292 289.18 463.00 201.91 223.00 234.64 324.64 12.00 292 306.50 532.00 206.50 292.00 206.50 274.00 13.00 292 326.69 607.00 215.92 367.00 188.23 7.00 236.69 14.00 292 349.57 688.00 229.57 448.00 178.14 88.00 210.29 15.00 292 375.00 775.00 247.00 535.00 175.00 175.00 193.00 16.00 292 402.88 868.00 267.88 628.00 177.88 268.00 183.50 88.00 17.00 292 433.12 967.00 291.94 727.00 186.06 367.00 180.76 187.00 18.00 292 465.67 1072.00 319.00 832.00 199.00 472.00 184.00 292.00 19.00 292 500.47 1183.00 348.89 943.00 216.26 583.00 192.58 403.00 20.00 292 537.50 1300.00 381.50 1060.00 237.50 700.00 206.00 520.00 22.00 292 618.09 1552.00 454.45 1312.00 290.82 952.00 245.82 772.00 23.00 292 661.61 1687.00 494.65 1447.00 322.48 1087.00 271.61 907.00

  15. P = 292 SRAC 5 SRMC 5 SRAC 9 SRMC 9 Short Run Equilibrium 2 Profit 1026 500 450 $ 400 350 300 250 200 150 100 50 0 0 5 10 15 20 25 30 35 Output MC = $292  y* = 12

  16. SRAC SRMC SRAC SRMC SRAC SRMC SRAC SRMC y Price 5 5 9 9 15 15 18 18 0.00 292 1.00 292 851.00 103.00 2291.00 6251.00 9041.00 2.00 292 479.00 112.00 1079.00 2879.00 4184.00 4.00 292 303.50 148.00 483.50 1203.50 1766.00 5.00 292 275.00 175.00 371.00 875.00 1289.00 6.00 292 261.00 208.00 301.00 661.00 976.00 7.00 292 256.14 247.00 256.14 7.00 513.29 757.57 8.00 292 257.75 292.00 227.75 52.00 407.75 599.00 9.00 292 264.33 343.00 211.00 103.00 331.00 481.00 10.00 292 275.00 400.00 203.00 160.00 275.00 392.00 11.00 292 289.18 463.00 201.91 223.00 234.64 324.64 12.00 292 306.50 532.00 206.50 292.00 206.50 274.00 13.00 292 326.69 607.00 215.92 367.00 188.23 7.00 236.69 14.00 292 349.57 688.00 229.57 448.00 178.14 88.00 210.29 15.00 292 375.00 775.00 247.00 535.00 175.00 175.00 193.00 16.00 292 402.88 868.00 267.88 628.00 177.88 268.00 183.50 88.00 17.00 292 433.12 967.00 291.94 727.00 186.06 367.00 180.76 187.00 18.00 292 465.67 1072.00 319.00 832.00 199.00 472.00 184.00 292.00 19.00 292 500.47 1183.00 348.89 943.00 216.26 583.00 192.58 403.00 20.00 292 537.50 1300.00 381.50 1060.00 237.50 700.00 206.00 520.00 22.00 292 618.09 1552.00 454.45 1312.00 290.82 952.00 245.82 772.00 23.00 292 661.61 1687.00 494.65 1447.00 322.48 1087.00 271.61 907.00

  17. P = 292 SRAC 9 SRMC 9 SRAC 15 SRMC 15 Short Run Equilibrium 3 Profit 1828.98 500 450 $ 400 350 300 250 200 150 100 50 0 0 5 10 15 20 25 30 35 Output MC = $292  y* = 16.25

  18. SRAC SRMC SRAC SRMC SRAC SRMC SRAC SRMC y Price 5 5 9 9 15 15 18 18 0.00 292 1.00 292 851.00 103.00 2291.00 6251.00 9041.00 2.00 292 479.00 112.00 1079.00 2879.00 4184.00 4.00 292 303.50 148.00 483.50 1203.50 1766.00 5.00 292 275.00 175.00 371.00 875.00 1289.00 6.00 292 261.00 208.00 301.00 661.00 976.00 7.00 292 256.14 247.00 256.14 7.00 513.29 757.57 8.00 292 257.75 292.00 227.75 52.00 407.75 599.00 9.00 292 264.33 343.00 211.00 103.00 331.00 481.00 10.00 292 275.00 400.00 203.00 160.00 275.00 392.00 11.00 292 289.18 463.00 201.91 223.00 234.64 324.64 12.00 292 306.50 532.00 206.50 292.00 206.50 274.00 13.00 292 326.69 607.00 215.92 367.00 188.23 7.00 236.69 14.00 292 349.57 688.00 229.57 448.00 178.14 88.00 210.29 15.00 292 375.00 775.00 247.00 535.00 175.00 175.00 193.00 16.00 292 402.88 868.00 267.88 628.00 177.88 268.00 183.50 88.00 17.00 292 433.12 967.00 291.94 727.00 186.06 367.00 180.76 187.00 18.00 292 465.67 1072.00 319.00 832.00 199.00 472.00 184.00 292.00 19.00 292 500.47 1183.00 348.89 943.00 216.26 583.00 192.58 403.00 20.00 292 537.50 1300.00 381.50 1060.00 237.50 700.00 206.00 520.00 22.00 292 618.09 1552.00 454.45 1312.00 290.82 952.00 245.82 772.00 23.00 292 661.61 1687.00 494.65 1447.00 322.48 1087.00 271.61 907.00

