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A.P. Economics

Illustrate a side-by-side market of a perfectly competitive firm experiencing economies of scale for three expansion phases. Understand the long-run adjustments to short-run conditions, including the impact on profit and market supply.

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A.P. Economics

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  1. A.P. Economics Warm Up: Illustrate a side-by-side market of a perfectly competitive firm experiencing economies of scale for three expansion phases.

  2. Long-Run Adjustments to Short-Run Conditions • A business can expand as long as • Firms will continue to expand as long as there are economies of scale to be realized, (this means: • and new firms will continue to enter as long as positive profits are being earned!! More firms will affect the It’s making profits Expanding production leads to lower costs per unit and thus higher profits). Market supply curve; it will increase.

  3. Label all of the appropriate parts of the side-by-side graph below. • Identify regions of profit, assuming there are no changes to the market. There are a lot of entrepreneurs out there that will want a piece of this profit!!! MARKET FIRM S Cost Price SRMC SRMC P SRAC Profit Profit SRAC LRAC D Level #2 Level #1 Quantity Outputs

  4. But the market does have changes, and in the long run, one industry can have an effect on the entire market!! • First, a firm’s expansion will lead to • Second, a firm’s expansion means there are profits to be made and new firms will enter the market (which in the long run they can!!!). More supply of output available in the market More supply of output available in the market

  5. Market Firm S0 Cost Price SRMC S1 SRMC P0 SRAC SRAC P1 LRAC D Level #2 Level #1 Quantity Outputs When economies of scale can be realized, firms have an incentive to expand. Thus firms will be pushed by competition to produce at their optimal scales. Price will be driven to the minimum point on the LRAC

  6. Each firm will choose the scale of plant that produces its product at minimum long-run average cost. Competition drives firms to adopt not just the most efficient technology in the short run, but also the most efficient scale of operation in the long run.

  7. In the long run, equilibrium price (P*) is equal to - , short-run and short-run • Profits are drive to • P* = Long-run average cost, Marginal cost, Average cost. Zero: SRMC = SRAC = LRAC

  8. Why are profits driven to zero? • any price above P* means • any price below P* means that there are profits to be made in the industry and new firms will continue to enter. That firms are suffering losses, and firms will exit the industry.

  9. Only at P* will profits be just equal to __________, and only at P* will the industry be in ______________________________. ZERO equilibrium • PLEASE, PLEASE, PLEASE, PLEASE, keep in mind these are concepts in perfect competition!!! I know you are all thinking, then why would a business exist if it can’t make a profit (or at least sustain it for very long). But in the real world, actually few businesses exist in this perfect competition; eventually we will talk about those other firms.

  10. Contraction to Equilibrium: • When firms in an industry suffer losses, there is an incentive for them to __________________. As firms exit, the supply curve shifts left, driving price up. As price rises, losses are gradually eliminated and the industry returns to equilibrium. Shut down & leave

  11. Final Thoughts: • Businesses expand when there is profit to be made. Investments (whether personal reinvestments or public through stocks) will flow toward ______________________________________ • Investments can be the allocation of resources AND financial capital to the industries in which profits are being made thus helping expand the industries further. Profit opportunities

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