Lecture # 15 Long Run Equilibrium

Transcription

1 I. Lng Run Equilibrium Lecture # 15 Lng Run Equilibrium We began class reviewing the cncept f lng run equilibrium. Nte that, t d the analysis, we typically use tw graphs: an industry supply and demand diagram and the cst curves fr a typical firm. The intersectin f supply and demand determines the market price. The firm takes this as given and determines its quantity by cmparing price t MC. If firms are making psitive prfits (starting at P0 and Q0 belw), ther firms will enter the market. This shifts ut the supply curve (the blue supply curve), lwering the price and reducing prfits fr each firm. The prcess cntinues until there are zer ecnmic prfits. The price is at the bttm f the average cst curve.

2 Example: increased csts In ur secnd example, we lked at what wuld happen if the perating csts increased. An example f this wuld be requiring firms t prvide health insurance t their wrkers. Again, we start with a market in lng-run equilibrium. Here, it is a change in csts that takes us ut f equilibrium. In this example, bth AC and MC increase. These are the red lines n the graph belw. As a result, the firm equates the current price f P0 t their new marginal cst. Output fr the firm falls t q1. The firm nw lses mney. The lss is shwn by the shaded rectangle n the graph. The distance between AC (nw higher than price) and price represents the lss per unit. Multiplying by quantity gives us the ttal lss.

3 Because firms are lsing mney, sme firms exit the market. This causes the supply curve t shift in. They will exit until we return t zer ecnmic prfits. This ccurs where the price hits the bttm f the new average cst curve (in red belw). By extending this price, P1, ver t the supply and demand diagram, we see that supply shifts in (blue line) until the price increases t P1. Nte that, in this example, the lng-run price remains higher than the initial price. The cst increase causes prices t rise.

4 The article n quina shws hw market changes lead t shrt run prfits and a new lng-run equilibrium. We start by illustrating a market in lng-run equilibrium. Thus, the AC curve fr a firm (in this case, a quina farmer) rests n the price that is determined by the market, s that there are zer ecnmic prfits. As quina becmes mre ppular, demand increases. This shifts the demand curve ut (blue line), leading t higher prices and prfits fr farmers. Nte frm the article that prices tripled frm

5 These higher prices are a signal that mre quina is needed. Because this is a prfitable business, mre farmers enter the market. Nte that while quina was traditinally grwn in Peru, as prices increased, farmers frm ver 50 cuntries entered the market. This shifts the supply curve ut, lwering prices (green line belw). Prices fell 40% in just a single year, frm 2014 t As lng as prfits are being made, farmers cntinue t enter, s that supply shifts ut until prices return t their riginal level. Firms nce again earn zer ecnmic prfits. The article als ntes sme additinal cmplicatins: Because prices were s lw, sme farmers stred quina rather than sell it. Thus, there will be even mre quina n the market next year, making prices fall further. The farmers that entered the market had lwer csts. If their csts are belw thse drawn abve fr the Peruvian farmers, thse farmers culd cntinue t enter the market. That wuld drive the Peruvian farmers ut f business, since they wuld lse mney at a price belw P0. Nte, fr example, that the article says the price fell belw the $2.60/kg price necessary t supprt Peruvian farmers.

6 The graph belw illustrates. Here we have tw sets f cst curves The black curves represent the cst curve fr prducers elsewhere in the wrld. Thse farms earn 0 ecnmic prfits when the quina price falls t $2/kg The red curves represent Peruvian farmers. They need a higher price ($2.60/kg) t earn 0 prfits. Thus, when the price reaches the new equilibrium price f $2/kg, they lse mney. The shaded bx represents their lss. What can Peruvian farmers, and their gvernment, d in respnse? They either need t lwer csts r cnvince cnsumers t pay mre fr Peruvian quina. Fr example, the Ecnmist article ntes attempts t carve ut niche markets, such as heirlm quina. Recall that perfect cmpetitin assumes identical prducts. If Peru can cnvince cnsumers that nt all quina is the same, they can try t cnvince them t pay mre fr Peruvian quina. Helping farmers get access t new technlgy culd help lwer the cst curve.