  19. P = 292 SRAC 15 SRMC 15 SRAC 18 SRMC 18 Short Run Equilibrium 4 Profit 1944 500 450 $ 400 350 300 250 200 150 100 50 0 0 5 10 15 20 25 30 35 Output MC = $292  y* = 18

  20. Profits are higher with the size 18 plant than with the size 15 plant With a price of $292, a size 18 plant makes more sense than a size 15 plant

  21. SRAC SRMC SRAC SRMC SRAC SRMC y Price 15 15 18 18 23 23 0.00 292 1.00 292 6251.00 9041.00 14891.00 5.00 292 875.00 1289.00 2219.00 6.00 292 661.00 976.00 1701.00 8.00 292 407.75 599.00 1067.75 9.00 292 331.00 481.00 864.33 10.00 292 275.00 392.00 707.00 12.00 292 206.50 274.00 486.50 13.00 292 188.23 7.00 236.69 409.77 14.00 292 178.14 88.00 210.29 349.57 15.00 292 175.00 175.00 193.00 303.00 16.00 292 177.88 268.00 183.50 88.00 267.88 17.00 292 186.06 367.00 180.76 187.00 242.53 18.00 292 199.00 472.00 184.00 292.00 225.67 19.00 292 216.26 583.00 192.58 403.00 216.26 103.00 20.00 292 237.50 700.00 206.00 520.00 213.50 220.00 21.00 292 262.43 823.00 223.86 643.00 216.71 343.00 22.00 292 290.82 952.00 245.82 772.00 225.36 472.00 23.00 292 322.48 1087.00 271.61 907.00 239.00 607.00 25.00 292 395.00 1375.00 333.80 1195.00 279.80 895.00

  22. P = 292 SRAC 18 SRMC 18 SRAC 23 SRMC 23 Short Run Equilibrium 5 Profit 1591.39 500 450 $ 400 350 300 250 200 150 100 50 0 0 5 10 15 20 25 30 35 Output MC = $292  y* = 20.59

  23. Profits are lower with the size 23 plant than with the size 18 plant We would not want the size 23 plant with prices of $292

  24. P = 607 SRAC 18 SRMC 18 SRAC 23 SRMC 23 When is the big plant optimal? Profit 8464 650 $ 600 550 500 450 400 350 300 250 200 150 100 50 0 0 5 10 15 20 25 30 35 Output MC = $607  y* = 23

  25. SRAC 9 SRMC 9 SRAC 15 SRMC 15 P = 175 What about lower prices? Profit 0.00 650 $ 600 550 500 450 400 350 300 250 200 150 100 50 0 0 5 10 15 20 25 30 35 MC = $175  y* = 15 Output

  26. The long run cost curve For any given price (or output) , there is an “optimal” plant size that gives the lowest level of costs (highest level of profits) The long run average total cost curve (LRATC) is an envelope curve that touches all the short run average total cost curves (SRATC) from below

  27. SRAC 5 SRMC 5 SRAC 9 SRMC 9 SRAC 15 SRMC 15 SRAC 18 SRMC 18 SRAC 23 SRMC 23 Consider the family of short run cost curves 500 450 $ 400 350 300 250 200 150 100 50 0 0 5 10 15 20 25 30 35 Output

  28. SRAC 5 SRMC 5 SRAC 9 SRMC 9 SRAC 15 SRMC 15 SRAC 18 SRMC 18 SRAC 23 SRMC 23 ATC MC We bound the short run curves with the long run curve 500 450 $ 400 350 300 250 200 150 100 50 0 0 5 10 15 20 25 30 35 Output SRMC = LRMC at “optimal” plant size

  29. SRAC 5 SRMC 5 ATC MC SRMC = LRMC at “optimal” plant size 500 450 $ 400 350 300 250 200 150 100 50 0 0 5 10 15 20 25 30 35 Output SRMC = LRMC  SRAC = LRAC

  30. SRAC 5 SRMC 5 SRAC 9 SRMC 9 ATC MC SRMC = LRMC at “optimal” plant size 500 450 $ 400 350 300 250 200 150 100 50 0 0 5 10 15 20 25 30 35 Output SRMC = LRMC  SRAC = LRAC

  31. SRAC 18 SRMC 18 ATC MC SRMC = LRMC at “optimal” plant size 500 450 $ 400 350 300 250 200 150 100 50 0 0 5 10 15 20 25 30 35 Output SRMC = LRMC  SRAC = LRAC

  32. SRAC 15 SRMC 15 SRAC 18 SRMC 18 ATC MC SRMC = LRMC at “optimal” plant size 500 450 $ 400 350 300 250 200 150 100 50 0 0 5 10 15 20 25 30 35 Output SRMC = LRMC = SRAC = LRAC

