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Chapter 7

Chapter 7. Profit Maximization and Perfect Competition. Choosing Output in the Long Run. In the long run, a firm can change all its inputs, including the size of the plant. We assume free entry and free exit. In the long run, the plant size will be

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Chapter 7

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  1. Chapter 7 Profit Maximization and Perfect Competition Chapter 7

  2. Choosing Output in the Long Run • In the long run, a firm can change all its inputs, including the size of the plant. • We assume free entry and free exit. Chapter 7

  3. In the long run, the plant size will be increased and output increased to q3. Long-run profit, EFGD > short run profit ABCD. LMC LAC SMC SAC D A E $40 P = MR C B G F $30 In the short run, the firm is faced with fixed inputs. P = $40 > ATC. Profit is equal to ABCD. q1 q2 q3 Output Choice in the Long Run Price ($ per unit of output) Output Chapter 7

  4. LMC LAC SMC SAC E $40 P = MR $30 Output Choice in the Long Run Price ($ per unit of output) Question: Is the producer making a profit after increased output lowers the price to $30? D A C B G F q1 q2 q3 Output Chapter 7

  5. Choosing Output in the Long Run • Accounting Profit & Economic Profit • Accounting profit = R - wL • Economic profit = R - wL - rK • wl = labor cost • rk= cost of capital Chapter 7

  6. Choosing Output in the Long Run Long-Run Competitive Equilibrium • Zero-Profit • If R > wL + rk, economic profits are positive • If R = wL + rk, zero economic profits, but the firms is earning a normal rate of return; indicating the industry is competitive • If R < wl + rk, consider going out of business Chapter 7

  7. Choosing Output in the Long Run Long-Run Competitive Equilibrium • Entry and Exit • The long-run response to short-run profits is to increase output and profits. • Profits will attract other producers. • More producers increase industry supply which lowers the market price. Chapter 7

  8. Profit attracts firms • Supply increases until profit = 0 S1 LMC P1 LAC S2 $30 P2 D Q1 Q2 Long-Run Competitive Equilibrium $ per unit of output $ per unit of output Firm Industry $40 q2 Output Output Chapter 7

  9. Choosing Output in the Long Run • Long-Run Competitive Equilibrium 1) MC = MR 2) P = LAC • No incentive to leave or enter • Profit = 0 3) Equilibrium Market Price Chapter 7

  10. Choosing Output in the Long Run • Economic Rent • Economic rent is the difference between what firms are willing to pay for an input and minimum amount necessary to obtain it. Chapter 7

  11. Producer Surplus • Producer surplus measures the difference between the market price that a producer receives and the marginal cost of production. Chapter 7

  12. A baseball team in a moderate-sized city sells enough tickets so that price is equal to marginal and average cost (profit = 0). LMC LAC $7 1.0 Firms Earn Zero Profit inLong-Run Equilibrium Ticket Price Season Tickets Sales (millions) Chapter 7

  13. LMC LAC Economic Rent $10 $7 1.3 Firms Earn Zero Profit inLong-Run Equilibrium Ticket Price A team with the same cost in a larger city sells tickets for $10. Season Tickets Sales (millions) Chapter 7

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