LONG RUN

1
LONG 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.

2
LONG-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.

3
Chair Industry Output and Average 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

4
Reasons Average Cost Grows 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.

5
Drawing the long-run supply curve
Initial Short-Run Supply
Market
Firm
Price
SMC
MR2
9.00
9.00
New Short-Run Supply
SATC2
Profit
SATC1
6.00
6.00
MR3
MR1
5.00
5.00
New Demand
Long-Run Supply
Initial Demand
10
14
22
10
14
11
Quantity
Quantity (thousands)
6
The Long-Run Market Supply 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.

7
Determining Number of Firms 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.

8
The Long-Run Market Supply Curve
28
i
Price of Chairs
24
h
20
e
500
1,000
1,500
Chairs Per Hour
9
The Long-Run Supply Curve

• The 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.

10
Increasing-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.

11
The Long-Run Market Supply Curve For a
Constant-Cost Industry
Price of Taxi Service per mile
TAXI
TAXI
TAXI
3
Long-Run Supply Curve
1,000
2,000
Miles of Taxi Service Per Hour
12
Constant-Cost Industries

• An 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.

13
Decreasing-Cost Industry

• An industry with a negatively-sloped long-run
  supply curve.
• The average cost of production decreases as the
  industry expands.

14
Short-Run versus Long-Run Supply 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.

15
Long-Run versus Short-Run Market Supply Curve
Long-Run Supply Curve
Short-Run Supply Curve
j
Price of Chairs
28
i
h
24
PRICE 24 28 SHORT RUN of Firms 50
50 Chairs by 1 firm 20 22 Chairs by all
firms 1,000 1,100 LONG RUN of Firms 50
75 Chairs by 1 firm 20 20 Chairs by all
firms 1,000 1,500
1,000
1,500
1,100
Chairs Per Hour
16
Long-Run versus Short-Run Market Supply 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

17
Effects 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 .

18
Short-Run and Long-Run Effects of an Increased
Demand for Video Rentals
Price of Video Rentals Per Night
Short-Run Supply
s
6.00
New Demand
Initial Demand
Long-Run Supply
f
2.15
Price Quantity
2.00
i
2.00 10
Short Run Change
6.00 14
Long Run Change
2.15 22
10
14
22
Quantity Thousands of Video Rentals per Day
19
Relationship between long-run and short-run cost
curves
SATC1
SATC3
SATC2
SMC1
Long-run average cost (LAC)
Dollars per unit
11
10
150
100
300
Units of output
20
Relationship between LAC and 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.

21
Relationship between long-run and short-run cost
curves
Long-run average cost (LAC)
Dollars per unit
10
Long-run marginal cost (LMC)
150
100
300
Units of output
22
MONOPOLY

• 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.

23
BARRIERS 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.

24
THE MONOPOLISTS OUTPUT DECISION

• How much output to produce at what price.
• Objective is to maximize profits
• The difference between total revenue and total
  cost.

25
TOTAL AND MARGINAL REVENUE

• Total Revenue ---
• Price times the quantity sold.
• Marginal Revenue ---
• The change in total revenue that results from
  selling one more unit of output.

26
PRICE QUANTITY TOTAL MARGINAL SOLD
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
6 24 -6
QUANTITY SOLD
QUANTITY SOLD
PRICE
14
12
10
8
DEMAND
6
4
2
QUANTITY SOLD
-2
1
2
3
4
5
6
-4
-6
MARGINAL REVENUE
27
DEMAND, 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

28
PRICE
b
14
c
12
MONOPOLISTS DEMAND ( MARKET DEMAND )
d
10
h
e
8
f
6
i
g
4
2
MARGINAL REVENUE
0
QUANTITY SOLD
1
2
3
4
5
6
- 2
j
- 4
- 6
k
29
THE 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

30
USING MARGINAL PRINCIPLE TO PICK PRICE 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

31
USING MARGINAL PRINCIPLE TO PICK PRICE AND
QUANTITY
PRICE
24
22
20
h
18
m
16
14
i
12
LONG-RUN MARGINAL COST EQUALS LONG-RUN AVERAGE
COST
10
PROFIT 8,100
8
n
6
4
MARKET DEMAND CURVE
2
MARGINAL REVENUE
200
400
600
800
1000
1200
1400
1600
1800
2000
DOSES OF DRUG PER HOUR
32
CALCULATING MARGINAL REVENUE

• Marginal Revenue
• Current Total Revenue - Previous
  Total Revenue
• Initial Price - Initial Quantity Slope of
  Demand Curve

33
MONOPOLY VERSUS PERFECT COMPETITION
PRICE
Market Demand Curve
C
m
15
M
Long-run average cost and market supply curve
D
p
6
900
1,800
Doses of Drug per hour
34
DEADWEIGHT LOSS

• Net loss associated with a monopoly (D).
• Monopoly is inefficient because it generates less
  output than a perfectly competitive market.