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Today SR market equilibrium Changes in equilibrium LR equilibrium – PowerPoint PPT presentation

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Title: Today


1
Today
  • SR market equilibrium
  • Changes in equilibrium
  • LR equilibrium

2
Short-Run Market Equilibrium
  • The price must clear the market (QD QS).
  • Every firm must be profit-maximizing, given its
    costs and the market price.
  • Firms may be making profits or losses.

3
Graph of SR Market Equilibrium
P
P
Typical Firm
Industry or Market
SRS
MC
ATC
P
P
AVC
D
q
Q
Q
Does this firm produce in the short run? If so,
how much?
4
Graph of SR Market Equilibrium
P
P
Typical Firm
Industry or Market
SRS
MC
ATC
P
P MR
AVC
D
q
Q
q
Q
Does this firm make profits in the short run? If
so, how much?
5
Graph of SR Market Equilibrium
P
P
Typical Firm
Industry or Market
SRS
MC
ATC
P
P MR
AVC
D
q
Q
q
Q
P - ATC profit per unit. Does the rectangle go
to the bottom of ATC?
6
Decrease in Demand
P
P
Typical Firm
Industry or Market
SRS
MC
ATC
P
AVC
PMR
D
D
q
Q
q
q
Q
Q
ATC - P loss per unit. Does the rectangle go to
the bottom of ATC?
7
Results of Decrease in Demand
  • Market price falls.
  • Firm responds by cutting its output.
  • This firm makes losses but still produces in the
    short run. (Why?)
  • Market quantity falls.

8
Further Decrease in Demand
P
P
Typical Firm
Industry or Market
SRS
MC
ATC
P
AVC
P MR
D
D
D
q
q
Q
Q
q
q
Q
Q
What does this firm do in the short run? Why?
9
Firm Supply in the Long Run
  • If price is less than ATC, a firm makes losses in
    the short run.
  • Such a firm will shut down in the long run.
  • Therefore, the firms long-run supply curve is
    its marginal cost curve above ATC.

10
Graphing the Firms Supply Curve
P
LRS
SRS
MC
ATC
P3
AVC
P2
P1
P0
q
11
Long-Run Equilibrium
  • The key to understanding the LR is firm entry and
    exit.

12
The Key
  • Profits are a signal for resources to flow into
    the industry new firms enter.
  • Losses are a signal for resources to leave the
    industry firms exit.

13
Conditions for Long Run Equilibrium
  • The market price clears the market.
  • Firms must max. profits, given their SR
    constraints.
  • Firms do not make profits or losses.
  • Firms must be at their lowest SRAC, given their
    level of production.
  • The assumption room for many firms implies
    firms produce at the lowest level of their LRAC
    curve.

14
Adjustment to LR Equilibrium
P
P
Typical Firm
Industry or Market
SRS
MC
ATC
P
P
D
q
Q
Q
What do you expect will happen in the long run?
15
Adjustment to LR Equilibrium
P
P
Typical Firm
Industry or Market
SRS
MC
SRS
ATC
P
P
P
D
q
Q
Q
Profits attract entry. Price falls. Firms
output falls, market output rises (why?). What
happens to the firms profits? Is this LR
equilibrium?
16
Adjustment to LR Equilibrium
P
P
Typical Firm
Industry or Market
SRS
MC
SRS
ATC
SRS
P
P
P
D
q
Q
q
Q
Q
Entry continues until the firm no longer earns
profits. Is this LR equilibrium?
17
LR Equilibrium
P
P
Typical Firm
Industry or Market
MC
LRATC
ATC
SRS
P
D
q
Q
q
Q
Q
In long run equilibrium, firms in a perfectly
competitive market will operate at the lowest
point on their LRAC curves.
18
Adjustment to LR equilibrium Case of Initial
Profits
  • Profits attract new firms into the market,
    increasing market supply.
  • Market price falls. All firms must cut back
    output and see lower profits.
  • Market quantity rises, though, due to larger
    number of firms.
  • Process continues until profits fall to zero.

19
Initial Losses
P
P
Typical Firm
Industry or Market
SRS
MC
ATC
P
AVC
PMR
D
q
Q
q
Q
Why is this not LR equilibrium? What will happen
in the LR?
20
Firm Exit
  • If a firm is making losses, then it will get out
    of business as soon as possible
  • expiration of lease, sale of property, etc.
  • Exception if it expects market conditions to
    improve soon enough, it may decide to wait it
    out.
  • May wait for others to exit first, or demand to
    increase. Note this could be quite costly. We
    usually ignore this possibility.

21
Initial Losses
P
P
Typical Firm
Industry or Market
SRS
SRS
MC
ATC
P
AVC
PMR
PMR
D
q
Q
q
Q
Firms exit. Market price rises. Remaining firms
produce more. Losses shrink. Market output falls.
Is this a LR equilibrium?
22
Initial Losses
P
P
Typical Firm
Industry or Market
SRS
SRS
SRS
MC
ATC
P
AVC
PMR
PMR
D
q
Q
Q
q
Q
q
Firms exit until none make losses. Is this a LR
equilibrium?
23
Coming Up
  • LR Industry Supply3 Cases
  • Market Efficiency

24
Group Work
  • Problems on Handout
  • LR supply
  • Industry supply
  • SR industry equilibrium
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