Today
 LR industry supply
– Constant cost
– Increasing cost
 Implications of LR equilibrium
Industry Supply in the Long
Run
The Key to understanding the long
run is firm entry and exit.
Case 1: Constant Cost Industry
 Assumes that firms’ costs are independent
of the size of the market. Expanding or
contracting demand yields the same price in
the long run.
– Firms’ cost curves do not shift as industry
output changes.
 Leads to a horizontal long-run industry
supply curve.
Initial LR Equilibrium
P
Typical Firm
P
MC
Industry or Market
SRS
ATC
LRATC
P
D
q
q
Q
Q
Thought experiment: What happens to the industry LR
equilibrium as market demand expands?
SR Response to Increase in
Demand
P
Typical Firm
P
MC
Industry or Market
SRS
ATC
LRATC
P
D’
D
q q’
q
Q
Q’
SR: price rises. Firms earn profits. Why isn’t this a
new LR equilibrium?
Q
LR Response to Increase in
Demand
P
Typical Firm
P
MC
1
ATC
SRS’
1
LRATC
0
0
P
Industry or Market
SRS
2
2
D’
D
q” q’
q
Q
Q”
LR: Firms enter until no more profits can be made.
Given our assumption, that is when price falls to its
original level. Second LR equilibrium.
Q
LR Industry Response to an
Increase in Demand
 Assuming that firms’ costs do not depend
on the size of the industry, and
 Beginning in LR equilibrium and increasing
demand:
– in the SR, price rises, firms’ profits and outputs
rise.
– In the LR, price returns to original level, firms
earn zero profits, each firm makes same q as
before, but market output is higher.
LR Response to Increase in
Demand
P
Typical Firm
P
Industry or Market
MC
ATC
LRATC
LRS
P
D’
D
q
q
Q”
Case 1: Horizontal Long-Run Supply Curve
Q
Q
Significance of Result
 For these industries, growing demand
(ceteris paribus) will not result in higher (or
lower) prices.
– Remember LRS is not predicting how prices
change over time.
 For these industries, there is a constant
opportunity cost of producing this good.
Case 2: Increasing Cost Industry
 Assumes rising opportunity cost as an
industry (or market) expands, causing firms’
costs to rise.
– Ex: market for milk & price of dairy land
 Results in an upward-sloping long-run
industry supply curve
Case 2 & LR Industry Supply
P
Typical Firm
P
LRATC (Q1)
Industry or Market
SRSSRS’
LRS
LRATC(Q0)
P
D’
D
q
Q0
Q1
Case 2: Upward-sloping Long-Run Supply Curve
Q
Significance of Case 2
 Growing demand for milk forces up the
price of milk.
 Less productive land is converted to dairy
farming.
 Opportunity cost of producing milk rises.
 Price of milk rises in the long run, even
though there are more milk farms.
 ***Result comes from the underlying
scarcity of dairy land.***
Profits for New Dairy Farms
 Consider the dairy farms that have opened
because of higher milk prices.
 Do they make profits, losses, or break even
in the long run? How do you know?
Profits for Old Dairy Farms.
 Consider the dairy farms that were in
business prior to the increase in demand.
 Will they make profits, losses, or break even
in the new long run equilibrium?
– What about dairy farmers who rent their land?
– What about dairy farmers who buy land that
has always been used for dairy farming?
– What about dairy farmers who already owned
dairy farms?
Coming Up:
 Prepare for second midterm exam.
Group Work
 Profits for Coal Mines
Coal Mining
 Assume the coal mining industry is
perfectly competitive.
 Consider two mines:
– Alpha mine has rich, easily accessible deposits.
– Beta mine has less desirable deposits. Its
marginal cost of producing coal is everywhere
twice as high as for Alpha.
Profits for Alpha & Beta Mines
 Assume the price of coal is high enough
that Beta mine is actively mining coal.
 Will Beta mine make economic profits,
economic losses or break even in the long
run?
 Suppose the total coal deposits in the two
mines are equal. What can you say about
the likely price of Alpha mine compared to
Beta mine?
Profits for Alpha & Beta Mines,
Cont’d.
 Will the two mines have the same fixed
costs?
 Will Alpha mine make economic profits,
economic losses or break even in the long
run? How do you know?