  33. ATC MC A less cluttered view 500 450 $ 400 350 300 250 200 150 100 50 0 0 5 10 15 20 25 30 35 Output

  34. SRAC 5 SRMC 5 SRAC 18 SRMC 18 SRAC 23 SRMC 23 ATC MC Some clutter, some detail 500 450 $ 400 350 300 250 200 150 100 50 0 0 5 10 15 20 25 30 35 Output

  35. Profit and Loss, Entry and Exit In a competitive market, economic profit and loss are the forces driving long run change The expectation of continued economic profit causes outsiders to enter the market; The expectation of continued economic losses causes firms in the market to exit

  36. Demand for the example market

  37. Assumptions about the industry structure 21 identical firms Each firm operates a size 18 plant

  38. Optimal output at various prices -- Plant size = 18 Price y*Supply CostAC 17187.00 3073.00 180.76 16.9410181.00 3062.16 180.75 17.2046208.00 3113.41 180.96 17.6068250.00 3205.48 182.06 18292.00 3312.00 184.00 19403.00 3659.00 192.58 20520.00 4120.00 206.00 21643.00 4701.00 223.86 22772.00 5408.00 245.82

  39. Optimal output at various prices -- Plant size = 18 Price y*Supply CostAC 16.9410181.00 3062.16 180.75 17187.00 3073.00 180.76 17.2046208.00 3113.41 180.96 17.6068250.00 3205.48 182.06 18292.00 3312.00 184.00 19403.00 3659.00 192.58 20520.00 4120.00 206.00 21643.00 4701.00 223.86 22772.00 5408.00 245.82 Supply is equal to MC above the minimum of AVC

  40. Supply - 1 Individual Firm Supply Supply is equal to MC above the minimum of AVC Supply for One Firm with Plant Size = 18 500 400 300 200 100 0 0 5 10 15 20 25 30 35

  41. Supply - 1 Supply - 21 Aggregate Supply Supply for 21 Firms with Plant Size = 18 700 600 500 400 300 200 100 0 0 100 200 300 400 500

  42. Market and Individual Firm Supply, Price, and Average Cost Supply Price Q y* 21 Firms AC 355.76 16.941074 181.00 180.75 357.00 17 187.00 180.76 361.30 17.204651 208.00 180.96 369.74 17.606817 250.00 182.06 378.00 18 292.00 184.00 399.00 19 403.00 192.58 420.00 20 520.00 206.00 441.00 21 643.00 223.86 462.00 22 772.00 245.82

  43. Supply - 21 D Putting supply and demand together P = $292 700 QS = 378 600 500 400 300 yi = 18 200 100 i = $1944 0 0 100 200 300 400 500

  44. NOPE Supply - 21 D In equilibrium, at a given quantity, supply and demand price must be equal 700 600 500 400 300 200 100 0 0 100 200 300 400 500

  45. NOPE Supply - 21 D In equilibrium, at a given quantity, supply and demand price must be equal 700 600 500 400 300 200 100 0 0 100 200 300 400 500

  46. Supply - 21 D In equilibrium, at a given quantity, supply and demand price must be equal P = $292 700 QS = 378 600 500 400 300 yi = 18 200 100 0 0 100 200 300 400 500

  47. Market and Individual Firm Supply,Supply Price, Average Cost and Demand Price Supply Price Demand Q y* 21 Firms AC Price 355.76 16.941074 181.00 180.75 314.24 357.00 17 187.00 180.76 313.00 361.30 17.204651 208.00 180.96 308.70 369.74 17.606817 250.00 182.06 300.26 378.00 18 292.00 184.00 292.00 399.00 19 403.00 192.58 271.00 420.00 20 520.00 206.00 250.00 441.00 21 643.00 223.86 229.00 462.00 22 772.00 245.82 208.00

  48. What about profits? Looks good! Supply Price Demand Q y* 21 Firms AC Price 355.76 16.941074 181.00 180.75 314.24 357.00 17 187.00 180.76 313.00 361.30 17.204651 208.00 180.96 308.70 369.74 17.606817 250.00 182.06 300.26 378.00 18 292.00 184.00 292.00 399.00 19 403.00 192.58 271.00 420.00 20 520.00 206.00 250.00 441.00 21 643.00 223.86 229.00 462.00 22 772.00 245.82 208.00

  49. With high profits, other firms will want to enter Let the number of firms increase to 26

  50. Market and Individual Firm Supply,Supply Price, Average Cost and Demand Price Plant Size 18 Number of firms 26 PricePrice Qy*Supply - 26ACDemand 440.47 16.941181.00 180.75 229.53 442.00 17187.00 180.76 228.00 450.33 17.320220.00 181.18 219.67 468.00 18292.00 184.00 202.00 494.00 19403.00 192.58 176.00 520.00 20520.00 206.00 150.00 546.00 21643.00 223.86 124.00 572.00 22772.00 245.82 98.00

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