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PROFESSOR: All right.

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So today we're going to continue
our discussion of the

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perfectly competitive
market outcome.

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And remember, once again, where
we're coming from here.

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We're trying to figure
out how firms

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decide how much to produce.

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We talked about the firm's
production decision in costs.

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Then we said how the firm
decides how much to produce is

00:00:43.220 --> 00:00:45.060
going to get dictated
by the market.

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We're going to talk about
different market structures.

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We'll start with our benchmark
of perfect competition and

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then move on to some more
interesting and realistic

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cases next.

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Now, I just want to finish up
where we were last time.

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Remember last time we were
dealing with a firm that had a

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cost function of the form
10 plus 0.5q squared.

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And if you remember, the key
condition we derived last time

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for profit maximization with a
perfectly competitive firm is

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that price equals marginal cost.
If you differentiate

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this with respect to q, you
get that that means that p

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equals q is the profit
maximizing

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condition for this firm.

00:01:26.850 --> 00:01:29.400
It sets the price equal to
quantity it's going to sell.

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That's the profit maximizing
condition with this particular

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functional form of the
cost function.

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Now, before we left last time,
I said, this was not enough.

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There's one other thing you have
to consider which is the

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firm's shutdown decision.

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In the short run, a firm might
not shut down even if it's

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losing money.

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And the reason is because the
firm has already paid its

00:01:54.360 --> 00:01:55.790
fixed costs.

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It's already paid 10.

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So even if it's losing money, it
might still not shut down.

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So, for example, imagine that
the price, as I said last

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time, imagine the price
fell from 6 to 3.

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The price equals 3.

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If the price equals 3, the firm
will choose to produce 3

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units, because it will
still follow the

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profit maximizing condition.

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It will still choose to
produce three units.

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If it produces 3 units,
its profits are its

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revenues which is 9--

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3 units at a price of 3--

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minus its cost which is 14.5.

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So that equals negative 5.5.

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So its profits are negative.

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So now I say, well, if profits
are negative, maybe I should

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shut down and stop
doing business.

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Well, what are its profits
if it shuts down?

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Negative 10.

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If it shuts down, its profits
are 0 minus 10

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equals negative 10.

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So it actually makes more money
by staying in business

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than shutting down, because
it has these fixed costs.

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So because it's going to pay the
10 anyway, as long as it's

00:03:05.500 --> 00:03:08.040
going to lose less than
10, it might as

00:03:08.040 --> 00:03:10.230
well stay in business.

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More generally, what we say is
a firm will stay in business

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in the short run as long
as its price covers

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its variable costs.

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So a firm will stay in business
so long as the price

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is greater or equal to
its variable costs.

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Then it will stay in business.

00:03:42.480 --> 00:03:44.500
If we go further--

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let me just derive it for a
second-- as long as they cover

00:03:45.980 --> 00:03:48.720
its fixed costs, that means a
firm will stay in business as

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long as its revenues
are greater than

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its variable costs.

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As long as its revenues are
greater than or equal to its

00:03:55.800 --> 00:03:57.320
variable costs, it will
stay in business.

00:04:00.010 --> 00:04:02.246
And that means that it will stay
in business at long as

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its price is greater than or
equal-- this should be a

00:04:04.540 --> 00:04:06.470
little q, sorry, this
is just a firm--

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as long as its price is greater
than or equal to

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variable costs over quantity, or
as long as price is greater

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than or equal to average
variable cost.

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As long as its price is greater
than or equal to its

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average variable cost, it
will stay in business.

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As long as its revenues cover
its variable costs, it will

00:04:26.440 --> 00:04:27.030
say in business.

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And that's saying the same as
long as its price is great

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than or equal to average
variable cost, it

00:04:31.045 --> 00:04:32.295
will stay in business.

00:04:34.930 --> 00:04:39.790
Now, what are the average
variable costs for our firm?

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Well, the variable costs
for our firm

00:04:42.880 --> 00:04:47.410
are 0.5 times q squared.

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The variable costs for our firm
are 0.5 times q squared.

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We know that in equilibrium, if
it's profit maximizing, it

00:05:00.510 --> 00:05:02.950
will produce where q equals p.

00:05:02.950 --> 00:05:05.040
So we can replace the
q with the p.

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The variable costs are 0.5 times
p squared, because we

00:05:08.320 --> 00:05:11.000
know we'll produce
where q equals p.

00:05:11.000 --> 00:05:17.510
So its average variable
costs are 0.5 times p.

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Its average variable costs
are 0.5 times p.

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Well, by definition,
p is always greater

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than 0.5 times p.

00:05:26.470 --> 00:05:30.440
So our firm will never go out of
business in the short run.

00:05:30.440 --> 00:05:33.500
In the short run, our firm will
never go out of business,

00:05:33.500 --> 00:05:37.900
because at the profit maximizing
price, at p equals

00:05:37.900 --> 00:05:42.460
q, it will always be producing
a point where the price is

00:05:42.460 --> 00:05:45.066
greater than its average
variable cost. So it will

00:05:45.066 --> 00:05:47.880
never shut down.

00:05:47.880 --> 00:05:50.580
So, more generally, when we
think about a short run supply

00:05:50.580 --> 00:05:52.550
decision, a short run supply
decision for a

00:05:52.550 --> 00:05:55.130
firm, there's two steps.

00:05:55.130 --> 00:05:59.260
The first step is set price
equal to marginal cost to

00:05:59.260 --> 00:06:02.310
figure out what the firm
is going to produce.

00:06:02.310 --> 00:06:07.670
So step one is set price equal
to marginal cost. And that

00:06:07.670 --> 00:06:10.200
will give you the firm's q*.

00:06:10.200 --> 00:06:13.550
That will give you what the
firm is going to produce.

00:06:13.550 --> 00:06:19.885
The second step is check that
price is greater than or equal

00:06:19.885 --> 00:06:21.210
to average variable costs.

00:06:21.210 --> 00:06:23.760
Because you may solve for an
optimal quantity that turns

00:06:23.760 --> 00:06:25.110
out to be a money loser
for the firm.

00:06:25.110 --> 00:06:26.840
So they'd rather shut down.

00:06:26.840 --> 00:06:28.180
So it's a two-step process.

00:06:28.180 --> 00:06:30.024
You've got to first solve for
the optimal quantity that the

00:06:30.024 --> 00:06:32.100
firm is going to produce.

00:06:32.100 --> 00:06:33.500
But then you've got to make sure
that the firm actually

00:06:33.500 --> 00:06:37.190
makes money on that quantity,
or it won't produce at all.

00:06:37.190 --> 00:06:39.920
And that's how we do the profit
maximization decision

00:06:39.920 --> 00:06:42.890
in the short run for the firm.

00:06:42.890 --> 00:06:45.520
You've got to produce at the
efficient point and make sure

00:06:45.520 --> 00:06:48.760
the firm actually makes
some money.

00:06:48.760 --> 00:06:52.530
All right, questions
about that?

00:06:52.530 --> 00:06:57.600
Now, armed with these rules,
we can now, finally, derive

00:06:57.600 --> 00:06:59.280
the supply curve.

00:06:59.280 --> 00:07:03.360
Remember we derived the demand
curve a number of lectures ago

00:07:03.360 --> 00:07:08.540
by getting the tangency at
different price ratios with

00:07:08.540 --> 00:07:09.690
the indifference curves.

00:07:09.690 --> 00:07:12.860
Well, to derive the firm's
supply function, what we now

00:07:12.860 --> 00:07:16.420
need to do is say, OK, at
different prices, how much

00:07:16.420 --> 00:07:17.760
will the firm produce?

00:07:17.760 --> 00:07:21.000
Well, we can now get that
if we go to Figure 11-1.

00:07:21.000 --> 00:07:24.640
We can now see the supply
curve for this firm.

00:07:24.640 --> 00:07:28.060
What we see is that at a price
of 3, it will produce 3 units.

00:07:28.060 --> 00:07:31.310
At a price of 4, it will produce
4 units, et cetera.

00:07:31.310 --> 00:07:35.860
The supply curve is the
marginal cost curve.

00:07:35.860 --> 00:07:37.920
So now we know where supply
curves come from.

00:07:37.920 --> 00:07:42.800
Supply curves are marginal cost
curves above the point

00:07:42.800 --> 00:07:45.590
where price equals average
variable cost. So the

00:07:45.590 --> 00:07:51.540
definition of a firm's supply
curve is the marginal cost

00:07:51.540 --> 00:07:58.290
curve above p is greater than
or equal to average variable

00:07:58.290 --> 00:08:01.920
cost. That is the firm's
short run supply curve.

00:08:01.920 --> 00:08:04.800
Now, in our case, p is always
greater than average variable

00:08:04.800 --> 00:08:07.940
cost. So the second condition
is irrelevant.

00:08:07.940 --> 00:08:09.750
The firm's supply curve is just
literally that marginal

00:08:09.750 --> 00:08:10.570
cost curve.

00:08:10.570 --> 00:08:13.170
With different functions, which
you may someday see in a

00:08:13.170 --> 00:08:16.680
problem set or an exam,
that won't be true.

00:08:16.680 --> 00:08:18.800
So, in that case, you'll
need to check

00:08:18.800 --> 00:08:21.380
that shutdown condition.

00:08:21.380 --> 00:08:25.880
But the supply curve is the
marginal cost curve above that

00:08:25.880 --> 00:08:28.010
0 profit point.

00:08:28.010 --> 00:08:30.390
And that's where supply
curves come from.

00:08:30.390 --> 00:08:32.740
So where supply curves comes
from is the same kind of

00:08:32.740 --> 00:08:34.679
maximization we did
with consumers.

00:08:34.679 --> 00:08:39.200
But instead of their parents
giving them their income, the

00:08:39.200 --> 00:08:41.460
market conditions firms face
are dictated by the

00:08:41.460 --> 00:08:44.440
competitive nature
of the market.

00:08:44.440 --> 00:08:47.710
And that's the firm's
supply curve.

00:08:47.710 --> 00:08:52.560
Now, this is the firm's
supply curve.

00:08:52.560 --> 00:08:54.590
Now, of course, what we talked
about in the first lecture was

00:08:54.590 --> 00:08:57.770
not firm supply curves but
market supply curves.

