• Short run: firms that shut down \((q^*=0)\) stuck in market, incur fixed costs \(\pi=-f\)

• Short run: firms that shut down \((q^*=0)\) stuck in market, incur fixed costs \(\pi=-f\)

• Long run: firms earning losses \((\pi < 0)\) can exit the market and earn \(\pi=0\)

  • No more fixed costs, firms can sell/abandon \(f\) at \(q^*=0\)

• Short run: firms that shut down \((q^*=0)\) stuck in market, incur fixed costs \(\pi=-f\)

• Long run: firms earning losses \((\pi < 0)\) can exit the market and earn \(\pi=0\)

  • No more fixed costs, firms can sell/abandon \(f\) at \(q^*=0\)

• Entrepreneurs not currently in market can enter and produce, if entry would earn them \(\pi>0\)

• Now we must combine optimizing individual firms with market-wide adjustment to equilibrium

• Since \(\pi = [p-AC(q)]q\), in the long run, profit-seeking firms will:

• Now we must combine optimizing individual firms with market-wide adjustment to equilibrium

• Since \(\pi = [p-AC(q)]q\), in the long run, profit-seeking firms will:

  • Enter markets where \(p>AC(q)\)

• Now we must combine optimizing individual firms with market-wide adjustment to equilibrium

• Since \(\pi = [p-AC(q)]q\), in the long run, profit-seeking firms will:

  • Enter markets where \(p>AC(q)\)
  • Exit markets where \(p<AC(q)\)

• Long-run equilibrium: entry and exit ceases when \(p=AC(q)\) for all firms, implying normal economic profits of \(\pi=0\)

• Long-run equilibrium: entry and exit ceases when \(p=AC(q)\) for all firms, implying normal economic profits of \(\pi=0\)

• Zero Profits Theorem: long run economic profits for all firms in a competitive industry are 0

• Firms must earn an accounting profit to stay in business

• Recall, we've defined a firm as a completely replicable recipe (production function) of resources

• Anyone can enter market, buy required factors, and produce \(q^*\) at market price \(p\) and earn the market rate of \(\pi\)

• Let's start considering some realistic differences between firms

• Firms may have different costs due to differences in:
  • Managerial talent
  • Worker talent
  • Location
  • First-mover advantage
  • Technological secrets/IP
  • License/permit access
  • Political connections
  • Lobbying

• Recall "economic" point of view:

• Producing your product pulls scarce resources out of other productive uses in the economy

• Profits attract resources to be pulled out of other uses

• Losses repel resources to be pulled away to other uses

• Zero profits \(\implies\) resources should stay where they are

  • Optimal use of resources!

• Supply and demand set the market-clearing price for all units exchanged (bought and sold)

• Demand function measures how much you would hypothetically be willing to pay for various quantities

  • "reservation price"

• You often actually pay (the market-clearing price, \(p^*)\) a lot less than your reservation price

• The difference is consumer surplus

$$CS=WTP-p^*$$

$$\begin{align*} CS&=\frac{1}{2}bh\\ CS&=\frac{1}{2}(5-0)(\$10-\$5)\\ CS&=\$12.50\\ \end{align*}$$

• Supply function measures how much you would hypothetically be willing to accept to sell various quantities

  • "reservation price"

• You often actually receive (the market-clearing price, \(p^*)\) a lot more than your reservation price

• The difference is producer surplus

$$PS=p^*-WTA$$

• Allocative efficiency: resources are allocated to highest-valued uses

  • Goods produced up to the point where \(MB=MC\) \((p=MC)\)

• All potential gains from trade are fully exhausted

• Economic surplus = Consumer surplus + Producer surplus

• Maximized in competitive equilibrium

• Resources flow away from those who value them the lowest to those that value them the highest

• The social value of resources is maximized by allocating them to their highest valued uses!