ECON 310 Lecture 8: l310x8

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ECON 310
E Funkhouser

Lecture 8 Price Determination in a Competitive Industry I. Introduction We have a rough idea of how the demand curve and the supply curve determine the equilibrium price and equilibrium quantity. We now want to see how the entry and exit of firms into the market occurs and how this results in a longrun price equal to the lowest point on the average cost curve. Short run industry equilibrium 1) No producer can change the amount of the fixed factor of production 2) Only firms that are currently employing the fixed factor of production can produce This means that there is no entry of firms into an industry in the shortrun Longrun industry equilibrium == no firm has an incentive to change 1) All factors of production are flexible 2) Each firm in the industry has no incentive to change its method or scale of production (otherwise this would not be a longrun equilibrium) 3) Profits are zero (or the fair rate of profit) and so no firm has an incentive to enter or exit the industry. Key idea When there are positive profits, more firms will enter an industry. This will shift the supply curve out, the price and profits per firm will fall. This will occur until all firms are earning zero (or the fair rate of) profit. II. Elasticity and Changes in Price and Quantity The elasticity of demand and the elasticity of supply can be used to calculate changes in the equilibrium price or equilibrium quantity when the demandsupply curves shift. .The key things to note are: 1) The change in quantity from the movement down the supply curve plus the change in quantity from movement up the demand curve must equal the change in quantity holding the price constant 2) The price change is the same moving up the supply curve and moving up the demand curve. But because we are moving down the supply curve and up the demand curve as we move from left to right in the graph, the direction of the price change is opposite for supply and demand
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