Chapter 11. Economic Change in a Competitive Industry in the Entrepreneurless Economy

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1 February 15, 2003 Chapter 11 Economic Change in a Competitive Industry in the Entrepreneurless Economy The goal of this chapter is to show how to use the theory of demand and supply for the entrepreneurless economy to represent change. To represent a change and its effects, we begin by assuming that there is a general economic equilibrium, as described at the end of Chapter Nine. Then we introduce some change, such as a change in preferences or in the conditions of supply. Next we trace the effects of the change. We do this by first showing how the change affects the demand and/or cost curves and then showing the short run and long run adjustments to the change. In this chapter, we present two examples: a change in preferences (part 1) and an innovation in technology (part 2). 1. THE EFFECTS OF A CHANGE IN PREFERENCES The effects of a change can be divided into two classes: market effects and welfare effects. Market effects consist of (1) the change in prices and quantities of the various goods and (2) the change in the industry structure (e.g., the number of firms in the various industries). Welfare effects consist of changes in well being, as measured in money, of the various roles represented in the model. We begin by discussing the market effects. Then we turn to the welfare effects. Market Effects We described the long-run equilibrium for a competitive industry at the end of Chapter Ten. We use this as the starting point in figure 11-1 below. An increase in industry demand is represented by a rise in the industry demand curve from D to D h in the right panel. The Long-Run and Short-Run Industry Supply Curves Before we can continue, we must distinguish between two kinds of industry supply curves: the long-run curve and the short-run curve. The long-run industry supply curve shows the quantities of a good that all firms together would supply at each price, given that new plant capital can be produced and that old plant capital can be completely used up. The assumption that capital can be produced means that all of the firms that want to enter or leave the industry can do so. The short-run supply curve shows the quantities that all firms together would supply at each price, given that new plant capital cannot be produced and, therefore, that no new firms can enter an industry. From a Change in Preferences to Changes in Demand Preferences refer to consumer wants. In the model of the entrepreneurless economy, they are represented by a shift of the industry demand curve. For example, we might assume that consumer preferences shift so that consumers demand more vegetables and less meat at each price. Because wants are relative, an increase in demand for one type of good must always be offset by a decrease in demand for at least one other type of good.

2 2 Knowledge and Entrepreneurship (11) Figure 11-1 INCREASE IN INDUSTRY DEMAND Figure 11-2 SHORT-RUN INDUSTRY EQUILIBRIUM 2

3 Economic Change in a Competitive Industry in the No Entrepreneur Economy (11) 3 In order to be brief in this chapter, we will examine in detail only the effects on an industry in which there is an increase in demand. The reader is advised to add to this by building a model of an industry in which there is a decrease in demand. Such a model is the mirror image of the one presented here. Equilibrium means that all existing firms have fully adjusted their choice of output to the behavior of the other firms in an effort to maximize surplus or minimize the deficit. In short-run equilibrium, we assume that they have adjusted only by increasing or decreasing their output; in long-run equilibrium, we assume that they may have adjusted by changing their plant capital also. Figure 11-2 contains two industry demand curves, D 1 and D 2, and two industry supply curves, SS and LS. We begin by assuming that the industry is in both short run and long equilibrium. This is given at point e, where both the SS and LS curve intersect the D 1 curve. An increase in industry demand is represented by a shift from the D 1 to the D 2 curve. The problem we face in this part is to show the effects of this change in the short run and in the long run. The technique of using both short and long run supply curves on the same graph enables us to represent a two-stage adjustment to a change in demand or supply: (1) a short-run adjustment and (2) a long-run adjustment. Our demonstration takes the following form. We begin by assuming a long-run equilibrium price, quantity, consumers surplus and economic rent. Then we introduce a change in industry demand or supply. We go on to identify, in turn, both a short-run equilibrium and the new long-run equilibrium. The Short-Run Adjustment to an Increase in Demand We use the short-run industry supply to help us determine how much the price and quantity of the consumers good will rise in the short run as a result of the change in demand. Look at the right panel of figure Starting with a price of p 1, the increase in demand causes a temporary shortage of Q d - Q 1. Firms respond to the shortage by raising price. How much will they be able to raise price? In order to find out the short-run industry equilibrium price, we must find the intersection of the new industry demand curve, D 2, and the short-run industry supply curve. This is given at the price p 2 and quantity Q 2. Now consider the effect on the firm's choice of output. This is shown in the left panel of figure As the price rises in the industry, the price also rises for each firm. The higher short-run equilibrium price faced by the firm is shown in the left panel by an upward shift of the firm s demand curve from D 1 to D 2. Assuming that there is no effect on costs, the rising price changes the surplus maximizing output from q 1 to q 2, where the new demand line faced by the firm crosses the marginal cost line. The rising price creates a gap between the price and average total cost, enabling the firm to earn surplus. The Long Run Adjustment to an Increase in Demand We now turn to the long-run adjustment. The short-run equilibrium surplus earned by firms in this industry implies that there are deficits in other industries. If firms elsewhere shift into this industry, they can earn a surplus. By definition, in the long-run, firms enter the surplus earning industry until the surplus is driven down to zero. As new firms enter, the industry short run supply curve shifts out to the right. This is because each new entrant adds a marginal cost curve to the existing curves. In the right panel of figure 11-4, new firms continue to enter. This causes the supply curve, SS 1, to shift to the right. With the increase in short-run industry supply, price must fall. Otherwise, there would be a surplus of the good in the industry. The price falls until the money surplus earned by the firm is driven back to zero. The long-run industry equilibrium situation is shown in the right panel of figure 11-4, where we see that the initial SS curve (SS 1 ) has shifted to the right until it ultimately equals the intersection of the new demand curve and the long run supply curve (SS 2 = LS = D 2 ). The long-run equilibrium price is p 3 and the long-run equilibrium quantity for the industry is Q 3. Notice in the left panel that the mc and ac curves have shifted upward from ac 1 and mc 1 to ac 3 and mc 3. This reflects the higher costs due to the entry of new firms.

