Perfectly Competitive Industry

1
Perfectly Competitive Industry

• Long Run Equilibrium Revisited Long Run Supply
  Constant Cost and Increasing Cost Industries
  Economic Efficiency

2
Long Run Equilibrium

• No incentives to enter or exit the industry
• Zero economic profits for marginal firm
• Each firm produces where PMC

3
Firms With Different Costs

• Firm not operating at the minimum of LRATC will
  suffer economic loss in long run equilibrium
• Some firms might earn economic rent if they have
  access to unique resources or talents.

4
Long Run Industry Supply

• Constant Cost Industry
• Long run expansion of industry does not affect
  input prices
• Increasing Cost Industry
• Long run expansion of industry leads to an
  increase in input prices
• Decreasing Cost Industry
• Long run expansion of industry leads to a
  decrease in input prices

5
Constant Cost Industry

• Cost curves are stable
• Long run supply is perfectly elastic
• Long run supply price is equal to the minimum
  long run average total cost
• Increases in demand increase short run price, but
  not long run price of product

6
Increasing Cost Industry

• As industry grows, cost curves shift up
• Likely to happen if industry is large user of an
  input in inelastic supply
• Computer software and software engineers
• Aluminum industry and bauxite
• Long run supply is upward sloping

7
Decreasing Cost Industry

• As industry grows, cost curves shift down.
• Likely to happen if there are economies of scale
  in production of specialized input.
• Industry uses specialized machinery
• Long run supply is downward sloping

8
Whats So Perfect?

• Firms operate at minimum point on average total
  cost -- thus insuring technical efficiency
• Because firms maximize profit, price equals
  marginal cost of producing last unit
• Because supply equal demand, price equals
  marginal benefit to consumers of last unit
  produced
• So marginal benefitmarginal cost and resources
  are not wasted.

9
Other Advantages

• No administrative or bureaucratic overhead
• Flexibility
• Changes in demand
• Changes in technology

10
Potential Problems

• Externalities
• Public Goods
• Imperfect Information and Uncertainty
• Rent Seeking
• Fairness/Equity Issues
• Market may adjust too fast or too slowly to suit
  us.

11
Will Competitive Firms Adopt New Production
Technology?

• Firm has incentive to adopt new technology if the
  cost of adoption is less than or equal to the
  present discounted value of expected increase in
  future earnings
• Early adopters of new technology may enjoy
  economic rent in short run
• As more firms adopt new technology, output
  expands in industry
• New long run equilibrium will reflect lower
  average total cost of production

12
Will Competitive Firms Introduce New Improved
Product?

• Firm will introduce new product if the cost of
  introducing new product is less than or equal to
  the present discounted value of expected increase
  in future earnings
• Firm may enjoy economic rent in short run because
  consumers may be willing to pay a higher price
  for the new product than for competitors products
• In long run, other firms will also introduce new
  improved product, competing away economic rent

13
Other Market Structures

• Monopoly
• Single seller
• Barriers to entry
• Monopolistic Competition
• Many sellers
• Differentiated products
• Economies of scale
• Free entry
• Oligopoly
• Few sellers
• Firms are not price takers