00:08:57.770 --> 00:08:59.480
So now let's take the next step
and say, well, where do

00:08:59.480 --> 00:09:00.850
market supply curves
come from?

00:09:00.850 --> 00:09:03.780
We now know where firm supply
curves come from.

00:09:03.780 --> 00:09:06.600
The marginal cost stork
brings them.

00:09:06.600 --> 00:09:09.640
Now, where do market supply
curves come from?

00:09:09.640 --> 00:09:15.010
Well, to do that, we need to now
imagine that there's not

00:09:15.010 --> 00:09:19.230
one firm in the market but
many firms in the market.

00:09:19.230 --> 00:09:25.080
And we need to recognize that
the market demand may not be

00:09:25.080 --> 00:09:26.090
perfectly elastic.

00:09:26.090 --> 00:09:30.700
But, as we talked about last
time, the firm's own demand

00:09:30.700 --> 00:09:32.140
will be close to perfectly
elastic.

00:09:32.140 --> 00:09:33.835
Or, in this case, a perfect
competition will

00:09:33.835 --> 00:09:36.830
be perfectly elastic.

00:09:36.830 --> 00:09:44.590
So, basically, the way to get
market demand is to say, look,

00:09:44.590 --> 00:09:46.330
we're going to take each firm.

00:09:46.330 --> 00:09:48.195
It's going to take a market
price as given.

00:09:51.420 --> 00:09:52.490
I'm sorry, we get
market supply.

00:09:52.490 --> 00:09:53.180
I'm sorry.

00:09:53.180 --> 00:09:56.030
Each firm is going to take
a market price as given.

00:09:56.030 --> 00:09:58.110
Based on that market price, it's
going to decide how much

00:09:58.110 --> 00:09:59.690
to produce.

00:09:59.690 --> 00:10:01.850
We're going to add up
that production.

00:10:01.850 --> 00:10:05.360
That will make a market
supply curve.

00:10:05.360 --> 00:10:07.570
And that market supply curve
will then interact with market

00:10:07.570 --> 00:10:09.750
demand to give you a price.

00:10:09.750 --> 00:10:12.830
If that price is the same one
the firms were using, then the

00:10:12.830 --> 00:10:15.000
whole thing is in equilibrium.

00:10:15.000 --> 00:10:19.320
Let me explain that in less
steps just to make it clear.

00:10:19.320 --> 00:10:23.190
Let's talk about the steps
involved in getting to short

00:10:23.190 --> 00:10:27.952
run equilibrium in the market,
the steps involved in getting

00:10:27.952 --> 00:10:31.400
to short run market
equilibrium.

00:10:31.400 --> 00:10:36.000
The first step is each firm
chooses an amount of capital.

00:10:36.000 --> 00:10:38.490
So the first step of the short
run is you're going to enter

00:10:38.490 --> 00:10:39.450
this market.

00:10:39.450 --> 00:10:41.370
And to enter this market, you're
going to have an amount

00:10:41.370 --> 00:10:43.860
of capital you're
going to pick.

00:10:43.860 --> 00:10:49.410
So each firm is going to have
some cost function which

00:10:49.410 --> 00:10:52.500
involves picking some amount
of capital or fixed costs.

00:10:57.040 --> 00:10:59.070
It's going to say, I want to
build a building this big.

00:11:03.350 --> 00:11:05.670
Having built that building,
we're going to get the firm's

00:11:05.670 --> 00:11:12.050
supply curve which
is p equals MC.

00:11:14.650 --> 00:11:15.260
That's step one.

00:11:15.260 --> 00:11:18.600
That's a step we've derived.

00:11:18.600 --> 00:11:23.690
The second step is we're going
to add up the firm's supply

00:11:23.690 --> 00:11:30.140
curves to get a market
supply curve.

00:11:33.040 --> 00:11:35.610
We're going to add up the firm's
supply curve to get a

00:11:35.610 --> 00:11:37.570
market supply curve.

00:11:37.570 --> 00:11:41.640
So, for example, suppose
that there's five

00:11:41.640 --> 00:11:42.890
firms in the market.

00:11:47.180 --> 00:11:50.750
Suppose that there's five
firms in the market.

00:11:53.530 --> 00:11:56.740
Those five firms are
going to produce.

00:11:56.740 --> 00:12:01.120
Now to see that, let's
go to Figure 11-2.

00:12:01.120 --> 00:12:02.740
This is the second step.

00:12:02.740 --> 00:12:06.180
It's how we get to that short
run market supply curve.

00:12:06.180 --> 00:12:09.600
Each firm has a marginal
cost curve.

00:12:09.600 --> 00:12:13.320
Here we're using our same cost
function we've used.

00:12:13.320 --> 00:12:15.340
That same cost function up
there where price equals

00:12:15.340 --> 00:12:18.980
marginal cost, where p equals
q, is the supply curve.

00:12:18.980 --> 00:12:20.900
So each firm has that
supply curve you see

00:12:20.900 --> 00:12:22.570
in the first panel.

00:12:22.570 --> 00:12:27.220
Then what you see is as you
add more firms, the second

00:12:27.220 --> 00:12:28.720
panel gives you the market
supply curve.

00:12:28.720 --> 00:12:31.280
So if there's only one firm in
the market, the market supply

00:12:31.280 --> 00:12:33.940
curve would be S1.

00:12:33.940 --> 00:12:36.600
Now, if there were two firms
in the market, the market

00:12:36.600 --> 00:12:37.460
supply curve is S2.

00:12:37.460 --> 00:12:40.770
That is, at a price of 2, you're
now producing 4 units

00:12:40.770 --> 00:12:42.020
in the market.

00:12:42.020 --> 00:12:45.180
If there's three firms,
the curve is S3, four

00:12:45.180 --> 00:12:46.980
firms, S4, and so on.

00:12:46.980 --> 00:12:51.850
As you add more firms, that
market supply curve shifts out

00:12:51.850 --> 00:12:55.070
and becomes flatter.

00:12:55.070 --> 00:12:56.730
Remember firms are
identical here.

00:12:56.730 --> 00:12:58.380
We're adding identical firms.
That was an assumption of

00:12:58.380 --> 00:12:59.300
perfect competition.

00:12:59.300 --> 00:13:01.340
We're adding more and
more identical firms

00:13:01.340 --> 00:13:02.430
producing the same good.

00:13:02.430 --> 00:13:06.120
You can see that market supply
curve is shifting out and

00:13:06.120 --> 00:13:08.170
becoming flatter.

00:13:08.170 --> 00:13:13.500
That is the supply of goods is
becoming more elastic as there

00:13:13.500 --> 00:13:17.960
are more firms. The more firms
in the market the more elastic

00:13:17.960 --> 00:13:18.530
the supply.

00:13:18.530 --> 00:13:20.820
And that comes to what we talked
about last time when I

00:13:20.820 --> 00:13:22.070
derived residual demand.

00:13:25.106 --> 00:13:27.120
It's sort of the flip
side of that.

00:13:27.120 --> 00:13:29.850
Basically, the more firms you
have with a given supply curve

00:13:29.850 --> 00:13:32.610
in the market, the more elastic
it's going to become.

00:13:32.610 --> 00:13:33.640
Why is that?

00:13:33.640 --> 00:13:35.115
Well, just think about it.

00:13:35.115 --> 00:13:37.150
Think about what elasticity
of supply is.

00:13:37.150 --> 00:13:40.000
It's saying, if I increase the
price by $1, how much more

00:13:40.000 --> 00:13:42.110
production do I call forth?

00:13:42.110 --> 00:13:44.920
Well, the more identical firms
I have, every time I increase

00:13:44.920 --> 00:13:47.970
the price by $1, I call forth
production from all these

00:13:47.970 --> 00:13:50.840
firms. So the more firms I have,
the more production I

00:13:50.840 --> 00:13:52.010
call forth.

00:13:52.010 --> 00:13:54.700
So for every increment in price,
the more firms in the

00:13:54.700 --> 00:13:56.840
market, the more production
I call forth.

00:13:56.840 --> 00:14:00.380
Therefore, the more elastic
is the supply.

00:14:00.380 --> 00:14:03.330
So as there are more firms,
that market supply curve

00:14:03.330 --> 00:14:05.670
becomes more and more elastic.

00:14:05.670 --> 00:14:06.970
And that's the market
supply curve.

00:14:06.970 --> 00:14:10.150
That's the second step.

00:14:10.150 --> 00:14:23.880
The third step is we intersect
market supply with market

00:14:23.880 --> 00:14:29.450
demand to get the equilibrium
price.

00:14:32.880 --> 00:14:36.900
So, in other words, we say,
look, there's some market

00:14:36.900 --> 00:14:38.900
supply, which we've derived.

00:14:38.900 --> 00:14:41.160
Now let's imagine there's
some market demand.

00:14:41.160 --> 00:14:43.240
And that will give us the
equilibrium price.

00:14:43.240 --> 00:14:51.510
So, for example, in our case,
market supply is what?

00:14:54.850 --> 00:14:56.230
Let's say, for example,
there's five

00:14:56.230 --> 00:14:56.850
firms in the market.

00:14:56.850 --> 00:14:59.120
Just to make an example, let's
say five firms have entered.

00:14:59.120 --> 00:15:00.970
There's five firms
in the market.

00:15:00.970 --> 00:15:06.710
Well, the total market supply
Q is 5 of the little q,

00:15:06.710 --> 00:15:10.290
because there's five identical
firms in the market.

00:15:10.290 --> 00:15:12.240
Five identical firms
are in the market.

00:15:12.240 --> 00:15:15.160
Well, we know, from the marginal
cost condition,

00:15:15.160 --> 00:15:18.450
that's the same as saying
Q equals 5 times p.

00:15:18.450 --> 00:15:22.200
So our market supply curve,
which is actually S5 on Figure

00:15:22.200 --> 00:15:24.940
11-2, is Q equals 5p.

00:15:24.940 --> 00:15:25.400
You can see that.

00:15:25.400 --> 00:15:27.860
Because when the price
is 2, Q equals 10.

00:15:27.860 --> 00:15:34.180
When the price is
5, Q equals 25.

00:15:34.180 --> 00:15:37.980
So you can see that S super 5
is the market supply curve.

