Chapter 8: Producers In The Long-Run

Chapter 8:Producers In The Long-Run

What is the long-run?

All factors of production can be variedYou can change your plant size

Profit Maximization & Cost Minimization

To maximize profits you must…minimize costs

YAY

Long-Run Cost Curves

LRAC: Long Run Average Cost Curve◦Boundary between attainable and unattainable

costs◦3 parts:

Decreasing costs Constant costs Increasing costs

Long-Run Cost Curves

Decreasing costs◦Output increases more than inputs

Output 20% Inputs (Cost) 10%◦Why?

I don’t know But if I had to guess: larger plant sizes provide more

opportunities for specialization

This is also called: ◦Economies of Scale◦Increasing Returns to Scale

Long-Run Cost Curves

Constant costs◦Output increases the same as inputs

Output 20% Inputs (Cost) 20%◦Why?

Prolly cuz at some point you cannot specialize any further

◦Minimum Efficient Scale (WTF) Lowest quantity output at constant costs

This is also called: ◦Constant Returns to Scale

Long-Run Cost Curves

Increasing costs◦Output increases the same as inputs

Output 10% Inputs (Cost) 20%◦Why?

You so big you can’t even handle it

This is also called: ◦Diseconomies of Scale◦Decreasing Returns to Scale

Long-Run and Short-Run Together

SRATCs cannot lie below the LRAC

SRATC touches the LRAC at the optimal output for that plant size

Picture

The Very Long-Run

Technology can change! FINALLY!◦What does this mean?

Things can get better◦2 Ways:

New Techniques Improved Inputs

Firms choices in the long run:◦Cost of an input goes up:

Substitute Innovate Both

Chapter 9:Competitive Markets

Market Structure & Firm Behaviour

Market Structure:◦Number/Size of Sellers◦Extent of Knowledge ◦Degree of Freedom of Entry◦Degree of Product Differentiation

Market Power:◦How much a firm can influence the market

Perfect Competition

What does it look like?◦Homogenous Product◦Consumers Have Perfect Information◦Firms Are Small◦Freedom of Entry & Exit

What does this mean?◦Firms take it… price that is

Demand Curves: Perfect Competition

Demand for the whole market: negatively sloped

Demand for a single firm: flat◦Why?

Quantity (Millions of Tonnes)

D

D (Firm)

Quantity (Thousands of Tonnes)

•

S

Total, Average & Marginal Revenue

Total Revenue: TR = p × Q

Average Revenue: AR = TR ÷ Q

Marginal Revenue: MR = TR ÷ Q

For perfect competition:◦P = MR = AR

Short-Run Decisions

Should we produce?◦If you lose money at all levels of output, don’t

produce

How much should we produce?◦If we can make monies, produce at MR = MC◦This means we produce where MC = price

Short-Run Supply CurvesFirms only supply if the price is higher than

the cost!

MC

•

AVC

q0 q2q1 q3q2q1q0q3

•••

•

••

•S=MC

Price

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Unit

p3

p2

p1

p0

p3

p2

p1p0

Output Output

Short-Run Supply Curves

The supply curve for a market is the sum of all the firm’s individual supply curves

• • •

34 2Quantity Quantity Quantity

333

7

SA = MCA SB = MCB SA+B

121

22

2

Long-Run Decisions

Entry & Exit◦Positive Profits: Firms Enter◦Negative Profits: Firms Exit

Speed of Exit:◦How fast does capital become obsolete?◦Are your fixed costs sunk costs?

Long-Run Equilibrium

Supply = DemandNo Incentive For Entry & Exit

What does this look like?◦Firms Maximize Profit: Short-Run p=mc◦Zero Economic Profits◦At Minimum Point On LRAC

Chapter 10: Monopoly

Revenue Concepts

Downward Sloping Demand Curve

MR Cuts Demand Curve in Half

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-2-4-6-8

-10

Average revenue (demand curve)

•

•

•

•

••

••

••

••

•

•

••

•

•Marginal revenue

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rs

Short Run Profit Maximization

MR = MC

Go To Demand

This Is Price

Profits, Break Even, Loss

•

••

•

MRD

ATC1

ATC2

ATC3MCc3

c2 = p0

c1Pric

e

q0 Output

Inefficiency of Monopoly

Monopolies produce where MC is less than price

Equilibrium quantity is lower

Deadweight loss

Inefficient

Entry Barriers

If the monopoly makes mad cash in the long run others want in.

We need barriers:◦Natural monopolies

Electricity◦Created barriers:

Patent law Legislation Threat of price cutting

Cartels

Multiple firms acting as one

Essentially a monopoly

Reduce OutputRaise Price

••

qm qc

pmpc

D

S = MC

Output

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nit

Problems Cartels Face

Incentive to CheatRestricting Entry

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per U

nit

OutputOutput

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MR

•••

S

E

ATC MC

DQ1

p1p1

p0 p0

Q0 q2q1 q0

Market Equilibrium

Firm Incentives

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Price Discrimination

Pricing units of the same commodity differently◦Not based on cost

When is this possible?◦Market Power◦Know Consumers Valuations◦No Arbitrage

Forms of Price Discrimination

Price Discrimination Among Units of Output◦Charging the consumer’s value at each unit

Price Discrimination Among Market Segments◦Charging different prices to different groups◦Charge a higher price to the group with less elastic

demand

Hurdle Pricing◦Firms create an obstacle consumers must overcome to

get the lower price

Among Units of Output

Price

QuantityD

S

p6

q6q4q3q2q1 q5

Consumer surplus

p5

p4

p3

p2

p1

Among Markets

• •MCA MCB

DA

DBMRA MRB

Market A Market B

Price

Pric e

pApB

Output OutputQA QB

Consequences of Price Discrimination

Price discrimination (done well) is always more profitable than a single price

A monopolist that discriminates will sell more units

If price discrimination increases output, total surplus increases

No general relationship between price discrimination and consumer welfare

Chapter 11: Imperfect Competition

The Canadian Economy

2/3 of the Economy:◦Large number of small firms

1/3 of the Economy:◦Small number of large firms

Sometimes measured by concentration ratio◦Shows market share of largest producers

The Canadian Economy

Imperfect Competition

Have differentiated products

Firms “administer” (choose) their prices◦They are price setters

Price change is rare◦It is costly◦Easier to let output vary with demand

Non-Price Competition

Competing on things other than price:◦Advertising

Gain market share Shift demand curve

◦Competing on quality or guarantees

◦Erecting barriers to entry

Monopolistic Competition

Firms produce one variety of differentiated product

Negatively sloped demand curve◦Close substitutes

Firms ignore each other

Freedom of entry and exit

Monopolistic Competition

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nit

ATCMC

D

MR

ESpS •

A Typical Firm in the Short Run

•

Output qS

The usual situation◦MR = MC◦Positive profits in this situation

Monopolistic Competition

Positive Profit???◦Firms enter the market

Excess capacity theorem◦Long run costs not minimized

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Output

••

• ECEL

pC

pL

qCqL

MR D

MC

LRAC

GOOD LUCK

A) Of course

B) Meh

C) Not my type

D) Shut up and teach me econ