Today LR industry supply Constant cost

Today ¨ LR industry supply – Constant cost – Increasing cost ¨ Implications of LR equilibrium

Industry Supply in the Long Run The Key to understanding the long run is firm entry and exit.

Case 1: Constant Cost Industry ¨ Assumes that firms’ costs are independent of the size of the market. Expanding or contracting demand yields the same price in the long run. – Firms’ cost curves do not shift as industry output changes. ¨ Leads to a horizontal long-run industry supply curve.

Initial LR Equilibrium P Typical Firm P MC Industry or Market SRS ATC LRATC P D q q Q Q Thought experiment: What happens to the industry LR equilibrium as market demand expands?

SR Response to Increase in Demand P Typical Firm P MC Industry or Market SRS ATC LRATC P D’ D q q’ q Q Q’ SR: price rises. Firms earn profits. Why isn’t this a new LR equilibrium? Q

LR Response to Increase in Demand P Typical Firm P MC 1 ATC LRATC SRS’ 1 0 0 P Industry or Market SRS 2 2 D’ D q” q’ q Q Q” LR: Firms enter until no more profits can be made. Given our assumption, that is when price falls to its original level. Second LR equilibrium. Q

LR Industry Response to an Increase in Demand ¨ Assuming that firms’ costs do not depend on the size of the industry, and ¨ Beginning in LR equilibrium and increasing demand: – in the SR, price rises, firms’ profits and outputs rise. – In the LR, price returns to original level, firms earn zero profits, each firm makes same q as before, but market output is higher.

LR Response to Increase in Demand P Typical Firm P Industry or Market MC ATC LRS P D’ D q q Q Q” Case 1: Horizontal Long-Run Supply Curve Q

Significance of Result ¨ For these industries, growing demand (ceteris paribus) will not result in higher (or lower) prices. – Remember LRS is not predicting how prices change over time. ¨ For these industries, there is a constant opportunity cost of producing this good.

Case 2: Increasing Cost Industry ¨ Assumes rising opportunity cost as an industry (or market) expands, causing firms’ costs to rise. – Ex: market for milk & price of dairy land ¨ Results in an upward-sloping long-run industry supply curve

Case 2 & LR Industry Supply P Typical Firm P LRATC (Q 1) Industry or Market SRSSRS’ LRS LRATC(Q 0) P D’ D q Q 0 Q 1 Case 2: Upward-sloping Long-Run Supply Curve Q

Significance of Case 2 ¨ Growing demand for milk forces up the price of milk. ¨ Less productive land is converted to dairy farming. ¨ Opportunity cost of producing milk rises. ¨ Price of milk rises in the long run, even though there are more milk farms. ¨ ***Result comes from the underlying scarcity of dairy land. ***

Profits for New Dairy Farms ¨ Consider the dairy farms that have opened because of higher milk prices. ¨ Do they make profits, losses, or break even in the long run? How do you know?

Profits for Old Dairy Farms. ¨ Consider the dairy farms that were in business prior to the increase in demand. ¨ Will they make profits, losses, or break even in the new long run equilibrium? – What about dairy farmers who rent their land? – What about dairy farmers who buy land that has always been used for dairy farming? – What about dairy farmers who already owned dairy farms?

Coming Up: ¨ Prepare for second midterm exam.

Group Work ¨ Profits for Coal Mines

Coal Mining ¨ Assume the coal mining industry is perfectly competitive. ¨ Consider two mines: – Alpha mine has rich, easily accessible deposits. – Beta mine has less desirable deposits. Its marginal cost of producing coal is everywhere twice as high as for Alpha.

Profits for Alpha & Beta Mines ¨ Assume the price of coal is high enough that Beta mine is actively mining coal. ¨ Will Beta mine make economic profits, economic losses or break even in the long run? ¨ Suppose the total coal deposits in the two mines are equal. What can you say about the likely price of Alpha mine compared to Beta mine?

Profits for Alpha & Beta Mines, Cont’d. ¨ Will the two mines have the same fixed costs? ¨ Will Alpha mine make economic profits, economic losses or break even in the long run? How do you know?