00:15:37.980 --> 00:15:39.230
Big Q equals 5p.

00:15:42.800 --> 00:15:44.260
Let's just make this up.

00:15:44.260 --> 00:15:46.290
So this is the quantity
supplied.

00:15:46.290 --> 00:15:51.280
Let's say the demand function is
that the quantity demanded

00:15:51.280 --> 00:15:54.930
is 30 minus p.

00:15:54.930 --> 00:15:56.470
I just made this up.

00:15:56.470 --> 00:15:57.370
I'm making all this up.

00:15:57.370 --> 00:15:59.550
But this is just an example
demand curve.

00:15:59.550 --> 00:16:03.430
We have a downward sloping
demand curve with a slope of

00:16:03.430 --> 00:16:05.080
negative 1.

00:16:05.080 --> 00:16:08.020
The quantity demanded
is 30 minus p.

00:16:08.020 --> 00:16:12.450
So to get equilibrium,
we set these equal.

00:16:12.450 --> 00:16:20.610
And we get that 30 minus p
equals 5p or p equals 5.

00:16:23.330 --> 00:16:28.830
30 minus p equals 5p or
p equals 5, that's the

00:16:28.830 --> 00:16:30.460
equilibrium price.

00:16:30.460 --> 00:16:34.470
Given the market supply curve,
given the demand curve, I've

00:16:34.470 --> 00:16:36.695
derived the equilibrium
price of 5.

00:16:39.480 --> 00:16:43.170
Now, at a price of 5, what's
the quantity demanded?

00:16:43.170 --> 00:16:46.840
At a price of 5, quantity
demanded equals 25.

00:16:46.840 --> 00:16:50.340
So, at a price of 5, the market
wants 25 of these

00:16:50.340 --> 00:16:51.980
things, whatever the heck
it's producing.

00:16:51.980 --> 00:16:55.960
At a price of 5, the market
wants 25 of them.

00:16:55.960 --> 00:16:58.520
That's the quantity demanded.

00:16:58.520 --> 00:17:05.270
Then the final step in solving
for equilibrium is that each

00:17:05.270 --> 00:17:07.595
firm then decides how
much to produce.

00:17:21.930 --> 00:17:24.150
Well, what is each firm going
to decide to produce?

00:17:24.150 --> 00:17:26.630
How much is each firm going
to decide to produce?

00:17:26.630 --> 00:17:28.590
Somebody raise their
hand and tell me.

00:17:28.590 --> 00:17:29.213
Yeah.

00:17:29.213 --> 00:17:29.980
AUDIENCE: p.

00:17:29.980 --> 00:17:30.740
PROFESSOR: p which is?

00:17:30.740 --> 00:17:31.150
AUDIENCE: 5

00:17:31.150 --> 00:17:31.415
PROFESSOR: 5.

00:17:31.415 --> 00:17:33.710
So each firm is going
to produce 5.

00:17:33.710 --> 00:17:35.260
How many firms are there?

00:17:35.260 --> 00:17:35.750
AUDIENCE: 5.

00:17:35.750 --> 00:17:36.820
PROFESSOR: How much
gets produced?

00:17:36.820 --> 00:17:37.215
AUDIENCE: 25.

00:17:37.215 --> 00:17:38.890
PROFESSOR: Which is exactly
what people want.

00:17:38.890 --> 00:17:41.020
We're done.

00:17:41.020 --> 00:17:43.840
That's the magic
of the market.

00:17:43.840 --> 00:17:45.950
Through these four steps, we've
gotten equilibrium which

00:17:45.950 --> 00:17:47.860
is defined as the quantity
supplied equals the quantity

00:17:47.860 --> 00:17:50.870
demanded, just by following
these steps.

00:17:50.870 --> 00:17:54.900
The firms didn't come at it
saying, hey, let's figure this

00:17:54.900 --> 00:17:57.290
out beforehand.

00:17:57.290 --> 00:17:59.310
Let's all get together and
coordinate and figure out how

00:17:59.310 --> 00:17:59.980
much we're going to produce
at what price.

00:17:59.980 --> 00:18:01.760
They didn't do that at all.

00:18:01.760 --> 00:18:04.550
The firms just entered
the market.

00:18:04.550 --> 00:18:07.010
They said, this is
my supply curve.

00:18:07.010 --> 00:18:08.330
We added it up.

00:18:08.330 --> 00:18:10.120
We interact it with demand.

00:18:10.120 --> 00:18:12.240
We find an equilibrium price.

00:18:12.240 --> 00:18:14.630
At that equilibrium price, the
quantity demanded equals the

00:18:14.630 --> 00:18:15.730
quantity supplied.

00:18:15.730 --> 00:18:16.980
We're done.

00:18:19.410 --> 00:18:23.290
We've now finally gotten to
where we started this course.

00:18:23.290 --> 00:18:25.650
We started this course with
a supply and demand graph.

00:18:25.650 --> 00:18:27.250
I told you how to
derive demand.

00:18:27.250 --> 00:18:29.360
You took a test on
that already.

00:18:29.360 --> 00:18:31.350
Now I've just told you where
supply comes from.

00:18:31.350 --> 00:18:32.760
Now we interact,
and we're done.

00:18:32.760 --> 00:18:35.860
And this tells us now, given
this price, how much each firm

00:18:35.860 --> 00:18:37.110
is going to produce.

00:18:39.680 --> 00:18:43.960
So, basically, what do you
need to find equilibrium?

00:18:43.960 --> 00:18:47.160
What do you need to find the
short run equilibrium?

00:18:47.160 --> 00:18:49.780
To find the short run
equilibrium, you need a demand

00:18:49.780 --> 00:18:56.790
function, a cost function, and a
number of firms. You have to

00:18:56.790 --> 00:18:58.840
be given a number firms, because
there's no entry and

00:18:58.840 --> 00:19:00.380
exit in the short
run, remember.

00:19:00.380 --> 00:19:03.220
So, basically, the firms are
magically put on the earth in

00:19:03.220 --> 00:19:04.400
the short run.

00:19:04.400 --> 00:19:07.230
So if you're asked about the
short run equilibrium, you

00:19:07.230 --> 00:19:08.420
have to be given the number
of firms. You

00:19:08.420 --> 00:19:10.120
can't derive that yet.

00:19:10.120 --> 00:19:11.270
That comes in the long run.

00:19:11.270 --> 00:19:14.100
But given a number of firms,
given a cost function, and

00:19:14.100 --> 00:19:17.310
given the demand function, you
can find the short run

00:19:17.310 --> 00:19:19.360
equilibrium.

00:19:19.360 --> 00:19:20.610
Questions about that?

00:19:23.400 --> 00:19:26.460
Now, with that in place, now
let's get to where it gets

00:19:26.460 --> 00:19:27.440
really interesting.

00:19:27.440 --> 00:19:29.640
Let's talk now about
the long run.

00:19:29.640 --> 00:19:31.830
Now what makes the long run
interesting is you no longer

00:19:31.830 --> 00:19:35.750
have to be given the number of
firms. Now, in the long run,

00:19:35.750 --> 00:19:37.800
we're going to actually
figure out how many

00:19:37.800 --> 00:19:39.510
firms are in the market.

00:19:39.510 --> 00:19:41.765
So at the end of the day, in the
long run, all we'll need

00:19:41.765 --> 00:19:44.170
is two things, a demand function
and a cost function.

00:19:44.170 --> 00:19:46.640
And then we'll be done.

00:19:46.640 --> 00:19:49.310
Now, here's the key thing
for the long run.

00:19:49.310 --> 00:19:51.630
The key point in the long run
is that in the long run, no

00:19:51.630 --> 00:19:53.290
one can lose money.

00:19:53.290 --> 00:19:54.170
So we don't have to
worry about the

00:19:54.170 --> 00:19:56.030
shutdown condition anymore.

00:19:56.030 --> 00:19:57.330
The shutdown condition
goes away.

00:19:57.330 --> 00:20:00.200
In the long run, nothing
is fixed.

00:20:00.200 --> 00:20:02.400
So in the long run, no
one loses money.

00:20:02.400 --> 00:20:04.560
There's no reason to be in the
market if you're losing money

00:20:04.560 --> 00:20:06.840
in the long run.

00:20:06.840 --> 00:20:09.520
So, in long run, the first thing
is now we only have one

00:20:09.520 --> 00:20:12.890
condition to worry about, which
is price equals marginal

00:20:12.890 --> 00:20:17.930
cost. Price equals marginal
cost is what we

00:20:17.930 --> 00:20:19.180
need to worry about.

00:20:25.870 --> 00:20:28.680
And you're only going to be in
a situation, in the long run,

00:20:28.680 --> 00:20:30.570
where you're only going
to be making either

00:20:30.570 --> 00:20:31.810
0 or positive profits.

00:20:31.810 --> 00:20:35.170
If you're making negative
profits, you'll be gone.

00:20:35.170 --> 00:20:39.180
Now, the key difference in the
long run, is now we can't take

00:20:39.180 --> 00:20:40.810
the number of firms as given.

00:20:40.810 --> 00:20:43.450
Now we need to derive the number
of firms. And the way

00:20:43.450 --> 00:20:47.920
we do that is by thinking
about entry and exit.

00:20:47.920 --> 00:20:50.060
Now, what's going to determine
entry and exit?

00:20:50.060 --> 00:20:51.970
Well, it's quite simple.

00:20:51.970 --> 00:20:56.160
If in the market, as it stands
today with some number of

00:20:56.160 --> 00:21:01.190
firms, there's profit to be
made, new firms will enter.

00:21:01.190 --> 00:21:03.500
If in the market, as it stands
today with some number of

00:21:03.500 --> 00:21:07.000
firms, there's losses being
made, some firms will leave.

00:21:07.000 --> 00:21:09.490
Remember, no one stays in
making losses anymore.

00:21:09.490 --> 00:21:14.890
And that continues until you
reach a situation where all

00:21:14.890 --> 00:21:16.860
firms make zero profit.

00:21:16.860 --> 00:21:20.470
And here's the key lesson.

00:21:20.470 --> 00:21:27.040
In a perfectly competitive
long run equilibrium, all

00:21:27.040 --> 00:21:30.960
firms make zero profit.

00:21:34.700 --> 00:21:37.860
It's the fundamental lesson
about perfect competition.

