11.2 Output, Price, and Profit inthe Short Run
Market Supplyin the Short Run
· Themarket supply curve in the short run shows the quantity supplied by the industryat each possible price when the number of firms is fixed. The quantity suppliedin the industry at any price is the summation of all quantities supplied byeach firm at that price.
qLand Mine: Students needrepeated reminders that to determine whether a firm can increase profit bychanging output, price and marginal cost are the only things to consider.Questions that throw average total cost into the mix often cause confusion.
Short-RunEquilibrium in Normal Times
· Innormal times, firms make zero economic profit. The figure to the right shows such a firm. Theprice is $3 per unit and the firm produces 3 units. P = ATC, so the firm has zero economicprofit.
qLand Mine: Students areoften skeptical that a zero economic profit is an acceptable outcome for anentrepreneur. The key is to reinforce the meaning of normal profit. A rationaldecision is one that is based on a weighing of the opportunity cost of eachalternative against its full benefits. Opportunitycost includes the benefits from forgone opportunities as well as explicitcosts. One of these forgone opportunities for the entrepreneur is pursuing hisor her next best activity. The value of this forgone opportunity is normal profit.So, when a firm makes zero economic profit, the entrepreneur earns normalprofit and enjoys the same benefits as those available in the next bestactivity. There is no incentive to change to the next best activity.
Short-RunEquilibrium in Good Times
· There are three possible profitoutcomes—an economic profit, zero economic profit, and an economic loss.
· Ifthe price exceeds the ATC, the firm makes an economic profit.
· Thefigure illustrates a perfectly competitive firm that is making an economic profit.The firm produces 4 units, has a price of $3 per unit, and makes an economicprofit equal to the area of the darkened rectangle.
Short-Run Equilibrium in Bad Times
· Ifthe price is less than the ATC, the firm incurs an economic loss.
· Thefigure illustrates a perfectly competitive firm that is suffering an economicloss. The firm produces 3 units, has a price of $3 per unit, and incurs an economicloss is equal to the area of the darkened rectangle.
n 15.3 Output, Price, andProfit inthe Long Run
· Ifthe price equals the ATC, the firm makes zero economic profit. In thiscase, the firm’s owners receive a normal profit.
Entry andExit
· Changesin market demand influence the output and the entry or exit decisions made byfirms.
· An increase in market demand shifts the demand curve rightward andraises the market price. Each firm in the industry responds by increasing itsquantity supplied.
· The higher price now exceeds eachfirm’s minimum ATC and the firms in the industry make an economic profit.The economic profit motivates firmsto enter the industry, therebyincreasing the market supply. The market supply curve shifts rightward and themarket price falls. Eventually the price falls to equal the minimum ATCfor each firm in the industry. At this price, firms in the industry no longer makean economic profit.
· The effects of a decrease in market demand are theopposite of those outlined above: The price falls, firms incur an economicloss, some firms exit thereby decreasing the supply and so the price risesuntil the surviving firms make zero economic profit.
Change inDemand
· When demand for a good increases, inthe short run the existing firms in an industry make an economic profit.
· The economic profit for the firms is aincentive for other firms to enter the industry in order to make an economicprofit. As they do, the supply increases which drives down the price. Entrycontinues until in the long run the firms make zero economic profit.
TechnologicalChange
· New, cost-saving technologiestypically require new plant and equipment. So it takes time for new technologyto spread throughout an industry.
· Firms that adopt the new technologylower their costs and their supply curves shift rightward. The price of thegood falls, so that firms using the old technology incur economic losses.
· Old-technology firms either adopt thenew technology or else exit the industry. In the long run, all the firms usethe new technology and make zero economic profit.
Is PerfectCompetition Efficient?
Resource allocation in a market is efficient when society values no other use of the resources more highly. Resource use is efficient when production is such that the marginal benefit of the good equals the marginal cost of the good.
A firm’s supply curve for a good is its marginal cost curve and so the market supply curve for a good is the society’s marginal cost curve.
The demand curve is the marginal benefit curve.
- In a competitive equilibrium, the quantity demanded equals the quantity supplied. The demand curve is the same as the marginal benefit curve and the supply curve is the same as the marginal cost curve, so at the competitive equilibrium, the marginal benefit equals the marginal cost. Resource use is efficient. Because resources are used efficiently, at the competitive equilibrium there is no other allocation of resources that will generate greater net benefits to society. The figure shows this outcome, where resource use is efficient at the equilibrium quantity of 3,000 units.
Point out to your students thatthe entry (or exit) discussed when the demand changes really shows how theself-interested decisions by firms’ owners promote the social interest by usingmore resources to produce those goods that are more highly valued by society.It is this intuition that helps reinforce the more technical definition ofallocative efficiency.
Is Perfect Competition Fair?
Perfect competition allows anyone to enter the market and the process of competition brings the maximum benefits for consumers. So fairness of opportunity and fairness as equality of outcomes are achieved in perfect competition in the long run.
