A.P. Economics

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

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.

1. Label all of the appropriate parts of the side-by-side graph below.2. Identify regions of profit, assuming there are no changes to the market.

S

D

Quantity

Price

P

Cost

Outputs

SRMC

SRACProfit

SRMC

SRACProfit

LRAC

Level #1

Level #2

There are a lot of entrepreneurs out

there that will want a piece of

this profit!!!

MARKET FIRM

• 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

S0

D

Quantity

Price

P0

Cost

Outputs

SRMC

SRACSRMC

SRAC

LRAC

Level #1

Level #2

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

S1

P1

Market Firm

• 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.

• 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

• 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.

Only at P* will profits be just equal to __________, and only at P* will the industry be in ______________________________.

• 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.

ZERO

equilibrium

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

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

TOP TEN:

10. Overnight Stay9. Wine

8. Lotion/Soap Basket 7. Photo - Frame

6. Spa/Salon Gift Cert.5. Lingerie4. Jewelry

3. Stuffed Animals2. Chocolate/Candy

1. Flowers