Elasticity of Market Supply:The Industryâ€™s Long-Run Supply Curve

<< Elasticity of Market Supply:Long-Run Competitive Equilibrium

Elasticity of Market Supply:Welfare loss if price is held below market-clearing level >>

Microeconomics ECO402

Lesson 26

The Industry's Long-Run Supply Curve

Long-Run Elasticity of Supply

1) Constant-cost industry

· Long-run supply is horizontal

· Small increase in price will induce an extremely large output increase

· Long-run supply elasticity is infinitely large

· Inputs would be readily available

2) Increasing-cost industry

· Long-run supply is upward-sloping and elasticity is positive

· The slope (elasticity) will depend on the rate of increase in input cost

· Long-run elasticity will generally be greater than short-run elasticity of supply

The Industry's Long-Run Supply Curve

Question:

Describe the long-run elasticity of supply in a decreasing -cost industry.

The Long-Run Supply of Housing

Scenario 1: Owner-occupied housing

Suburban or rural areas

National market for inputs

Questions

Is this an increasing or a constant-cost industry?

What would you predict about the elasticity of supply?

Scenario 2: Rental property

Urban location

High-rise construction cost

Questions

Is this an increasing or a constant-cost industry?

What would you predict about the elasticity of supply?

The Industry's Long-Run Supply Curve

The Effects of a Tax

In an earlier chapter we studied how firms respond to taxes on an input.

Now, we will consider how a firm responds to a tax on its output.

126

Microeconomics ECO402

Effect of an Output Tax on a Competitive Firm's Output

Price

MC2 = MC1 + tax

The firm will

reduce output to

($ per

An output tax

the point at which

unit of

raises the firm's

the marginal cost

output)

marginal cost by the

plus the tax equals

amount of the tax.

the price.

AVC

Output

Effect of

Output Tax on Industry Output

Price

S2 = S1 + t

($ per

unit of

output)

Tax shifts S1 to S2 and

output falls to Q2. Price

increases to P2.

Output

Evaluating

the Gains & Losses from Government Policies:

Consumer & Producer Surplus

Review

Consumer surplus is the total benefit or value that consumers receive beyond what

they pay for the good.

Producer surplus is the total benefit or revenue that producers receive beyond what it

cost to produce a good.

127

Microeconomics ECO402

Price

Consumer

Surplus

Between 0 and Q0

producers receive

Producer

a net gain from

Surplus

selling each product--

producer surplus.

Quantity

Consumer

To determine the welfare effect of a governmental policy we can measure the gain or loss in

consumer and producer surplus.

Welfare Effects

Gains and losses caused by government intervention in the market.

Suppose the government

imposes a price ceiling Pmax

Price

which is below the

Market-clearing price P0.

Deadweight

The gain to consumers is

the difference between

the rectangle A and the

triangle B.

The loss to producers is

the sum of rectangle A and

Pmax

triangle C. Triangle

B and C togethermeasure

the deadweight loss.

Quantity

Change

consumer & producer surplus from price controls

Observations:

The total loss is equal to area B + C.

The total change in surplus = (A - B) + (-A - C) = -B - C

The deadweight loss is the inefficiency of the price controls or the loss of the producer

surplus exceeds the gain from consumer surplus.

128

Microeconomics ECO402

Observation

Consumers can experience a net loss in consumer surplus when the demand is

sufficiently inelastic

Effect of Price Controls When Demand Is Inelastic

If demand is sufficiently

inelastic, triangle B can

Price

be larger than rectangle

A and the consumer

suffers a net loss from

price controls.

Example

Pmax

Oil price controls

and gasoline shortages

Quantity

Price

($/mcf)

The gain to consumers

2.4

rectangle A minus

triangle B, and the loss

2.0

producers is rectangle

A plus triangle C.

(Pmax)1.0

30 Quantity (Tcf)

15 1

Price Controls and Natural Gas Shortages

129

Microeconomics ECO402

The Efficiency of a Competitive Market

When do competitive markets generate an inefficient allocation of resources or market

failure?

1) Externalities

· Costs or benefits that do not show up as part of the market price (e.g. pollution)

2) Lack of Information

· Imperfect information prevents consumers from making utility-maximizing decisions.

Government intervention in these markets can increase efficiency.

Government intervention without a market failure creates inefficiency or deadweight loss.

130

Table of Contents: