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L16 - Monopoly - 11042013.pdf

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James Pesando

Organic Farming Students agree: 1. If DD for organic food increases, (economic) profits of organic farms will increase 2. In the long run, these profits will disappear as more farmers switch to organic crops Now show formally how this happens Short-Run versus Long-Run Impact of An Increase in Demand Short-Run Market Individual Firm 1. P1 > ATC => firms earn economic profits 2. Firms enter industry => SS shifts to SS1 and P1 falls Long-Run Market 1. P1 falls as new firms enter 2. If constant cost industry, P1 falls to P0 3. Industry output increases from Q1 to Q2 (more firms) Insight In response to higher DD by consumers firms initially earn economic profits new firms enter industry market price falls (to initial level, if constant cost industry) economic profits are eliminated The Market Works Long-Run Industry Supply Curve Initial Equilibrium: 10,000 firms P=$20 = MC = (Minimum) ATC Demand Increases, Market Price Increases (from $20 to $25) These 10,000 firms earn economic profits 1,000 NEW firms enter industry Case 1: New firms have identical cost schedules as existing firms In long run, P=$20 = minimum (unchanged) ATC 10,000 “old” firms and 1,000 “new” earn zero economic profits Long-Run Industry Supply Curve is Horizontal Case 2: The MC of “new” firms are $2 higher, so ATC is $2 higher In long run, P=$22 = (minimum) ATC of “new” firms 10,000 “old” firms earn economic profits 1,000 “new” firms earn zero economic profit Long-run equilibrium since no ”new” firms enter or exit industry Long-run Industry Supply Curve is Upward-Sloping Insights: 1. New firms may - for example - have to pay higher wages 2. We need only to “track” the (minimum) ATC of “new” firms to
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