Age of Economics and Competitive Markets

Introduction to Economics

  • IMBA Andrew Schein: Topic covers competitive markets in the long run.
    • Key Topics:
    1. Long run equilibrium
    2. Changes in long run equilibrium
    3. The invisible hand

Entry and Exit of Firms

  • In a competitive market, firms will:
    • Enter if they see profits.
    • Exit if experiencing losses.
  • Profit Equilibrium:
    • This pursuit of profit leads to zero economic profits in the long run, represented as:
      PQ=TCPQ = TC
  • Simplified:
    • At long run equilibrium:
      P=ATCP = ATC
    • Where:
    • If P > ATC: Firms are profitable.
    • If P < ATC: Firms incur losses.

Long Run Equilibrium

  • Equilibrium conditions combine short run rules:
    • P=MC=ATCP = MC = ATC
  • Graphical Representation:
    • Quantity in the market versus Quantity of individual firms with Price (P), Marginal Cost (MC), Average Total Cost (ATC) depicted by supply (S) and demand (D) curves.

Example 1: Market Adjustments

  • Scenario: Price set at 10 (points A and B) results in firms losing money (below ATC).
  • Market Response:
    • Firms exit the market, reducing supply and increasing the price.
  • New Equilibrium:
    • Achieved at points C and E.

Example 2: Market Dynamics

  • Scenario: Price remains at 10 (points A and B) resulting in firms making profits (above ATC).
  • Market Response:
    • New firms enter, increasing supply, thus lowering price.
  • New Equilibrium:
    • Established at points C and E.

Changes in Long Run Equilibrium

  • Scenario: Increase in demand due to substitute price change.
  • Initial Position: Points A and B (equilibrium).
  • Short-run Effect: Movement to points C and E.
  • Long-run Adjustment:
    • Entry of firms leads to new equilibrium at points F and B.

Technological Changes in Equilibrium

  • Scenario: Technological improvements lead to cost reductions and profit increases.
  • Initial Equilibrium: Points A and B.
  • Long run Adjustments:
    • Price drops to 8, establishing new equilibrium at points C and E.

The Invisible Hand

  • Adam Smith's Theory:
    • “Every individual neither intends to promote the public interest…but is led by an invisible hand…”
    • Pursuing self-interest breeds beneficial outcomes for society.

The Invisible Hand in Capitalism

  • Role of Government:
    • Minimal intervention, mainly to enforce laws.
    • Exceptions include public goods, externalities, monopolies, and macroeconomic issues.
  • Economic Growth:
    • Capitalist economies show superior growth compared to communist economies.
    • Examples: East vs. West Germany; North vs. South Korea images.

Market Effects of New Light Rail System

  • Initial State: Market in long-run equilibrium (points A and B).
  • Demand Shift: Increased utility from light rail leads to reduced bus demand.
  • Short-run Changes:
    • Demand curve shifts left; new equilibrium at point C with lower price and quantity.
    • Firms produce less at point E and incur losses.
  • Long-run Adjustment:
    • Firms exit, leading to new equilibrium at point F with increased prices and zero economic profits.

The Invisible Hand Demonstration

  • Selfish Interest: Consumers prefer light rail over buses; firms exit bus market to avoid losses.
  • Outcome: Remaining bus companies optimize production at minimum ATC, reflecting efficiency through the invisible hand.