7 II. Ecnmic Rent Questin: in real life, we certainly see firms earning psitive prfits, even in the lng run. Hw d we explain that? One thing t nte is that, even if lng run prfits are zer, shrt run prfits may be psitive. Anther ptential benefit is ecnmic rent. Ecnmic rent -- a payment t the wner f an input beynd the minimum necessary fr the factr t be supplied Can be psitive, even when ecnmic prfits are zer. This is because ecnmic prfits include pprtunity cst. In this case, ne f the pprtunity csts is nt "cashing in" n the ecnmic rent (e.g. using, rather than selling a valuable prperty). Examples f ecnmic rent In this example, ecnmic rent cmes frm the value f a scarce lcatin. Cnsider tw factries. One is lcated near a prt. The ther is inland, s that its prducts must be delivered t the prt by truck. Bth factries participate in a glbal market, s that they are price takers. Because the factry near the prt has lwer csts, it earns higher prfits. As a result, its land is wrth mre. If bth factries were ffered fr sale, the factry near the prt wuld sell fr a higher price. Thus, the higher prfits earned by the factry near the prt are an ecnmic rent. It is cmpensatin fr the prime lcatin. Nte that ecnmic prfits are still 0. This ecnmic rent cmpensates fr an pprtunity cst. Because the factry site near the prt is wrth mre, the pprtunity cst f running that factry is higher than fr the inland factry.

8 The Crn Laws in 19th century England shw hw a change in plicy creates ecnmic rent. These laws restricted imprts f grain int England, leading t higher prices. Higher grain prices increased demand fr farmland. The aristcratic class was able t charge farmers higher rents. Thus, it was landwners, wh had cntrl f a scarce resurce (land), that benefited frm the Crn Laws. The graph belw illustrates. The market begins in lng run equilibrium, with zer ecnmic prfits. Csts are represented by the black AC and MC curves. The tariffs cause the supply curve t shift in (blue line belw). Fewer grains are cming int England frm ther cuntries. This causes prices t rise and lwers quantity. Individual farms nw make a prfit. In ur ther examples, this wuld have caused English farmers t enter the market, lwering prices nce again. In effect, English farmers wuld have replaced freign farmers and supply wuld have returned t the riginal black supply curve. Hwever, that did nt happen here because farmland was a scarce resurce. Instead, as mre farmers tried t enter, the rent that landwners culd charge increased. This shifts the average cst curve up (red line belw). Thus, a zer-prfit lng run equilibrium was reached nt by supply increasing, but by rising csts. Prices remained higher, and aristcratic landwners were the main beneficiary f the tariffs.

9 The example f hw Uber has affected bth taxi drivers and the value f their licenses (e.g. taxi medallins) shws bth the effects f a license and hw new technlgies can disrupt a market and change the value f a license. Again, we start in lng run equilibrium. Here, we illustrate the market fr rides, shwing the ride market n the left, and a taxi driver as the typical firm. I've drawn supply t be relatively inelastic, since the number f medallins is fixed. Nte that it need nt be perfectly inelastic. Althugh the number f medallins is fixed, taxi drivers can chse hw much effrt they wish t use (e.g. number f hurs driving per day). Uber increases cmpetitin fr rides. This leads t an increase in supply. Supply shifts ut (in blue belw) I've shwn the new supply curve as mre elastic, as Uber drivers have mre flexibility than regular taxi drivers. This lwers the market price Since taxi drivers with medallins have higher csts than Uber drivers, they are nw lsing mney.

10 Taxi drivers cannt cntinue t perate with high medallin csts. They may decide t exit the market. Hwever, if they d, medallin wners will want t sell their medallins t smene else. Hwever, they will be unable t d s unless they lwer the price. Thus, whether it is t the current driver r a new driver, the medallin wner will need t lwer the price he charges fr the medallin. Since the medallin is a fixed cst f taxi peratin, this nly shifts the average cst curve (AC). Nte that we must return t a new equilibrium with zer ecnmic prfits. Thus, the AC curve shifts dwn until it rests upn the new price line, as shwn belw. Thus, the impact f Uber is t reduce the ecnmic rent f medallin wners. Like ur ther rent examples, the value f the ecnmic rent is determined by market prices, rather than the cst f a medallin determining market prices. Ecnmic rent cmes frm scarcity. In this example, as nted in the New Yrk Times article, scarcity came frm regulatin. Requiring licenses fr specific ccupatin restricts supply. We ll discuss this further in class n Wednesday.