L11: Competition (2/3)

It is possible, but not certain, that some firms are capturing rents It is possible, but not certain, that all firms are making zero profits Barriers to entry, input costs that rise with output, and non-identical firms are three reasons that the long-run supply curve may slope upwards. But knowing that we face a long-run upward-sloping supply curve is not sufficient to conclude that any of them are present. If there are input costs that rise with output, but there are identical firms with no barriers to entry, then no firms are capturing rents, and all firms are making zero profits. However, if there are non-identical firms or barriers to entry, then some firms maybe be capturing rents and making profits.

If there is a long-run upward-sloping supply curve, are firms capturing rents? Are firms making zero profits? Are you certain?

* ...each firm is producing at its greatest efficiency. * ...average cost equals price for each firm in the market * ...average cost is minimized for each firm in the market * ...profits are driven to zero for each firm in the market Market demand is unchanged by firm entry. The market supply curve becomes increasingly elastic with firm entry. It does not ever become perfectly inelastic. Firms enter until average cost equals price, which is the point at which profits are driven to zero. This is also the point at which average cost is minimized, which is by definition the point at which the firm is operating at greatest efficiency.

In long-run perfect competition, firms will continue to enter the market until... (4)

* When total cost exceeds total revenue * When average cost exceeds price * When average cost exceeds average revenue * When average cost exceeds marginal revenue In the long run, a firm should shut down when total cost exceeds total revenue. Dividing by quantity, this is also when average cost exceeds average revenue. In competition, average revenue is marginal revenue, and marginal revenue is price. In every given situation, the firm will shut down in the long run.

In long-run perfect competition, in which situations will a firm necessarily decide to shut down? (4)

1. Zero 2. Perfect elasticity 3. produce at minimum average cost With non-identical firms, with costly entry and exit, or with rising input costs, not all of these results are necessarily true. But with identical firms, free entry and exit, and fixed input costs, all these results are true. Market price will be equal to the long-run minimum average cost of each firm in the market, driving their profits to zero, and squeezing out every firm that charges above or below that price.

In the long run, with identical firms, free entry and exit, and fixed input costs, firm entry and exit will... 1. Drive profits to 2. Drive the market supply curve to 3. Drive each firm in the market to

Market price increases; Other firms in the market realize increased profits (or decreased losses) When a firm exits the market, the short run supply curve shifts inward and becomes less elastic. This decreases market quantity and increases price, as the market equilibrium shifts along the market demand curve. The higher market price means each other firm remaining in the market realizes increased profits (or decreased losses), as the firms are all price-takers. Market demand depends only on consumer preferences, and is unchanged by firm entry and exit.

Suppose a firm exits a competitive market. What happens in the short-run?

1. 1.56 2 Argentina (.48 per kilo) The United States produces cotton at a cost of 1.56, making a profit of 1.56−1.56=0.00 per kilogram. Iran chooses not to produce cotton at a cost of 1.56, as they would make a loss on it. All countries shown are capacity constrainted, including Brazil. Brazil appears to be able to supply about 600 million kilograms of cotton.

Suppose market demand for cotton is perfectly inelastic at 4 billion kg of cotton per year, and that the market supply curve is as shown below. 1. What is the market price for cotton? 2. Which countries produce cotton at a profit? 3. Which countires are capacity constrained?

In the long run, a firm's demand for labor is more elastic In the long run, firms can adjust the amount of capital they use as an input. This gives them additional flexibility for determining how much labor to use as an input; in the long run the firm can choose which short-run demand curve to use. The flexibility manifests as more elastic demand.

What is different about a firm's demand for labor in the long run, relative to the short run?

Input prices are often determined by a competitive market Input prices are often determined by a competitive market, such as the market for labor, and their prices will be determined by supply and demand. Input costs that rise with output, such as wages, increase the minimum average cost of higher quantities of output. This creates an upward-sloping output supply curve. Input prices are not driven to zero by competition. Firms do minimize the cost of their inputs, but this does not explain why input prices are not fixed.

What is unrealistic about the assumption that input prices are fixed?

A, C. Barriers to entry and exit, such as large sunk costs, mean that there is no longer free entry and exit. This makes entry difficult even for firms for which it would be profitable to produce in the long run. If firms are not identical — if some firms can produce at a lower minimum average cost — then they can stay in the market and make profits. However they might not out-compete all other firms because they cannot supply the market quantity demanded; that is, they are capacity-constrained.

Which of the following are reasons why firm entry and exit might not drive profits to zero for all firms? A. Barriers to entry and exit B. Excess demand C. Some firms can produce at a lower minimum average cost, but have capacity constraints D. Firms exit when economic profits are too low