4 4 Knowledge and Entrepreneurship (11) Figure 11-4 LONG-RUN INDUSTRY EQUILIBRIUM We have assumed that the change in costs leads the firm to produce the same quantity as before the change. This assumption is made for the sake of convenience. We also assume that the industry is an increasing cost industry. We can explain this by assuming that as new firms enter, their competition for resources causes existing firms' costs to rise. The long run industry supply curve is upsloping. We could have assumed a decreasing cost industry or a constant cost industry. In a decreasing cost industry, the ac 3 curve would lie below the ac 1 curve and the LS curve would be downsloping. In a constant cost industry, the ac 3 curve would be the same as the ac 1 curve and the LS curve would be a horizontal line. Other Industries In our discussion, we represented the effects of an increase in demand. In at least one other industry, there would be a decrease in demand. To complete our analysis, we should represent that also. We should show how this change leads firms to face deficits in the short run, which would lead some of them to leave the industry in the long run. As firms left, the demand curve faced by each remaining firm would shift up and, assuming an increasing cost industry, the cost curves would shift down. In the industry, the exit of firms would lead the short-run industry supply curve to shift back to the left. The end result would again be a zero money surplus model of the firm and an industry model in which the new demand equals the long-run supply and the short-run supply. To show this in figure 11-4, we would only have to change the labels on the curves. Welfare Effects of the Increase in Demand In order to find the welfare effects, we must consider changes in the well being, as measured in m oney, of three roles: producers (firms), consumers, and suppliers of the specialized resources. In Chapter Nine, we showed how consumers benefit from exchange. They receive consumers surplus. We can determine the effects of an increase in demand on consumers by comparing the consumers surplus before and after the increase. Finding the benefits to producers and the owners of resources is more complicated. The first step is to distinguish between short run and long run gains. In the short run model, firms can earn surplus

5 Economic Change in a Competitive Industry in the No Entrepreneur Economy (11) 5 and incur deficits. We can regard the surplus (deficit) as a gain (deficit) to producers. However, we have seen that in the long run, economic surplus is zero. Therefore producers surplus must be zero in the long run. Ordinarily, when economists measure the welfare effects of a change, they are interested in long run effects. As a result, they disregard any short run surplus or deficits to producers on the grounds that they are temporary. Instead, they assume that all surpluses go to the owners of specialized resources. Following this convention, we assume that all of what we called suppliers gain in Chapter Nine consists of surplus to owners of specialized resources. We call this surplus economic rent. Economic rent refers to the surplus that owners of specialized resources receive, after deducting opportunity costs, because producers have a derived demand for their services. We now discuss this concept in greater detail. Economic Rent To elucidate the concept of economic rent, imagine an economy in which there are only two extreme classes of resources: purely specialized resources and purely non-specific resource. We defined these resources in Chapter Nine. We illustrate economic rent by referring to figure If the demand for the good produced with your specialized resource is low, then the demand for your resource will also be low. The amount of money that is paid to all of the owners of that resource will be low. In the graph, if demand for the good is D 1, the total economic rent received by all of owners of the specialized resources is only efg. If the demand for the good is a higher D 2, total economic rent is a higher cdg. If the demand is higher still, at D 3, total economic rent is abg. The typical good is produced with many types of resources of varying degrees of specialization. This simple model helps us see that the more specialized resources receive increases in economic rent when there is an increase in market demand. Of course, they are also exposed to decreases in economic rent if there is a fall in market demand. Moreover, if a resource can be produced, like plant capital can be; when the economic rent rises high enough, copies of the resource will be made and the owners of specialized resources will face greater competition. Figure 11-5 ECONOMIC RENT