00:21:37.860 --> 00:21:39.340
Obviously, there's no
place that works

00:21:39.340 --> 00:21:40.110
like this in the world.

00:21:40.110 --> 00:21:41.650
This is an extreme.

00:21:41.650 --> 00:21:43.420
But, nonetheless, you should
understand this extreme.

00:21:43.420 --> 00:21:45.090
In a perfectly competitive
long run equilibrium, all

00:21:45.090 --> 00:21:46.220
firms make zero profit.

00:21:46.220 --> 00:21:47.140
Why?

00:21:47.140 --> 00:21:49.810
Because if there's any profit
to be made, a new firm will

00:21:49.810 --> 00:21:51.770
enter and take it away.

00:21:51.770 --> 00:21:53.805
And if there's any unprofitable
industry, a firm

00:21:53.805 --> 00:21:56.780
will exit until the profits
go back to zero.

00:21:56.780 --> 00:22:02.130
So profits will always be zero
in the long run equilibrium.

00:22:02.130 --> 00:22:06.910
Now, to understand how this
works, let's think about a

00:22:06.910 --> 00:22:07.730
realistic example.

00:22:07.730 --> 00:22:11.300
Let's think about the PC market
circa 1990 when all you

00:22:11.300 --> 00:22:13.196
youngins were being born.

00:22:13.196 --> 00:22:16.870
It's circa about 1990,
the PC market, cast

00:22:16.870 --> 00:22:18.180
your mind way back.

00:22:18.180 --> 00:22:20.710
It's a history lesson
for you guys.

00:22:20.710 --> 00:22:27.220
In 1990, not that many
folks had PCs.

00:22:27.220 --> 00:22:31.190
There was still a vibrant use
of mainframe computers.

00:22:31.190 --> 00:22:34.490
And, basically, you had big
firms like IBM who were

00:22:34.490 --> 00:22:36.590
producing these mainframe
computers, which is what I did

00:22:36.590 --> 00:22:37.310
my computing on.

00:22:37.310 --> 00:22:40.390
A lot of people did their
computing on it in 1990.

00:22:40.390 --> 00:22:42.130
And there was starting to
be a market, however,

00:22:42.130 --> 00:22:43.530
for personal computers.

00:22:43.530 --> 00:22:46.330
The chip strength had gotten
large enough that it was

00:22:46.330 --> 00:22:48.636
actually viable to have desktop
computing that was

00:22:48.636 --> 00:22:49.930
powerful enough.

00:22:49.930 --> 00:22:52.320
Firms like Dell were starting
out-- not starting out,

00:22:52.320 --> 00:22:54.320
necessarily-- but were starting
to make money making

00:22:54.320 --> 00:22:57.670
desktop computers, making PCs.

00:23:03.470 --> 00:23:06.050
Let's actually think about how
that market might look.

00:23:06.050 --> 00:23:11.020
So let's actually talk about,
in Figure 11-3, this is the

00:23:11.020 --> 00:23:15.960
market for PCs circa 1990.

00:23:15.960 --> 00:23:19.190
In 1990, if you were making
PCs, that was a great

00:23:19.190 --> 00:23:20.650
business to be in.

00:23:20.650 --> 00:23:23.240
Because people wanted them,
there weren't that many firms

00:23:23.240 --> 00:23:25.840
making them, and you were
making a killing.

00:23:25.840 --> 00:23:30.630
So if you were Dell in 1990,
that was a great place to be.

00:23:30.630 --> 00:23:35.800
So let's say Dell in 1990 was
facing a demand curve D and

00:23:35.800 --> 00:23:37.510
the supply curve SR1.

00:23:41.580 --> 00:23:44.000
The supply curve was pretty
steep because there weren't

00:23:44.000 --> 00:23:46.880
many firms making PCs.

00:23:46.880 --> 00:23:49.760
So the market price was P1.

00:23:52.570 --> 00:23:54.400
So on the right, you
have the market.

00:23:54.400 --> 00:23:55.820
We should label this actually.

00:23:55.820 --> 00:23:57.090
On the right, you
have the market.

00:23:57.090 --> 00:24:00.350
On the left, you have Dell.

00:24:00.350 --> 00:24:02.310
On the right, you
have the market.

00:24:02.310 --> 00:24:06.480
In the market, in initial
equilibrium, there's a price

00:24:06.480 --> 00:24:10.090
of P1 with big Q1 being sold.

00:24:10.090 --> 00:24:13.420
So Q1 PCs are being sold
at a high price of P1.

00:24:13.420 --> 00:24:15.770
It's the novel technology.

00:24:15.770 --> 00:24:18.500
People want it, but not many
firms are doing it.

00:24:18.500 --> 00:24:19.700
What happens with Dell?

00:24:19.700 --> 00:24:21.790
Now let's go to the left-hand
side diagram.

00:24:21.790 --> 00:24:25.440
Well, Dell is producing where
that price equals their

00:24:25.440 --> 00:24:28.480
marginal cost. That price
equals their marginal

00:24:28.480 --> 00:24:30.790
cost at little q1.

00:24:30.790 --> 00:24:34.900
So Dell's producing little q1.

00:24:34.900 --> 00:24:40.840
But its average costs at that
point are all the way down.

00:24:40.840 --> 00:24:41.720
It's not really labeled.

00:24:41.720 --> 00:24:45.670
But you can see it's where
that vertical line for Q1

00:24:45.670 --> 00:24:49.080
intersects average total cost.
That's where their costs are.

00:24:49.080 --> 00:24:53.350
So, in each unit, they're making
the height between

00:24:53.350 --> 00:24:55.570
marginal cost and average
total cost at that Q1.

00:24:55.570 --> 00:24:57.200
They're making that
vertical bar.

00:24:57.200 --> 00:25:00.670
So they make that entire
rectangle of profit.

00:25:00.670 --> 00:25:04.250
So Dell makes a big profit,
because not many firms are in

00:25:04.250 --> 00:25:05.070
this business.

00:25:05.070 --> 00:25:07.590
And yet demand for
PCs are high.

00:25:07.590 --> 00:25:11.760
And that's where things
are circa 1990.

00:25:11.760 --> 00:25:12.840
So what happens?

00:25:12.840 --> 00:25:14.180
Well, Gateway arrives.

00:25:14.180 --> 00:25:15.650
Does Gateway still exist?

00:25:15.650 --> 00:25:16.460
Do people still buy Gateway?

00:25:16.460 --> 00:25:17.560
Gateway is gone, right?

00:25:17.560 --> 00:25:19.160
So, while Gateway was
big, they were

00:25:19.160 --> 00:25:21.700
sort of a big upstart.

00:25:21.700 --> 00:25:24.070
They had the boxes with cow
colors on them and stuff.

00:25:24.070 --> 00:25:27.590
You guys didn't even
know Gateway?

00:25:27.590 --> 00:25:28.490
Well, they were big.

00:25:28.490 --> 00:25:32.520
They were the first cheap
knockoff computer makers that

00:25:32.520 --> 00:25:34.790
competed with the big folks.

00:25:34.790 --> 00:25:38.710
And they came and said
look, we can do this.

00:25:38.710 --> 00:25:39.910
OK, we can produce.

00:25:39.910 --> 00:25:40.880
This is a profitable business.

00:25:40.880 --> 00:25:41.750
We can make PCs.

00:25:41.750 --> 00:25:42.970
It's not that expensive.

00:25:42.970 --> 00:25:45.360
It's largely a variable
cost business.

00:25:45.360 --> 00:25:47.100
You just have to build
your plant first.

00:25:47.100 --> 00:25:49.200
So they built their plant,
and then they come in.

00:25:49.200 --> 00:25:51.900
Well, what happens when
a new firm comes in?

00:25:51.900 --> 00:25:54.720
The market supply
curve flattens.

00:25:54.720 --> 00:25:57.340
Because now, at any price,
you're producing more.

00:25:57.340 --> 00:26:03.016
So the market supply curve
flattens to the point SR2.

00:26:03.016 --> 00:26:04.720
In fact, maybe it's
not just Gateway.

00:26:04.720 --> 00:26:07.510
Maybe you get a bunch of
entrants until you get the

00:26:07.510 --> 00:26:08.790
market supply curve SR2.

00:26:08.790 --> 00:26:15.390
Well, SR2 intersects demand
at a new higher market

00:26:15.390 --> 00:26:16.640
quantity big Q2.

00:26:20.840 --> 00:26:24.400
Well, that higher market
quantity going to the left,

00:26:24.400 --> 00:26:27.300
there's now no longer
profits to be made.

00:26:27.300 --> 00:26:30.220
Because at that market quantity,
Dell is going to

00:26:30.220 --> 00:26:32.330
produce little q2.

00:26:32.330 --> 00:26:36.090
Little q2 is exactly at the
minimum of the average total

00:26:36.090 --> 00:26:38.510
cost curve.

00:26:38.510 --> 00:26:40.990
It's where the marginal cost
curve intersects the average

00:26:40.990 --> 00:26:42.730
total cost curve, the
minimum of that

00:26:42.730 --> 00:26:43.890
average total cost curve.

00:26:43.890 --> 00:26:45.520
So Dell no longer
makes profits.

00:26:48.080 --> 00:26:50.900
Dell shrinks its production.

00:26:50.900 --> 00:26:51.730
The price has fallen.

00:26:51.730 --> 00:26:52.610
It doesn't lower its price.

00:26:52.610 --> 00:26:53.660
Dell doesn't set the price.

00:26:53.660 --> 00:26:55.320
Remember, this a price
taker in a

00:26:55.320 --> 00:26:56.370
perfectly competitive market.

00:26:56.370 --> 00:26:59.160
The price is given by that
diagram on the right.

00:26:59.160 --> 00:27:00.870
Dell gets a price of P2.

00:27:00.870 --> 00:27:03.700
It says look, at P2, I have
to produce along my

00:27:03.700 --> 00:27:04.540
marginal cost curve.

00:27:04.540 --> 00:27:05.370
I have no choice.

00:27:05.370 --> 00:27:08.600
That's what's profit
maximizing.

00:27:08.600 --> 00:27:10.660
I can't choose a point not on
that marginal cost curve.

00:27:10.660 --> 00:27:12.370
That will not be profit
maximizing.

