LONG RUNLONG RUN

A period of time over which the number of firms in an industry can change their production facilities. In the long run, firms can enter or leave an industry, and existing firms can modify their facilities or build new facilities.

• The time required for a firm to build a production facility and start producing output.

• The long run varies across industries.

LONG-RUN SUPPLY CURVELONG-RUN SUPPLY CURVE

• Shows the relationship between price and quantity supplied over a period of time long enough that firms can enter or leave the market and firms can modify their production facilities.

Chair Industry Output and Chair Industry Output and Average Production CostAverage Production Cost

Number Industry Chairs Total Average of firms Output per Cost for Cost Per

Firm Firm Chair

25 500 20 $400 $20

50 1,000 20 $480 $24

75 1,500 20 $560 $28

The average cost of chair industry increases as the industry grows for two reasons:

Reasons Average Cost Reasons Average Cost Grows As Industry GrowsGrows As Industry Grows

• Increasing Input Prices

As an industry grows, it competes with other industries for limited amounts of various inputs; this competition drives up the prices of these inputs.

• Less Productive Inputs

A small industry only uses the most productive inputs, but as the industry grows, firms may be forced to use less productive inputs.

Drawing the long-run supply Drawing the long-run supply curvecurve

Drawing the long-run supply Drawing the long-run supply curvecurve

Price

5.00

10 14

InitialDemand

NewDemand

Quantity (thousands)

InitialShort-Run

Supply

6.00

22

9.00

5.00

10 14Quantity

SMC

6.00SATC1

MR1

9.00MR2

MR3

SATC2

Market Firm

Long-RunSupply

NewShort-Run

Supply

Profit

11

The Long-Run Market The Long-Run Market Supply CurveSupply Curve

• How much output produced at each price.

• Determine the total output of the industry by multiplying the output per firm by the number of firms in the industry.

Determining Number of Determining Number of Firms in an IndustryFirms in an Industry

• Whenever opportunity to make profit - price exceeds average cost - firms enter market.

• Firms continue to enter until economic profit is zero.

• To find number of firms in the market, find the quantity of chairs at which average cost equals market price.

20

24

28

Price of

Chairs$

500 1,000 1,500

Chairs Per Hour

The Long-Run Market Supply The Long-Run Market Supply CurveCurve

e

h

i

The Long-Run Supply CurveThe Long-Run Supply CurveThe preceding long-run supply curve:

• Is positively sloped.

• The higher the price of chairs, the larger the quantity supplied.

• An increase in the price of chairs makes chair production more profitable, so

• firms enter the market,

• increasing the total output of the industry.

Increasing-Cost IndustryIncreasing-Cost Industry

An industry with a positively-sloped long-run supply curve.

• Indicates average cost of production increases as industry grows.

• Supply curve will be relatively steep if average cost increases rapidly as industry grows.

• With rapidly increasing average cost, a relatively large increase in price is needed to get firms to produce more output.

3

Price of

TaxiService

$per mile

1,000 2,000

Miles of Taxi Service Per Hour

The Long-Run Market Supply Curve For The Long-Run Market Supply Curve For a Constant-Cost Industrya Constant-Cost Industry

Long-Run Supply Curve

TAXI TAXI TAXI

Constant-Cost IndustriesConstant-Cost IndustriesAn industry with a horizontal long-run supply curve.• Indicates average cost of production is constant.• It can continue to buy inputs at the same prices, and

these inputs are as productive as inputs in the smaller industry.

• Industry must be small part of relative input markets: industry does not affect the prices of inputs.

Decreasing-Cost IndustryDecreasing-Cost Industry

An industry with a negatively-sloped long-run supply curve.

• The average cost of production decreases as the industry expands.

Short-Run versus Long-Run Short-Run versus Long-Run Supply CurvesSupply Curves

• Long-run response to change in price is much greater than short-run response.

• The long-run supply curve is much flatter than the short run curve, meaning that the quantity of chairs increases by a larger amount in the long run.