6 6 Knowledge and Entrepreneurship (11) The Ricardian Theory of Land Rent In the last subsection, we described the idea that the rent on a specialized resource that is limited in supply rises as more of it is employed. This idea was first described by the classical economist David Ricardo in the early part of the 18 th century. He presented a simple model like that of figure In that model, we assume that the amount of land is fixed at L. If the demand for that land is D 1, its equilibrium price is a low P 1. If the demand is D 2, equilibrium price is P 2, and so on. Suppose that you lived for many years in a growing city. If you owned land in the city, you would realize that as the population and wealth of the city increased, the demand for land would also increase. The price of your land would rise to many times its original price. Ricardo extended this analysis by distinguishing between land of different degrees of fertility. He argued that as the demand for farm land increased, less and less fertile land would be settled and brought into use to produce food. As this happened the rent on the more fertile land would rise. This theory is called the theory of differential rent. It maintains that, other things equal, superior resources of a specialized type are used first. As demand for the resources increases, (1) resources that are less superior are brought into use and (2) the more superior resources earn a rent that is higher than the less superior ones. The land at the margin or marginal land is less fertile than all of the other land. Its price would be zero, whild all of the other land would have a positive price. The demand for a resource is sometimes called a derived demand. The demand is derived from the demand for consumers goods in the sense that if the demand for consumers goods rises, firms increase their demands for resources. Thus a higher price in an industry is followed by higher prices in the markets for the specialized resources necessary to produce the good. Figure 11-6 DEMAND AND LAND PRICES The Surplus from Exchange in Long-Run Equilibrium Recalling the idea of consumers surplus, we are now in a position to show, step-by-step the long-run equilibrium gains from exchange to the consumer and resource owner role. Refer to figure 11-7, which

7 Economic Change in a Competitive Industry in the No Entrepreneur Economy (11) 7 shows a supply curve and demand curve in the A industry. Consider the first unit q 1. Suppose for some reason that firms decided to produce only one unit and that the unit is produced by the lowest-cost firm. Then, in a competitive market for resources, the money a firm would have to pay for the specialized resources needed to supply the first unit would be as low as possible, at mr. If that unit was given for free to the consumer who is willing to pay the highest price for it, the total consumer surplus in terms of money would be br. It follows that the net surplus would be bm. The distance mr represents the opportunity cost to the suppliers of the specialized resources. This is the money that they could earn if their resources were used to produce some other good. Suppose that the consumer must pay a price of p. Then his surplus would be be. If we assume that firms earn no surplus, then the money, em, would go to the owners of the specialized resources in the form of economic rent. Now suppose, in addition, that the second unit, q 2, is also produced at the lowest cost by the lowest cost producer and given for free to the consumer who is willing to pay the highest price for it. The net surplus from the second unit is ck. If the price is p, the consumer who buys the second unit gains cf, while the owners of the specialized resources needed to produce it receive a gain fk. The opportunity cost of supplying the second unit is kt. The surplus from the third unit is dh. The consumer of the second unit receives less surplus than the consumer of the first unit because he values it less yet must pay the same price. The owners of specialized resources needed to produce the second unit also receive less surplus than the owners of the resources needed to produce the first unit. The reason for this is that their opportunity cost is higher. The higher opportunity cost may be due to the lower productivity of the resources that are used to produce the second unit of the good. For example, the resources might be inferior grade rice land. Assuming that all grades of rice land have the same alternative use value, lower-grade land would be used only after the superior land. Because superior land is more productive, less of it would be needed and rice growers would bid the price per hectare higher than inferior land with the same alternative use. Thus the owner of the superior land would receive higher rent than the owner of the inferior land. Figure 11-7 LONG RUN SURPLUS FROM EXCHANGE