00:27:12.370 --> 00:27:14.790
Well, where does that
price intersect that

00:27:14.790 --> 00:27:15.930
marginal cost curve?

00:27:15.930 --> 00:27:17.390
At little q2.

00:27:17.390 --> 00:27:18.510
So I'm producing at little q2.

00:27:18.510 --> 00:27:21.240
And at little q2, I
make no profit.

00:27:21.240 --> 00:27:23.730
So the entry of Gateway and
other firms into the PC

00:27:23.730 --> 00:27:29.720
business has removed the profit
from the PC business.

00:27:29.720 --> 00:27:31.700
Now note what's interesting
here.

00:27:31.700 --> 00:27:34.940
Market quantity has gone up.

00:27:34.940 --> 00:27:37.540
Big Q2 is bigger than big Q1.

00:27:37.540 --> 00:27:39.910
But Dell's quantity
has gone down.

00:27:39.910 --> 00:27:42.310
Little q2 is smaller
than little q1.

00:27:42.310 --> 00:27:44.730
That's because more firms are
in the market producing.

00:27:44.730 --> 00:27:47.600
So as more firms come in, total
market quantity goes up.

00:27:47.600 --> 00:27:50.110
But any given firm is going
to produce less.

00:27:50.110 --> 00:27:54.290
And that will continue until
profits go to zero.

00:27:54.290 --> 00:27:58.150
That is how firm entry
wipes out profits.

00:27:58.150 --> 00:28:02.970
That is how firm entry wipes out
profits, by driving firms

00:28:02.970 --> 00:28:08.000
to the point where price
equals average cost.

00:28:08.000 --> 00:28:11.900
So, in the long run, firms
make zero profit because,

00:28:11.900 --> 00:28:20.720
first of all, entry drives price
down to average cost.

00:28:20.720 --> 00:28:23.730
Entry drives price down to
average cost. And when price

00:28:23.730 --> 00:28:27.290
equals average cost,
profits are zero.

00:28:27.290 --> 00:28:28.790
Profits are zero when price
equals average cost. Because

00:28:28.790 --> 00:28:35.670
profits are pq minus C. So if
you divide by qp profits are p

00:28:35.670 --> 00:28:37.040
minus average costs.

00:28:37.040 --> 00:28:40.360
So if price equals average
cost, profits are zero.

00:28:40.360 --> 00:28:42.230
So entry drives profits
to zero.

00:28:42.230 --> 00:28:45.760
It drives price to equal average
cost. Since price

00:28:45.760 --> 00:28:48.720
equals marginal cost, it's the
point where marginal cost

00:28:48.720 --> 00:28:54.410
equals average cost. That's the
technological outcome in a

00:28:54.410 --> 00:28:57.000
perfectly competitive long
run equilibrium.

00:28:57.000 --> 00:28:59.610
You'll end up producing where
marginal cost equals average

00:28:59.610 --> 00:29:02.750
cost. That's what will end up
happening naturally through

00:29:02.750 --> 00:29:04.000
the forces of entry.

00:29:08.380 --> 00:29:12.220
Likewise, you see this through
the force of exit.

00:29:12.220 --> 00:29:13.990
Now let's go to Figure 11-4.

00:29:13.990 --> 00:29:15.240
And now let's look at IBM.

00:29:22.400 --> 00:29:24.430
I guess we're calling this the
broader computer market now.

00:29:24.430 --> 00:29:25.430
It's not just a PC market.

00:29:25.430 --> 00:29:26.680
It's the broader computer
market.

00:29:30.140 --> 00:29:35.670
So IBM, they're producing
these mainframes.

00:29:41.670 --> 00:29:42.640
This is the mainframe market.

00:29:42.640 --> 00:29:43.220
This isn't the PC market.

00:29:43.220 --> 00:29:44.470
This is the mainframe market.

00:29:44.470 --> 00:29:47.300
In the mainframe market, now
people don't want mainframes

00:29:47.300 --> 00:29:49.090
much anymore.

00:29:49.090 --> 00:29:50.640
But there were a lot
of firms producing.

00:29:50.640 --> 00:29:52.420
There was IBM and tons of other
firms producing these

00:29:52.420 --> 00:29:52.820
mainframes.

00:29:52.820 --> 00:29:53.890
Because that's what
everybody wanted.

00:29:53.890 --> 00:29:57.820
So the original supply curve
was very flat at SR1.

00:29:57.820 --> 00:29:59.540
So, initially, in the mainframe
market, we're in

00:29:59.540 --> 00:30:07.840
equilibrium with quantity Q1--
big Q1-- and a price P1.

00:30:07.840 --> 00:30:09.380
And what's happening there?

00:30:09.380 --> 00:30:11.740
Where does that price intersect
marginal cost?

00:30:11.740 --> 00:30:16.070
It intersects marginal cost for
IBM at little q1 which is

00:30:16.070 --> 00:30:21.586
below average total cost.
So IBM is losing money.

00:30:21.586 --> 00:30:24.950
In the initial short run
equilibrium, IBM is producing

00:30:24.950 --> 00:30:28.120
at little q1, and it's
losing money.

00:30:28.120 --> 00:30:29.580
Now, why is it still
in business?

00:30:29.580 --> 00:30:30.730
Because it's the short run.

00:30:30.730 --> 00:30:33.340
And as long as those losses are
less than its fixed cost,

00:30:33.340 --> 00:30:35.410
it's staying in business.

00:30:35.410 --> 00:30:38.010
So, in the short run,
you can lose money.

00:30:38.010 --> 00:30:39.300
So IBM is losing money.

00:30:39.300 --> 00:30:41.050
Because it's built
this big plant.

00:30:41.050 --> 00:30:42.700
It's cranking out these
mainframes.

00:30:42.700 --> 00:30:43.750
People don't want
them anymore.

00:30:43.750 --> 00:30:48.580
The price has fallen so low
that they can still make

00:30:48.580 --> 00:30:51.990
enough money than it costs to
produce the next mainframe.

00:30:51.990 --> 00:30:55.480
Price is still greater than
marginal costs, but price is

00:30:55.480 --> 00:30:58.540
below average costs.

00:30:58.540 --> 00:30:59.070
I'm sorry.

00:30:59.070 --> 00:31:00.555
Prices are greater than average
variable cost. But

00:31:00.555 --> 00:31:02.880
it's lower the total average
cost. They're losing money.

00:31:02.880 --> 00:31:03.770
So what happens?

00:31:03.770 --> 00:31:06.370
They leave.

00:31:06.370 --> 00:31:07.790
There was a company
called [? Deck ?]

00:31:07.790 --> 00:31:10.590
that went out of business.

00:31:10.590 --> 00:31:14.760
And what happened was that then
raised the supply curve.

00:31:14.760 --> 00:31:17.800
It steepened the supply curve
in the mainframe market.

00:31:21.520 --> 00:31:23.230
It steepened the supply curve,
because now you have fewer

00:31:23.230 --> 00:31:25.200
firms producing mainframes.

00:31:25.200 --> 00:31:26.390
That supply curve
gets steeper.

00:31:26.390 --> 00:31:28.420
That raises the price.

00:31:28.420 --> 00:31:32.040
And, indeed, exit will continue
until you raise the

00:31:32.040 --> 00:31:35.620
price to the point where
marginal cost equals average

00:31:35.620 --> 00:31:38.270
total cost.

00:31:38.270 --> 00:31:41.500
And what you'll see is the
market will shrink from

00:31:41.500 --> 00:31:43.150
big Q1 to big Q2.

00:31:43.150 --> 00:31:46.000
The remaining market
participants will increase

00:31:46.000 --> 00:31:49.310
from little q1 to little q2.

00:31:49.310 --> 00:31:54.110
And profits go to 0 with price
going to the minimum average

00:31:54.110 --> 00:31:58.830
cost. So through both entry
and exit, we get this

00:31:58.830 --> 00:32:04.690
condition that's illustrated
in Figure 11-5.

00:32:04.690 --> 00:32:11.220
In 11-5, we see that in the long
run, firms always supply

00:32:11.220 --> 00:32:15.500
not on a single curve but
at a single point.

00:32:15.500 --> 00:32:19.220
In the long run, with a
perfectly competitive market,

00:32:19.220 --> 00:32:22.290
for a given firm, there is no
longer even meaningfully a

00:32:22.290 --> 00:32:23.900
supply curve to a firm.

00:32:23.900 --> 00:32:26.810
There's just literally
a supply point.

00:32:26.810 --> 00:32:30.390
Every firm produces at exactly
the point where marginal costs

00:32:30.390 --> 00:32:32.600
equal average costs.

00:32:32.600 --> 00:32:35.860
So in some sense, once again,
for a given firm--

00:32:35.860 --> 00:32:39.010
this is not the market-- but for
a given firm, there's not

00:32:39.010 --> 00:32:41.440
even meaningfully a supply
curve anymore.

00:32:41.440 --> 00:32:44.430
For a given firm, in the long
run, they literally choose one

00:32:44.430 --> 00:32:48.220
production point which is
technologically given.

00:32:48.220 --> 00:32:49.330
So this is interesting.

00:32:49.330 --> 00:32:52.900
For a given firm, the market
doesn't matter.

00:32:52.900 --> 00:32:54.550
For a given firm in a perfectly
competitive market,

00:32:54.550 --> 00:32:57.350
we don't need to know anything
about demand.

00:32:57.350 --> 00:33:00.520
All we need to know is the
firm's production function.

00:33:00.520 --> 00:33:01.210
That's all we need to know.

00:33:01.210 --> 00:33:03.735
We don't even need to know
anything about costs.

00:33:03.735 --> 00:33:07.960
Well, we need to know
cost. We need to

00:33:07.960 --> 00:33:09.040
know their cost function.

00:33:09.040 --> 00:33:11.380
All we need to know is
their cost function.

00:33:11.380 --> 00:33:14.270
And then all we need to do is
derive where marginal costs

00:33:14.270 --> 00:33:17.140
equals average costs,
and we're done.

00:33:17.140 --> 00:33:18.650
This is the power of the
perfectly competitive

00:33:18.650 --> 00:33:19.150
equilibrium.

00:33:19.150 --> 00:33:21.120
This is why economists
love it so much.

