Lecture Economics (19/e) - Chapter 9: Pure competition in the long run

After reading this chapter, you should be able to: Explain how the long run differs from the short run in pure competition; describe why profits encourage entry into a purely competitive industry and losses result in firms exiting the industry; explain how the entry and exit of firms affects resource flows and long-run profits and losses; explain the differences between constant-cost, increasing-cost, and decreasing-cost industries.

09 PureCompetitionintheLongRun McGrawưHill/Irwin Copyrightâ2012byTheMcGrawưHillCompanies,Inc.Allrightsreserved TheLongRuninPureCompetition In the long run • Firms can expand or contract capacity • Firms enter and exit the industry LO1 9-2 Profit Maximization in the Long Run • Easy entry and exit • The only long-run adjustment we • • LO2 consider Identical costs • All firms in the industry have identical costs Constant-cost industry • Entry and exit not affect resource prices 9-3 Long­Run Equilibrium • Entry eliminates profits • Firms enter • Supply increases • Price falls • Exit eliminates losses • Firms exit • Supply decreases • Price rises LO3 9-4 Entry Eliminates Economic Profits S1 MC $60 ATC 50 40 $60 S2 50 MR 40 D2 D1 LO3 9-5 Exit Eliminates Losses S3 MC $60 ATC S1 50 50 40 $60 MR 40 D1 D3 LO3 9-6 • • LO4 • Long Run Supply Constant cost industry • Entry/exit does not affect LR ATC • Constant resource price • Special case Increasing cost industry • Most industries • LR ATC increases with expansion • Specialized resources Decreasing cost industry 9-7 LR Supply: Constant­Cost Industry $50 Z3 Z1 D1 D3 Q3 90,000 LO4 Z2 Q1 100,000 S D2 Q2 110,000 9-8 LR Supply: Increasing­Cost Industry S P2 $55 Y2 P1 $50 Y1 P3 $40 Y3 D2 D1 D3 Q3 90,000 LO4 Q1 100,000 Q2 110,000 9-9 LR Supply: Decreasing­Cost Industry P3 $55 X3 X1 P1 $50 X2 P2 $40 D3 S D2 D1 Q3 90,000 LO4 Q1 100,000 Q2 110,000 9-10 Pure Competition and Efficiency  • In the long run, efficiency is achieved • Productive efficiency • Producing where P = ATC • Allocative efficiency • Producing where P = MC LO5 9-11 Pure Competition and Efficiency P=MC=Minimum ATC (Normal Profit) MC Consumer Surplus S ATC P MR P Producer Surplus D Qf LO5 Qe 9-12 Dynamic Adjustments • Purely competitive markets will • LO6 automatically adjust to • Changes in consumer tastes • Resource supplies • Technology Recall the “Invisible Hand” 9-13 Technological Advance: Competition • Entrepreneurs would like to increase profits beyond just a normal profit • Decrease costs by innovating • New product development LO6 9-14 Creative Destruction • Competition and innovation may lead to “creative destruction” • Creation of new products and methods destroys the old products and methods LO6 9-15 Efficiency Gains from Entry • Patent protected prescription drugs earn • substantial economic profits for the pharmaceutical company Generic drugs become available as the patent expires on the existing drug • Results in a 30-40% reduction price • Greater consumer surplus and efficiency 9-16 Efficiency Gains from Entry a P1 P2 S b c d f D Q1 Q2 9-17 .. .The Long Run in Pure Competition • In the long run • Firms can expand or contract capacity • Firms enter and exit the industry LO1 9-2 Profit Maximization in the Long Run • Easy entry... The only long- run adjustment we • • LO2 consider Identical costs • All firms in the industry have identical costs Constant-cost industry • Entry and exit not affect resource prices 9-3 Long Run Equilibrium... 110,000 9-1 0 Pure Competition and Efficiency  • In the long run, efficiency is achieved • Productive efficiency • Producing where P = ATC • Allocative efficiency • Producing where P = MC LO5 9-1 1 Pure Competition and Efficiency