8 8 Knowledge and Entrepreneurship (11) Assuming that the market for good A is in equilibrium, the price would be p and the quantity of the good exchanged would be q. The surplus to consumers, or consumers surplus, would be apg. The economic rent would be pgn. Classifying the Welfare Effects of an Increase in Demand We now show the long-run welfare effects of an increase in demand. We do this by comparing consumers surplus and economic rent of the industry in long-run equilibrium before the increase in demand with consumers' surplus and economic rent afterwards. Consider figure Consumers' surplus has risen from def to abc. Because abc is greater than def, consumers, taken as a whole, have gained in terms of money. Some consumers are likely to lose as a result of the higher demand. You can see this by putting yourself in the shoes of an original demander before the increase in demand. Suppose that the increase in demand is due to the other people deciding that this product yields more utility than previously. You, however, experience no change in your demand. Since the increase in demand drives up the price from p 1 to p 2, you may decide to shift some of your purchases to some other good. Unless there is a corresponding fall in the prices of the other goods you buy, you will be a loser. In this kind of model, there is likely to be a fall in the prices of other goods, since the shift of firms from other industries into this one will have reduced specialized resource prices in those industries. If we just consider the industry in question, however, it is clear that you lose because of the higher price. Figure 11-8 WELFARE EFFECTS OF AN INCREASE IN DEMAND

9 Economic Change in a Competitive Industry in the No Entrepreneur Economy (11) 9 Figure 11-9 WELFARE EFFECTS OF AN INCREASE IN DEMAND (2) Now consider the owners of specialized resources. Before the increase in demand they received a total of efg in economic rent. In the new long-run equilibrium, they receive bcg. They have gained bcef, as shown by the shaded area in figure The total gain in consumers and resource suppliers surplus (economic rent) is aced. It is possible, though unlikely, that the new consumers surplus after a change in demand would be less than the old consumers surplus. Suppose that the new demand curve has a shape like that drawn in figure The consumers s surplus after the increase in demand, abc, would be less than the area of consumers surplus before the increase in demand, def. 2. THE EFFECTS OF INNOVATION There are two types of innovation: (1) the discovery and use of a new and superior good and (2) the discovery and use of a new and superior method of production. The models we have been using are mainly useful for discussing the second type, since they assume that the number of goods in an economy is fixed. So we shall restrict our discussion to this type. We first describe the market effects and then the welfare effects. Market Effects Suppose that a firm discovers a new and superior method of production. Immediately after its discovery, its cost curves shift downward. For simplicity, suppose that they shift in a way that is shown in figure The average and marginal cost curves shift from ac 1 and mc 1, respectively, to ac 2 and mc 2. This means that the innovating firm will want to sell a larger quantity than before and that it can earn a surplus by doing so. In the example, the firm maximizes surplus by increasing output to q 2. Its surplus is abdc (total

10 10 Knowledge and Entrepreneurship (11) revenue abe0 - total cost cde0). Although it increases output, we assume that the firm is so small that its greater output has no effect on industry price. Some innovations of this type could be copied by other firms in the industry, even in the short run. However, to simplify our analysis, we assume that copying requires the production of new plant capital, which cannot occur in the short run. In the long run, the methods of production will be copied by the existing firms in the industry and by outsiders who enter the industry. In the long run, the plant capital needed for copying can be produced. The copying reduces surplus to the innovators in two ways. First, the increase in industry supply causes the market price to fall, thus reducing the revenue to the innovating producer. This is represented by a downward shift of the demand curve faced by the firm. In the left panel of figure 11-11, it shifts down from D 1 to D 2. Second, the increased bids by copiers for the resources that are specialized in using the new method of production raise the costs of production to each firm. This is shown on the same panel of figure by an upward shift of the cost curves from ac 2 and mc 2 to ac 3 and mc 3. In our example, the innovator s money surplus returns to zero and he produces the same output as before. Let us summarize the market effects from the innovating firm s point of view. At first, the innovation enables the firm to earn short run surplus. In the long run, new plant capital is produced and new firms enter the industry. As this occurs, the firm's demand falls and costs rise. This is due to the competition that results from copying by existing firms and the entry of new firms. The increased competition bids down the price of the good and it bids up the price of the specialized resources. The end result is that the innovating firm is no better off in the long run than it was in the first place. In the new long run equilibrium, it makes zero surplus. Now let us look at this sequence of events from the standpoint of the industry in the long run. The innovation, combined with its later adoption by all firms, causes the long run supply curve to shift out from LS 1 to LS 2, as shown in the right panel of figure This causes the long-run equilibrium price in the industry to fall from p 1 to p 2.

