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Chia-Hui Chen
Lecture 16
Long Run Supply and the Analysis of
Competitive Markets
Outline
1. Chap 8: Long Run Equilibrium
2. Chap 8: Long Run Market Supply
3. Chap 9: Gains and Losses from Government Policies
In the long run, firms earn zero profit, and in the short run, firms can have
positive profit. However, the short run profit is not always higher because firms
can also have negative profit (when P < AT C).
10
8 LMC
P7 SMC
6
5 SAC
LAC
4
0
0 1 2 3 4 5 6 7 8 9 10
x
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2 Long Run Market Supply 2
In Figure 3, the original price 2 is lower than AC. Firms have a loss and
start leaving the market, and the market supply shifts from S1 to S2 .
5 5
4.5 4.5 S2
4 4
3.5
LAC 3.5 S1
3 3
2.5 2.5
2 2
1.5
LMC 1.5
D
1 1
0.5 0.5
0 0
0 0.5 1 1.5 2 2.5 3 3.5 4 4.5 5 0 0.5 1 1.5 2 2.5 3 3.5 4 4.5 5
Q Q
5 5
4.5 4.5 S2
4 4
3.5
LAC 3.5 S1
3 3
2.5 2.5
2 2
1.5
LMC 1.5
D
1 1
0.5 0.5
0 0
0 0.5 1 1.5 2 2.5 3 3.5 4 4.5 5 0 0.5 1 1.5 2 2.5 3 3.5 4 4.5 5
Q Q
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OpenCourseWare (http://ocw.mit.edu), Massachusetts Institute of Technology. Downloaded on [DD Month
YYYY].
2 Long Run Market Supply 3
Constant-Cost Industry
In constant-cost industry, price of inputs does not change. If the price is higher
than minimum LAC. new firms will keep entering, so the supply is perfectly
elastic at P = minimumLAC. Long run supply is a horizontal line at the price
equal to the minimum LAC (see Figure 4(b)).
5 4
4.5 3.8
4 3.6
3.5
LAC 3.4
P* SL
3 3.2
P*
2.5 3
P
P
2 2.8
1 2.4
0.5 2.2
Q*
0 2
0 0.5 1 1.5 2 2.5 3 3.5 4 4.5 5 0 0.5 1 1.5 2 2.5 3 3.5 4 4.5 5
Q Q
(a) Long Run Cost in Constant-Cost In- (b) Supply Curve in Constant-Cost In
dustry. dustry.
Increasing-Cost Industry
Price of some or all inputs rises as production is expanded and demand of inputs
increases. When the price increase from P ∗ to P ′ , firms are making profit. Old
4.5
3.5
LAC
3
P* 5
4.5
P’
2.5
P
3.5
2
P* SL
3
1.5 LMC
P
2.5
2
1
1.5
0.5 1
Q* 0.5
0
0 0.5 1 1.5 2 2.5 3 3.5 4 4.5 5
Q
0
0 0.5 1 1.5 2 2.5 3 3.5 4 4.5 5
Q
(a) Long Run Cost in Increasing-Cost (b) Supply Curve in Increasing-Cost In-
Industry. dustry.
firms expand and new firms enter, so the demand of inputs increase, and so do
the prices of inputs. Firm’s cost curves increase to LM C ′ and LAC ′ / Since now
firms have zero profit, new firms stop entering. The quantity supplied increases
but is still finite. Thus the supply curve is upward sloping.
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3 Gains and Losses from Government Policies 4
4.5
4
S
3.5
Consumer Surplus
3
Producer Surplus
2.5
P
2
D
1.5
0.5
0
0 0.5 1 1.5 2 2.5 3 3.5 4 4.5 5
Q
Price Ceiling
When there is no intervention, the equilibrium price and quantity are P ∗ and
Q∗ , respectively. Now government sets a price ceiling, namely, a maximum price
P̄ (see Figure 7). The changes in consumer surplus and producer surplus are as
follows:
ΔCS = A − B,
ΔP S = −A − C,
ΔCS + ΔP S = −B − C.
Deadweight loss, or net loss of CS + P S, is −(B + C) in this case. Government
should maximize economic efficiency: maximize CS + P S. If policies cause
deadweight loss, they impose an economy cost on the economy.
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3 Gains and Losses from Government Policies 5
4.5
P̄ 3.5
P *3
B
A C
P
2.5
P 2
1.5
0.5 Q′ Q∗
0
0 0.5 1 1.5 2 2.5 3 3.5 4 4.5 5
Q
Price Floor
Government sets a price floor (price support), namely, a minimum price P (see
Figure 8). The changes in consumer surplus and producer surplus from the
competitive equilibrium (P ∗ , Q∗ ) to the new equilibrium (P , Q′ ) are as follows:
ΔCS = −A − B;
ΔP S = A − C;
ΔCS + ΔP S = −B − C.
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3 Gains and Losses from Government Policies 6
4.5
4 S
3.5
3
B
2.5
A C
P
2
D
1.5
0.5
0
0 0.5 1 1.5 2 2.5 3 3.5 4 4.5 5
Q
Cite as: Chia-Hui Chen, course materials for 14.01 Principles of Microeconomics, Fall 2007. MIT
OpenCourseWare (http://ocw.mit.edu), Massachusetts Institute of Technology. Downloaded on [DD Month
YYYY].