00:33:21.120 --> 00:33:23.830
Because we don't need to
go through all this.

00:33:23.830 --> 00:33:24.910
This is all short run stuff.

00:33:24.910 --> 00:33:26.010
In the long run, it's easy.

00:33:26.010 --> 00:33:27.661
You just say, give me a cost
function, I'll tell you what

00:33:27.661 --> 00:33:29.160
the firm will produce.

00:33:29.160 --> 00:33:31.270
And I'll tell you what
the price is.

00:33:31.270 --> 00:33:33.200
The firm will produce where
marginal cost equals average

00:33:33.200 --> 00:33:35.400
cost. And the price will be
where marginal cost equals

00:33:35.400 --> 00:33:36.460
average costs.

00:33:36.460 --> 00:33:39.300
I can tell you the p and the q
in equilibrium just if you

00:33:39.300 --> 00:33:40.880
give me a cost function.

00:33:40.880 --> 00:33:43.950
And that's the beauty of the
long run perfectly competitive

00:33:43.950 --> 00:33:44.310
equilibrium.

00:33:44.310 --> 00:33:46.290
That's why it's so attractive
to economists for modeling

00:33:46.290 --> 00:33:47.590
purposes and other things.

00:33:47.590 --> 00:33:50.150
It's incredibly easy
to work with.

00:33:50.150 --> 00:33:55.090
Because all you need is a cost
function, and you're done.

00:33:55.090 --> 00:33:59.430
The key lesson is what is true
at the point where marginal

00:33:59.430 --> 00:34:01.950
costs equals average costs?

00:34:01.950 --> 00:34:03.910
Well, look at our graph.

00:34:03.910 --> 00:34:08.090
That is the point of
cost minimization.

00:34:08.090 --> 00:34:11.730
Note that that is the very
minimum point of the long run

00:34:11.730 --> 00:34:13.250
average cost curve.

00:34:13.250 --> 00:34:17.940
So where marginal cost equals
average cost is the point of

00:34:17.940 --> 00:34:19.190
cost minimization.

00:34:21.719 --> 00:34:23.320
So we're saying further--

00:34:23.320 --> 00:34:24.780
this is even more powerful--

00:34:24.780 --> 00:34:27.120
we're saying that in the long
run of perfectly competitive

00:34:27.120 --> 00:34:29.440
equilibrium firms will,
by definition,

00:34:29.440 --> 00:34:31.050
minimize their costs.

00:34:31.050 --> 00:34:34.830
They will produce as efficiently
as possible not

00:34:34.830 --> 00:34:36.900
because God told them
to, but through the

00:34:36.900 --> 00:34:39.300
power of the market.

00:34:39.300 --> 00:34:41.940
Because what happens if you
start a firm and you aren't

00:34:41.940 --> 00:34:43.900
cost minimizing?

00:34:43.900 --> 00:34:45.010
What happens?

00:34:45.010 --> 00:34:48.114
What happens is, in the short
run, you might make money even

00:34:48.114 --> 00:34:49.880
if you aren't cost minimizing.

00:34:49.880 --> 00:34:52.750
But, in long run, you'll get
driven out of business.

00:34:52.750 --> 00:34:55.300
Because if there's someone
else who can produce more

00:34:55.300 --> 00:34:59.150
cheaply than you, they'll be
able to charge a lower price

00:34:59.150 --> 00:35:00.480
and drive you out of business.

00:35:00.480 --> 00:35:03.020
Your price will end up above the
long run equilibrium price

00:35:03.020 --> 00:35:04.940
if you're not cost minimizing.

00:35:04.940 --> 00:35:08.090
So any firm that is not cost
minimizing will get driven out

00:35:08.090 --> 00:35:09.520
of business.

00:35:09.520 --> 00:35:13.540
And the equilibrium will be a
market where all firms are

00:35:13.540 --> 00:35:16.570
producing at the cost
minimizing level.

00:35:16.570 --> 00:35:21.830
And that's why we get the high
tech Figure 11-6, which is

00:35:21.830 --> 00:35:24.580
that the long run market
supply curve

00:35:24.580 --> 00:35:25.830
is perfectly elastic.

00:35:30.200 --> 00:35:31.910
Now this comes all the way back
to what I talked about at

00:35:31.910 --> 00:35:33.700
the beginning of the
last lecture.

00:35:33.700 --> 00:35:35.960
Remember I said, what
determines perfect

00:35:35.960 --> 00:35:36.620
competition?

00:35:36.620 --> 00:35:41.300
Two things, the demand curve
to the firm was perfectly

00:35:41.300 --> 00:35:46.120
elastic, and the supply
curve to the market

00:35:46.120 --> 00:35:49.350
is perfectly elastic.

00:35:49.350 --> 00:35:51.670
And we talked last time about
why the demand curve to the

00:35:51.670 --> 00:35:52.660
firm is perfectly elastic.

00:35:52.660 --> 00:35:54.900
Because with lots of firms, any
given firm has a perfectly

00:35:54.900 --> 00:35:56.160
elastic demand.

00:35:56.160 --> 00:35:58.940
Now we've just derived why the
market supply curve is

00:35:58.940 --> 00:36:01.090
perfectly elastic.

00:36:01.090 --> 00:36:05.650
It's perfectly elastic at the
cost minimizing point.

00:36:05.650 --> 00:36:08.790
If the price ever rises above
that cost minimizing point,

00:36:08.790 --> 00:36:11.350
what happens?

00:36:11.350 --> 00:36:15.910
What happens if the price should
suddenly rise above it?

00:36:15.910 --> 00:36:17.402
What happens?

00:36:17.402 --> 00:36:21.720
Firms enter and drive
the price back down.

00:36:21.720 --> 00:36:24.670
If the price ever drops below
that cost minimizing point,

00:36:24.670 --> 00:36:27.610
firms exit, and the price
goes back up.

00:36:27.610 --> 00:36:30.760
So through the power of firm
entry and exit, in the long

00:36:30.760 --> 00:36:35.400
run, you end up with a
horizontal or perfectly

00:36:35.400 --> 00:36:37.560
elastic supply curve.

00:36:37.560 --> 00:36:38.810
And that's perfect
competition.

00:36:41.600 --> 00:36:43.037
Questions about that?

00:36:43.037 --> 00:36:44.031
Yeah?

00:36:44.031 --> 00:36:49.001
AUDIENCE: You said that if it's
not profit maximizing,

00:36:49.001 --> 00:36:51.983
then it cannot
[INAUDIBLE PHRASE].

00:36:51.983 --> 00:36:54.970
But [INAUDIBLE PHRASE].

00:36:54.970 --> 00:36:55.530
PROFESSOR: Yes, they are.

00:36:55.530 --> 00:36:56.570
So that's a great point.

00:36:56.570 --> 00:36:59.280
So what will happen is it's not
that a firm will charge a

00:36:59.280 --> 00:37:00.110
lower price.

00:37:00.110 --> 00:37:01.140
I shouldn't have said
it that way.

00:37:01.140 --> 00:37:03.150
It's that another
firm will enter.

00:37:03.150 --> 00:37:05.140
And, by definition, the price
will then fall, because the

00:37:05.140 --> 00:37:08.170
supply curve will flatten, and
the price will then fall.

00:37:08.170 --> 00:37:10.490
So if you're in there producing
inefficiently and I

00:37:10.490 --> 00:37:12.690
say, hey, your firm sucks.

00:37:12.690 --> 00:37:15.050
I can come in and produce much
more efficiently than you.

00:37:15.050 --> 00:37:17.740
I'll hop in, that will flatten
the supply curve.

00:37:17.740 --> 00:37:18.800
The price will fall.

00:37:18.800 --> 00:37:22.300
At that price, if I'm
not cost minimizing,

00:37:22.300 --> 00:37:23.310
I'll be losing money.

00:37:23.310 --> 00:37:26.070
So I'll leave.

00:37:26.070 --> 00:37:27.770
That's a good clarifying
question.

00:37:27.770 --> 00:37:31.080
So if we have a market with a
bunch of guys in it, and one

00:37:31.080 --> 00:37:34.100
of them is not cost minimizing,
well, that means

00:37:34.100 --> 00:37:36.390
someone else can come in.

00:37:36.390 --> 00:37:39.640
They'll, in the short run,
expand the market.

00:37:39.640 --> 00:37:43.040
That will flatten the supply
curve, drive the price down.

00:37:43.040 --> 00:37:45.490
At that lower price, the
non-cost maximizing firm says,

00:37:45.490 --> 00:37:46.060
I'm losing money.

00:37:46.060 --> 00:37:47.410
So I leave.

00:37:47.410 --> 00:37:49.610
The price goes back up, and it
goes up and down and up and

00:37:49.610 --> 00:37:51.250
down until it settles
at this point

00:37:51.250 --> 00:37:54.640
where costs are minimized.

00:37:54.640 --> 00:37:57.945
So perfect competition leads to
a perfectly elastic supply

00:37:57.945 --> 00:37:59.195
and cost minimization.

00:38:01.460 --> 00:38:04.300
So that is our extreme.

00:38:04.300 --> 00:38:08.950
That is the theoretical
point of no return.

00:38:08.950 --> 00:38:11.710
Of course, in reality,
we never get there.

00:38:11.710 --> 00:38:14.270
In reality, there's no such
thing as a purely perfectly

00:38:14.270 --> 00:38:17.410
competitive equilibrium.

00:38:17.410 --> 00:38:18.300
Why not?

00:38:18.300 --> 00:38:23.950
Well, in the long run, supply
is actually upward sloping.

00:38:23.950 --> 00:38:27.270
In the long run, market supply
will be upward sloping.

00:38:27.270 --> 00:38:30.640
And that's going to be for
at least three reasons.

00:38:30.640 --> 00:38:33.810
So why is long run supply upward
sloping in reality?

00:38:45.100 --> 00:38:47.350
Well, in reality, if would be
for at least three reasons.

00:38:47.350 --> 00:38:51.180
The first reason is that entry
and exit are not free.

00:38:51.180 --> 00:38:58.410
There could be barriers
to entry or exit.

00:38:58.410 --> 00:39:01.650
Even in the long run, there
could be barriers

00:39:01.650 --> 00:39:04.220
to entry and exit.