11 Economic Change in a Competitive Industry in the No Entrepreneur Economy (11) 11 Figure SURPLUS-MAXIMIZING POSITION OF AN INNOVATING FIRM Figure LONG RUN EQUILIBRIUM AFTER AN INNOVATION

12 12 Knowledge and Entrepreneurship (11) In the example, we have assumed that the new long-run surplus maximizing quantity for the firm is the same as the old long-run surplus maximizing quantity. This need not be the case. However, if we make this assumption, then there will be more firms in the industry after the adjustment to the innovation. We know this because the quantity produced by all firms together is higher (Q 2 > Q 1 ), yet the quantity produced by each firm (q 1 ) is the same as before. Welfare Effects Most of the short run gains from a successful innovation go to the innovating firm in the form of higher surplus. The innovating firm may also employ additional specialized resources, thereby benefitting their owners, although it is also possible that the innovation will reduce the demand for resources (or for some kinds of resources). All discoveries of a new and superior method of production save on resources needed to produce a given quantity of the good. Thus an innovation reduces the demand for the resources needed to produce a given output. However, the amount of output produced in the industry rises. Whether suppliers of specialized resources in this industry gain in the short run depends on whether the reduced demand for specialized resources due to the innovation offsets the increased demand for resources due to the desire to produce a higher output. If it does, then the suppliers of specialized resources, as a group, lose. If it does not, they gain. Figure LONG-RUN GAINS DUE TO INNOVATION It is also possible that an innovation in the production of a good will make a resource obsolete with respect to producing that good. If this happens, suppliers of the obsolete resource will lose the opportunity to earn economic rent in the innovating industry. If the owner of such a resource has no other rent-earning possibilities, the resource will become a non-resource. Now consider the long-run. No firms, including the innovating firm, make surplus in the long-run. If the innovator does not gain in the long run from the technological change he causes, who does? Figure shows part of the answer. The technological change shifts the long-run supply from LS 1 to LS 2. First

13 Economic Change in a Competitive Industry in the No Entrepreneur Economy (11) 13 consider the increase in consumers' surplus. Because consumers buy the larger quantity q 2 at the lower price p 2, they gain a surplus of bcfd. Thus consumers definitely gain. The graph shows an additional change. The economic rent changes from bcg to dfh. There is a gain of gefh but a loss of bced. It is not evident which is larger. We could draw a set of demand and supply curves for which the gain in economic rent would be greater than the loss. But we could also draw a set for which the surplus would be less than the loss. Thinking of the resources as a whole, we simply cannot be certain whether individuals in their role as owners of specialized resources will gain in the long run. In the long run, the benefits from an innovation are received not by the innovator or by copiers but by consumers and possibly by some suppliers of specialized resources. The additional surplus, whether it is consumers' surplus or rent to specialized resources, is gcfh. Thus, we say that innovation benefits either the innovator and possibly the owners of certain specialized resources in the short-run. In the long-run, the innovation benefits consumers and possibly the suppliers of some specialized resources. Although we cannot be certain about the change in economic rent, there is no doubt that the innovation raises the sum of the consumers surplus and economic rent. 3. SIGNALING AND CONSUMER SOVEREIGNTY Signaling Having completed our presentation of the short run-long run model, we now return to the issue of how the model is useful. In Chapter Ten, we pointed out that one use of the model is to help us identify and describe an economy-wide signaling function of prices. Consider first the signaling that occurs as a result of the increase in demand. The change in demand leads surplus-maximizing firms to change their bids for resources. In the short run, the changes in bids signal owners to shift their variable resources into the industry. The changes also signal the producers to shift resources into the production of plant capital for the expanding industry and away from the typical other industry. In the long run, new plant capital is produced and firms enter the industry. The entry decreases industry price. This decrease signals firms already in the industry to reduce output by hiring fewer variable resources. It also signals outside firms to stop entering. Now consider signaling in the model of a change in technology. The surplus that can be earned by a firm that copies the new, lower cost methods of production acts as a signal to firms in the industry and to outsiders to bid for some resources and plant capital to take advantage of the new methods. Their bids signal the producers of plant capital to shift their resources toward the production of the kind of plant capital that will enable the firms to adopt the new methods and away from the typical other kinds of plant capital. As firms copy the technology, they bid up the prices of the resources needed to take advantage of the new methods and they bid down the prices of the product. Both of these factors squeeze the surplus to zero, thereby sending a signal to outsiders to stop entering the industry. Consumer Sovereignty The model also helps us demonstrate consumer sovereignty. Consumer sovereignty refers to the idea that all choices in the market economy are carried out with the goal of producing goods for consumers. Choices are not made according to the directions of a central planner, or individual sovereign (king). Consumers, as a group, are the sovereigns. In the model of an increase in industry demand, firms and resource suppliers respond instantly to changes in consumer demand by causing resources to be shifted into those industries where consumer demand has risen and out of those industries where demand has fallen. And they cause new plant capital to be produced as soon as possible in order to take advantage of surplusearning opportunities. The result is that the initially high price to consumers falls to one that is as low as possible, given that firms need a normal surplus to continue to operate and that resources have to be paid amounts at least equal their opportunity costs to keep them in their current uses. Competing firms singlemindedly aim to maximize surplus and they can do so only by catering to every change in consumer demand that is expressed.