• The short-run supply curve is much steeper than the long-run supply curve because there are diminishing returns in the short run.

24

28Price of

Chairs$

1,000 1,500

Chairs Per Hour

Long-Run versus Short-Run Market Supply Long-Run versus Short-Run Market Supply CurveCurve

hi

jShort-Run Supply Curve

Long-Run SupplyCurve

PRICE $24 $28SHORT RUN# of Firms 50 50 Chairs by 1 firm 20 22Chairs by all firms 1,000 1,100 LONG RUN# of Firms 50 75Chairs by 1 firm 20 20Chairs by all firms 1,000 1,500

1,100

Long-Run versus Short-Run Market Long-Run versus Short-Run Market Supply CurveSupply Curve

Price elasticity of supply measures difference between short-run and long-run responses to change in price:

• Change in price = 16.67% = 4/24

• Short-run change in quantity = 10% = 100/1000

• Short-run price elasticity of supply = 0.60

• Long-run change in quantity = 50% = 500/1000

• Long-run price elasticity of supply = 3.00

Effects of Increased DemandEffects of Increased Demand• Increased demand results in rightward shift in demand curve, causing

a shortage at the original price: quantity demand exceeds quantity supplied at the original price.

In Short Run

• The number of firms is fixed,

• Supply curve is relatively steep,

• Price increases by large amount,

In Long Run

• Firms can enter market,

• Supply curve is relatively flat,

• Price increases by small amount .

Price of Video Rentals

$ Per Night6.00

2.00

10 14

i

s

InitialDemand

NewDemand

Quantity: Thousands of Video Rentals per Day

Short-RunSupply

2.15

22

fLong-Run Supply

Price Quantity

Short RunChange

Long RunChange

$2.00 10

$6.00 14

$2.15 22

Short-Run and Long-Run Effects of an Short-Run and Long-Run Effects of an Increased Demand for Video RentalsIncreased Demand for Video Rentals

Relationship between long-Relationship between long-run and short-run cost run and short-run cost

curvescurves

11

10

100 150

Units of output

Long-run average

cost (LAC)

Do

llars

per

un

it

SATC1

SATC2SMC1

300

SATC3

Relationship between LAC Relationship between LAC and LMCand LMC

• Long-run marginal cost is the change in total cost resulting from producing an extra unit of output in the long-run.

• When LAC is downward-sloping, LMC must lie below LAC.

• When LAC is horizontal, LMC and LAC are equal.

Relationship between long-Relationship between long-run and short-run cost run and short-run cost

curvescurves

10

100 150

Units of output

Long-run average

cost (LAC)

Do

llars

per

un

it

300

Long-run marginal

cost (LMC)

MONOPOLYMONOPOLY

An industry served by a single firm.

Occurs when some barrier to entry exists, preventing other firms from entering the market.

• PATENT --

Granted by the government, giving an inventor exclusive right to sell a new product for some period of time.

• Government implicitly grants monopoly power.

For example, government permits major league baseball to restrict the number and location of teams.

BARRIERS TO ENTRYBARRIERS TO ENTRY

• FRANCHISE or LICENSING SCHEME --

Government designates single firm to sell a particular good:

• Off-street parking;

• National Park Food Concessions;

• Radio and TV FCC licensing.

• NATURAL MONOPOLY --

Economies of Scale

Single firm would be profitable; a pair of firms would lose money;

Second firm would make price less than average cost.

THETHE MONOPOLIST’SMONOPOLIST’S OUTPUT OUTPUT DECISIONDECISION

How much output to produce at what price.

Objective is to maximize profits:

The difference between total revenue and total cost.

TOTAL AND MARGINAL TOTAL AND MARGINAL REVENUEREVENUE

• Total Revenue ---

Price times the quantity sold.

• Marginal Revenue ---

The change in total revenue that results from selling one more unit of output.