00:39:04.220 --> 00:39:07.110
There could be features of the
market which make it hard to

00:39:07.110 --> 00:39:09.590
leave or hard to join.

00:39:09.590 --> 00:39:12.870
A classic example is something
that we introduced a couple

00:39:12.870 --> 00:39:17.500
lectures ago, the notion of sunk
costs, costs which even

00:39:17.500 --> 00:39:19.750
in the long run might
be fixed.

00:39:26.850 --> 00:39:30.380
If they're large sunk costs, if
one firm's incurred them,

00:39:30.380 --> 00:39:32.480
another firm is going to say,
look, it's not worth it

00:39:32.480 --> 00:39:33.730
for me to get in.

00:39:36.990 --> 00:39:40.470
If you have to build such a
massive plant to produce your

00:39:40.470 --> 00:39:43.160
good, then it takes an
unbelievable amount of

00:39:43.160 --> 00:39:45.560
capital, it's a huge investment,
and once you're

00:39:45.560 --> 00:39:48.670
in, it's going to be really hard
to drive you out, because

00:39:48.670 --> 00:39:50.590
you made that big investment,
other firms

00:39:50.590 --> 00:39:52.670
might say, forget it.

00:39:52.670 --> 00:39:55.080
Dell made this huge investment
in this huge plant.

00:39:55.080 --> 00:39:56.730
They're never going to leave
having built that plant.

00:39:56.730 --> 00:39:59.180
That's virtually a sunk cost.
So I'm not even going to

00:39:59.180 --> 00:40:00.590
bother entering.

00:40:00.590 --> 00:40:02.580
So Dell can exist making
some profit, maybe

00:40:02.580 --> 00:40:03.570
not too much profit.

00:40:03.570 --> 00:40:05.470
If they make too much profit,
then another firm

00:40:05.470 --> 00:40:07.230
will build a plant.

00:40:07.230 --> 00:40:09.040
Well, as long as they're not
making too much profit, they

00:40:09.040 --> 00:40:09.950
can make some profit.

00:40:09.950 --> 00:40:11.590
Because another firm says,
you know what, I

00:40:11.590 --> 00:40:12.500
can't fight that battle.

00:40:12.500 --> 00:40:14.640
I can't build a plant
that big.

00:40:14.640 --> 00:40:17.300
Or there could be other
things like that.

00:40:23.170 --> 00:40:24.660
That's sort of a natural
barrier to entry.

00:40:24.660 --> 00:40:26.580
There are some artificial
barriers to entry we see.

00:40:26.580 --> 00:40:31.120
For example, take med school.

00:40:31.120 --> 00:40:34.330
The number of slots to be
doctors is limited by the

00:40:34.330 --> 00:40:35.740
physician profession.

00:40:35.740 --> 00:40:38.230
So even if docs make lots of
money, which they do--

00:40:38.230 --> 00:40:39.730
especially specialists--

00:40:39.730 --> 00:40:42.120
you can't just compete and
have new doctors enter.

00:40:42.120 --> 00:40:44.070
Because the number of slots
are actually limited.

00:40:44.070 --> 00:40:46.760
You have to be licensed by an
organization which is run by

00:40:46.760 --> 00:40:48.660
the people making
all the money.

00:40:48.660 --> 00:40:51.320
So if you're a doc, and
you're in, this is

00:40:51.320 --> 00:40:52.180
a pretty good deal.

00:40:52.180 --> 00:40:53.390
You say, hey, let's have
a system where new

00:40:53.390 --> 00:40:54.950
docs can't be licensed.

00:40:54.950 --> 00:40:56.240
They'll have to come
to me, and I can

00:40:56.240 --> 00:40:57.560
charge whatever I want.

00:40:57.560 --> 00:40:58.490
That's a barrier to entry.

00:40:58.490 --> 00:41:00.400
We call that occupational
licensing.

00:41:00.400 --> 00:41:01.460
We see that in lots
of professions.

00:41:01.460 --> 00:41:04.390
Plumbing, taxi drivers,
we see it everywhere.

00:41:04.390 --> 00:41:07.420
It's occupational licensing.

00:41:07.420 --> 00:41:09.180
A second example, of
course, is patents.

00:41:09.180 --> 00:41:11.660
And we'll talk about patents
more in a few lectures.

00:41:11.660 --> 00:41:15.160
If I invented a new drug, and
it's patented, nobody can sell

00:41:15.160 --> 00:41:17.770
that same chemical compound
for 17 years.

00:41:17.770 --> 00:41:20.620
That's a barrier to entry.

00:41:20.620 --> 00:41:22.890
There could be more informal
barriers to entry.

00:41:22.890 --> 00:41:26.150
Let's say you're around Port
Authority setting up these

00:41:26.150 --> 00:41:27.680
little shlocky stands, the
ones we said were perfect

00:41:27.680 --> 00:41:29.720
competition.

00:41:29.720 --> 00:41:31.650
You've got yours, and the guy
comes in next to you, you just

00:41:31.650 --> 00:41:33.710
beat the crap out out of him.

00:41:33.710 --> 00:41:35.190
That's an informal
barrier to entry.

00:41:35.190 --> 00:41:38.120
You say, you come in, and you're
going to get beaten up.

00:41:38.120 --> 00:41:40.320
The guy says, well look, if it's
a big profit, it's worth

00:41:40.320 --> 00:41:41.390
getting beaten up.

00:41:41.390 --> 00:41:42.970
Or I'll hire protection
if it's a big profit.

00:41:42.970 --> 00:41:44.160
But it's not that big of a
profit, I'm not going to

00:41:44.160 --> 00:41:45.670
bother getting beaten
up over it.

00:41:45.670 --> 00:41:46.690
So I'll let you make
your profit.

00:41:46.690 --> 00:41:48.110
I won't come in.

00:41:48.110 --> 00:41:50.780
So barriers to entry exist
all over the place.

00:41:50.780 --> 00:41:53.250
And they're a big reason why
we don't get a perfectly

00:41:53.250 --> 00:41:56.620
elastic supply curve in most
markets because of things like

00:41:56.620 --> 00:41:59.540
patents or thuggery.

00:41:59.540 --> 00:42:02.820
So that's one example of
why you don't get it.

00:42:02.820 --> 00:42:04.880
Another example of why you
might not get a perfectly

00:42:04.880 --> 00:42:11.960
elastic supply curve is that
firms might differ.

00:42:11.960 --> 00:42:15.150
In particular, we have assumed
critically, through the last

00:42:15.150 --> 00:42:18.870
lecture and this lecture, that
firms are identical.

00:42:18.870 --> 00:42:19.970
We have assumed that firms
are identical.

00:42:19.970 --> 00:42:22.560
But, in fact, of course,
firms aren't.

00:42:22.560 --> 00:42:25.770
And one firm's cost minimizing
production level might be

00:42:25.770 --> 00:42:27.040
different than another
firm's cost

00:42:27.040 --> 00:42:28.810
minimizing production level.

00:42:28.810 --> 00:42:30.900
Not all firms will have
exactly the same cost

00:42:30.900 --> 00:42:32.590
minimizing production level.

00:42:32.590 --> 00:42:36.430
In particular, some firms may
have a lower minimum average

00:42:36.430 --> 00:42:39.480
cost than others for a while.

00:42:39.480 --> 00:42:41.740
So it may be that as long as
I'm producing less than x

00:42:41.740 --> 00:42:47.080
units, I have a lower minimum
average cost than you do.

00:42:47.080 --> 00:42:49.710
But once I produce more than x
units, my minimum average cost

00:42:49.710 --> 00:42:51.900
rises to above yours.

00:42:51.900 --> 00:42:56.780
Well, in that case, I might be
able to make money for a while

00:42:56.780 --> 00:42:57.410
staying in.

00:42:57.410 --> 00:42:59.480
But then once I produce too
much, I'm going to have to

00:42:59.480 --> 00:43:00.900
raise the price.

00:43:00.900 --> 00:43:04.550
So to see this, there's a great
example in Perloff which

00:43:04.550 --> 00:43:07.170
you see in Figure 11-7, where
he talks about the

00:43:07.170 --> 00:43:10.940
international long run market
supply curve for cotton.

00:43:10.940 --> 00:43:16.540
And he says, look, in Pakistan,
you can produce

00:43:16.540 --> 00:43:18.350
cotton incredibly cheaply.

00:43:18.350 --> 00:43:20.500
This is a dated example, but in
Pakistan, you can produce

00:43:20.500 --> 00:43:22.080
cotton incredibly cheaply.

00:43:22.080 --> 00:43:26.960
You can produce it at
$0.71 per kilogram.

00:43:26.960 --> 00:43:32.190
So if the world demand for
cotton is less than $2 billion

00:43:32.190 --> 00:43:34.990
kilograms per year, or less than
$1.8 billion kilograms

00:43:34.990 --> 00:43:39.400
per year, then Pakistan would
provide it all, and the price

00:43:39.400 --> 00:43:42.290
would be $0.71.

00:43:42.290 --> 00:43:43.900
But let's say the demand
is more than that.

00:43:43.900 --> 00:43:46.290
Well, Pakistan just runs
out of cotton.

00:43:46.290 --> 00:43:46.880
They can't do that.

00:43:46.880 --> 00:43:48.450
Well, then you have to go to
the next cheapest country.

00:43:48.450 --> 00:43:50.110
Well, the next cheapest
country is Argentina.

00:43:50.110 --> 00:43:53.100
It costs a lot more to
produce cotton there.

00:43:53.100 --> 00:43:55.240
And then comes Australia,
Brazil, Nicaragua, Turkey,

00:43:55.240 --> 00:43:56.060
then finally the US.

00:43:56.060 --> 00:43:59.380
And then Iran is the
most expensive.

00:43:59.380 --> 00:44:02.460
So this is, effectively, an
upward sloping supply curve.

00:44:02.460 --> 00:44:05.340
It's stepwise, but it's an
upward sloping supply in the

00:44:05.340 --> 00:44:10.980
sense that as you want more
quantity, the price goes up.

00:44:10.980 --> 00:44:14.750
So if the market wants $5
billion kilograms of cotton a

00:44:14.750 --> 00:44:19.000
year, then that means that the
marginal producer is the US

00:44:19.000 --> 00:44:22.940
even though they're much less
efficient than Pakistan.