14 14 Knowledge and Entrepreneurship (11) Similarly, competing firms and owners of capital-producing resources respond to an improvement in technology by causing reduced prices of the consumers goods produced with that technology. In the long run, they cause plant capital to be produced to take advantage of the new technology. The result, as we have seen, is that the main beneficiaries of a technological improvement are the consumers. Consumer sovereignty does not mean that every consumer gains from every change in the market economy. Like firms that compete for customers, consumers compete for goods. Some gain and some lose, depending on how the prices of the goods they are inclined to buy change. However, the model of a competitive industry in an entrepreneurless economy enables us to show how consumers, in general, gain from competition among the surplus-maximizing suppliers of goods and resources. Chapter Define economic rent, purely specialized resource, non-specific resource, derived demand, consumer sovereignty. 2. Assume a long run equilibrium in a competitive industry in the entrepreneurless economy. Draw the equilibrium of the industry and firm side by side in two panels. Show how a decrease in industry demand affects the firm in the short run. Be sure to explain your graph in words. Make sure that the graphs for the firm are consistent with the graphs for the industry. 3. Assume a long run equilibrium in a competitive industry in the entrepreneurless economy. Draw the equilibrium of the industry and firm side by side in two panels. Show how an increase in industry demand affects the firm in the short run. Be sure to explain your graph in words. Make sure that the graphs for the firm are consistent with the graphs for the industry. 4. Assume a long run equilibrium in a competitive industry in the entrepreneurless economy. Draw the equilibrium of the industry and firm side by side in two panels. Show how an increase in industry demand affects the firm in the long run. Be sure to explain your graph in words. Make sure that the graphs for the firm are consistent with the graphs for the industry. 5. Assume a long run equilibrium in a competitive industry in the entrepreneurless economy. Draw the equilibrium of the industry and firm side by side in two panels. Show how a decrease in industry demand affects the firm in the long run. Be sure to explain your graph in words. Make sure that the graphs for the firm are consistent with the graphs for the industry. 6. In building the model of the surplus from exchange in long run equilibrium, we say that the owners of the specialized resources needed to produce the second unit of a good receive less economic rent that the owners of the resources needed to produce the first unit. What basis do we have for concluding this? 7. Describe the Ricardian theory of differential rent. 8. Use a graph to show that the price of a purely specialized resource depends entirely on the height of the demand for that resource. You may wish to use the example of land. Explain your graph in words. 9. Show graphically and describe in words the welfare effects of an increase in demand. 10. Show graphically and describe in words the welfare effects of a decrease in demand. 11. Show graphically and tell in words the market effects of an innovation. In other words show and tell the effects (1) on industry price and quantity and (2) on price, quantity, costs and revenues of the innovating firm. A sensible approach would be to draw a graph containing two panels one of the firm and one of the industry. 12. Show graphically and tell in words the welfare effects of an innovation. In other words show and tell the effects on consumers surplus and economic rent in the industry. 13. Our model of the effects of a change in demand in a competitive industry helps us demonstrate the signaling function of prices. Explain. (In your explanation, you should begin by defining the signaling function of prices.) 14. Our model of the effects of a change in demand in a competitive industry helps us demonstrate consumer sovereignty. Explain. (In your explanation, you should begin by defining consumer sovereignty.)

15 Economic Change in a Competitive Industry in the No Entrepreneur Economy (11) 15 Gunning s Address J. Patrick Gunning Professor of Economics/ College of Business Feng Chia University 100 Wenhwa Rd, Taichung Taiwan, R.O.C. Please send feedback gunning@fcu.edu.tw Go to Pat Gunning's Pages Mirror Site of Pat Gunning's Pages