PRICE QUANTITY TOTAL MARGINALSOLD REVENUE REVENUE

$16 0 0 ---

$14 1 $14 $14

$12 2 $24 $10

$10 3 $30 $6

$8 4 $32 $2

$6 5 $30 -$2

$4$4 6 6 $24$24 -$6-$6

QUANTITY SOLD

MA

RG

INA

L R

EV

EN

UE

($6)

($4)

($2)

$0

$2

$4

$6

$8

$10

$12

$14

1 2 3 4 5 6

QUANTITY SOLD

TO

TAL

REV

EN

UE

$0

$5

$10

$15

$20

$25

$30

$35

1 2 3 4 5 6

PRICE$$

2468

101214

-2-4-6

1 2 3 4 5 6QUANTITY SOLD

DEMAND

MARGINAL REVENUE

QUANTITY SOLD

QUANTITY SOLD

DEMAND, TOTAL REVENUE AND MARGINAL REVENUEDEMAND, TOTAL REVENUE AND MARGINAL REVENUE

PRICE QUANTITY SOLD TOTAL REVENUE MARGINAL REVENUE

$16 0 0

---

$14 1 $14

$14

$12 2 $24

$10

$10 3 $30

$6

$8 4 $32

$2

$6 5 $30

-$2

$4 6 $24 -$6

PRICEPRICE$$$$

QUANTITY SOLDQUANTITY SOLD

- 6

- 2

- 4

2

4

6

8

10

12

14

1 2 3 4 5 6

MONOPOLIST’S DEMANDMONOPOLIST’S DEMAND( MARKET DEMAND )( MARKET DEMAND )

MARGINAL REVENUEMARGINAL REVENUE

b

c

d

e

f

g

h

i

j

k

0

THE MARGINAL PRINCIPLETHE MARGINAL PRINCIPLE Increase the level of an activity if its marginal

benefit exceeds its marginal cost, but reduce the level if the marginal cost exceeds the marginal benefit. If possible, pick the level at which the marginal benefit equals the marginal cost.

MARGINAL REVENUE = MARGINAL COST

USING MARGINAL PRINCIPLE TO PICK USING MARGINAL PRINCIPLE TO PICK PRICE AND QUANTITYPRICE AND QUANTITY

PRICE QUANTITY MARGINAL MARGINAL SOLD REVENUE COST

$18 600 $12 $6

$17 700 $10 $6

$16 800 $8 $6

$15 900 $6 $6

$14 1,000 $4 $6

$13 1,100 $2 $6

$12 1,200 $0 $6

USING MARGINAL PRINCIPLE TO PICK USING MARGINAL PRINCIPLE TO PICK PRICE AND QUANTITYPRICE AND QUANTITY

PRICEPRICE$$$$

DOSES OF DRUG PER HOURDOSES OF DRUG PER HOUR

2

468

1012141618202224

200 400 600 800 100012001400160018002000

PROFIT = $8,100PROFIT = $8,100

h

m

ii

n

MARKET DEMAND CURVEMARKET DEMAND CURVEMARGINAL REVENUEMARGINAL REVENUE

LONG-RUN MARGINAL COSTLONG-RUN MARGINAL COSTEQUALSEQUALS

LONG-RUN AVERAGE COSTLONG-RUN AVERAGE COST

CALCULATING MARGINAL CALCULATING MARGINAL REVENUEREVENUE

• Marginal Revenue

= Current Total Revenue - Previous Total Revenue

= Initial Price - [ Initial Quantity *

Slope of Demand Curve ]

MONOPOLY VERSUS MONOPOLY VERSUS PERFECT COMPETITIONPERFECT COMPETITION

PRICEPRICE

Doses of Drug per hourDoses of Drug per hour900 1,800

Long-run average cost andLong-run average cost andmarket supply curvemarket supply curve

Market DemandMarket DemandCurveCurve

CC

MM DD

mm

pp

$15$15

$6$6

DEADWEIGHT LOSSDEADWEIGHT LOSS• Net loss associated with a monopoly (D).

• Monopoly is inefficient because it generates less output than a perfectly competitive market.