00:44:22.940 --> 00:44:25.370
Because Pakistan hit
a constraint.

00:44:25.370 --> 00:44:28.340
You have to go to that next
less efficient producer.

00:44:28.340 --> 00:44:32.190
So that's taking an upward
sloping supply curve.

00:44:32.190 --> 00:44:35.340
Basically you're getting an
upward sloping supply curve,

00:44:35.340 --> 00:44:37.380
because you have constraints
on how much any

00:44:37.380 --> 00:44:39.380
given firm can produce.

00:44:39.380 --> 00:44:42.570
Those constraints can make you
move onto less efficient firms

00:44:42.570 --> 00:44:44.360
as you go on.

00:44:44.360 --> 00:44:46.440
And so in a market, you'll end
up, in reality, with a

00:44:46.440 --> 00:44:48.670
distribution of firms
ranging from most

00:44:48.670 --> 00:44:50.970
efficient to least efficient.

00:44:50.970 --> 00:44:52.740
The most efficient would produce
as much as it can at

00:44:52.740 --> 00:44:53.760
that efficiency level.

00:44:53.760 --> 00:44:55.660
But then some less efficient
ones will get in the game as

00:44:55.660 --> 00:44:57.690
well just depending on
where demand is.

00:44:57.690 --> 00:44:59.540
So you can see if you put in
demand curves at different

00:44:59.540 --> 00:45:02.070
points in the supply curve,
you get different prices.

00:45:02.070 --> 00:45:04.970
That's an upward sloping
supply curve.

00:45:04.970 --> 00:45:07.810
That's a second reason.

00:45:07.810 --> 00:45:09.350
And then a third reason--

00:45:09.350 --> 00:45:11.680
these aren't a comprehensive
list, but types of reasons why

00:45:11.680 --> 00:45:13.870
supply curves will slope
up in reality--

00:45:13.870 --> 00:45:19.610
is that input prices might rise
as the market expands.

00:45:19.610 --> 00:45:21.400
We've assumed fixed
input prices.

00:45:21.400 --> 00:45:25.300
I gave you an r and w, and
I assume they were fixed.

00:45:25.300 --> 00:45:27.640
But, in fact, that might
not be true.

00:45:27.640 --> 00:45:32.470
It might be that, in reality,
as you want to produce more,

00:45:32.470 --> 00:45:34.690
you need to buy more
of the input.

00:45:34.690 --> 00:45:36.650
Well, if you need to buy more
of the input, and the input

00:45:36.650 --> 00:45:39.320
has an upward sloping supply
curve, then you'll have to pay

00:45:39.320 --> 00:45:41.030
more to get more
of that input.

00:45:41.030 --> 00:45:44.260
So to see that, let's run
through an example.

00:45:44.260 --> 00:45:47.550
Let's imagine that you want to
produce something in the long

00:45:47.550 --> 00:45:50.690
run, and you need more
labor to produce it.

00:45:50.690 --> 00:45:52.570
So as you produce more of
it, you need more labor.

00:45:55.860 --> 00:45:57.860
So now let's go to
Figure 11-8.

00:45:57.860 --> 00:46:01.050
You're initially, in your firm,
demanding L1 units of

00:46:01.050 --> 00:46:03.990
labor at a the wage of W1.

00:46:03.990 --> 00:46:07.570
And let's say that at that
point, at that wage, you're

00:46:07.570 --> 00:46:09.160
cost minimizing.

00:46:09.160 --> 00:46:12.320
That's the cost minimizing
point, and you've got this

00:46:12.320 --> 00:46:15.210
flat supply curve.

00:46:15.210 --> 00:46:15.900
You're at that point.

00:46:15.900 --> 00:46:17.800
Now let's say you want
to produce more.

00:46:17.800 --> 00:46:19.615
Well, to produce more, you've
got to go to the market and

00:46:19.615 --> 00:46:20.830
hire more labor.

00:46:20.830 --> 00:46:24.940
If the supply curve for labor is
upward sloping, if labor is

00:46:24.940 --> 00:46:27.550
not a perfectly competitive
market and, therefore, is an

00:46:27.550 --> 00:46:29.330
upward sloping supply,
they'll say, fine.

00:46:29.330 --> 00:46:30.520
If you want more workers,
you've got to pay more.

00:46:30.520 --> 00:46:32.410
You've got to pay W2.

00:46:32.410 --> 00:46:34.590
You've got to pay more
for your workers.

00:46:34.590 --> 00:46:35.920
Well, think about
what that does.

00:46:35.920 --> 00:46:38.030
Now, go to Figure 11-9.

00:46:38.030 --> 00:46:45.730
What that means is that as I
produce more units, I have to

00:46:45.730 --> 00:46:48.300
pay more for the labor.

00:46:48.300 --> 00:46:50.460
Now let's start on the left-hand
side figure.

00:46:50.460 --> 00:46:56.000
That says that if I'm producing
little q1 as a firm,

00:46:56.000 --> 00:46:58.230
my marginal cost is MC super
1, and my average

00:46:58.230 --> 00:46:59.990
cost is AC super 1.

00:46:59.990 --> 00:47:02.370
So I'm at P1.

00:47:02.370 --> 00:47:08.230
Now if I want to produce more,
if I want to produce q2, my

00:47:08.230 --> 00:47:10.560
average cost is going to be
higher, and my marginal cost

00:47:10.560 --> 00:47:11.690
is going to be higher, because
I have to pay a

00:47:11.690 --> 00:47:13.790
higher wage to workers.

00:47:13.790 --> 00:47:15.650
So that's going to shift
me up to have to

00:47:15.650 --> 00:47:18.770
charge a higher price.

00:47:18.770 --> 00:47:20.720
Now, I'm still cost
minimizing.

00:47:20.720 --> 00:47:23.420
Given the wage the market
gives me, I'm still cost

00:47:23.420 --> 00:47:23.620
minimizing.

00:47:23.620 --> 00:47:25.520
There's nothing non-cost
minimizing about this.

00:47:25.520 --> 00:47:27.180
I'm still cost minimizing.

00:47:27.180 --> 00:47:29.730
But to cost minimize, I
have to charge more.

00:47:29.730 --> 00:47:32.600
Because the market's charging
me a higher price.

00:47:32.600 --> 00:47:36.890
If you go back to solving our
initial production decision,

00:47:36.890 --> 00:47:39.360
you'll see that because this is
a higher wage, that's going

00:47:39.360 --> 00:47:42.060
to shift my cost function up.

00:47:42.060 --> 00:47:44.070
A high wage is going to
make my costs higher.

00:47:44.070 --> 00:47:47.450
That's going to make my cost
minimizing price be higher.

00:47:47.450 --> 00:47:49.030
So I'm going to shift.

00:47:49.030 --> 00:47:50.520
I'm going to need to charge
a higher price.

00:47:50.520 --> 00:47:53.050
That, itself, will also
yield an upward

00:47:53.050 --> 00:47:55.530
sloping supply curve.

00:47:55.530 --> 00:47:59.820
So an upward sloping supply
curve comes from the fact that

00:47:59.820 --> 00:48:02.510
as I produce more, I've
got to pay higher

00:48:02.510 --> 00:48:03.870
prices for my inputs.

00:48:03.870 --> 00:48:05.910
That means I've got to charge
higher prices for my outputs.

00:48:08.560 --> 00:48:12.310
So these are three examples of
reasons why, in reality, we

00:48:12.310 --> 00:48:15.550
don't see a perfectly flat
long run supply curve.

00:48:15.550 --> 00:48:19.490
So once again, to review,
because this is the end of

00:48:19.490 --> 00:48:23.660
this particular topic, to review
where we are, the way

00:48:23.660 --> 00:48:25.940
it works is firms are given
a cost function.

00:48:25.940 --> 00:48:28.810
Well, they choose
a technology.

00:48:28.810 --> 00:48:30.390
That gives them a
cost function.

00:48:30.390 --> 00:48:31.800
They enter the market.

00:48:31.800 --> 00:48:35.250
In the short run, they're stuck
with that technology.

00:48:35.250 --> 00:48:37.860
So they decide to produce where
price equals marginal

00:48:37.860 --> 00:48:39.830
cost as long as they're not
losing more money than they've

00:48:39.830 --> 00:48:41.600
paid in fixed costs.

00:48:41.600 --> 00:48:45.440
In the long run, firms come in
and out until the point where

00:48:45.440 --> 00:48:48.530
every firm is producing
efficiently.

00:48:48.530 --> 00:48:51.110
As long as entry is free, as
long as there are not barriers

00:48:51.110 --> 00:48:54.910
to entry, every firm is
producing efficiently.

00:48:57.640 --> 00:48:59.410
Then every firm is producing
at a single point, which is

00:48:59.410 --> 00:49:02.700
where marginal cost equals
average cost. That yields a

00:49:02.700 --> 00:49:07.080
flat long run supply curve at
the technological minimum.

00:49:07.080 --> 00:49:10.540
In reality, supply curves slope
up because there might

00:49:10.540 --> 00:49:13.470
be barriers to entry which
leads to non-cost

00:49:13.470 --> 00:49:14.720
minimization.

00:49:20.540 --> 00:49:22.040
So this leads to non-cost
minimization.

00:49:24.630 --> 00:49:26.700
And then there's two reasons,
even if you're cost

00:49:26.700 --> 00:49:31.480
minimizing, you still could
have capacity constraints,

00:49:31.480 --> 00:49:38.480
which is like our cotton
example, or you could have

00:49:38.480 --> 00:49:40.210
upward sloping input supply.

00:49:47.810 --> 00:49:51.540
So that's why, in reality, we
draw the upward sloping supply

00:49:51.540 --> 00:49:53.720
curves that we started with at
the beginning of this course

00:49:53.720 --> 00:49:56.550
even with a perfectly
competitive market.

00:49:56.550 --> 00:49:58.140
So let's stop there.

00:49:58.140 --> 00:50:00.520
That's a lot of stuff to digest.
We're going to come

00:50:00.520 --> 00:50:03.100
back next time and talk about
why all this is crap, and

00:50:03.100 --> 00:50:05.240
firms don't really cost minimize
or maximize profits

00:50:05.240 --> 00:50:06.490
or any of that.