Book cover for Intermediate Microeconomics: A Modern Approach

Intermediate Microeconomics: A Modern Approach

Hal R. Varian

ISBN #9780393927023

7th Edition

224 Questions

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7,544 Students Helped

Homework Questions

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Summary
Learning Objectives
Key Concepts
Example Problems
Explanations
Common Mistakes

Summary

This chapter section explores industry supply by distinguishing between short-run and long-run supply dynamics. It emphasizes that while short-run supply is constrained by fixed factors, the long-run allows full adjustment, culminating in zero economic profits. Real-world examples, such as taxi and liquor licenses, illustrate economic rent and fixed factors, while the analysis of government interventions, like taxation and price controls, reveals their impact on market supply. Understanding these interactions is crucial for assessing industry behavior and policy outcomes.

Learning Objectives

1

Differentiate between short-run and long-run industry supply and understand their unique characteristics.

2

Explain how industry equilibrium is established under fixed and flexible production factors.

3

Analyze the concept of zero economic profits in long-run equilibrium and its implications.

4

Evaluate the role of economic rent and fixed factors using real-world examples such as taxi and liquor licenses.

5

Assess the impact of taxation, price controls, and government policies on market supply dynamics over time.

Key Concepts

CONCEPT

DEFINITION

Industry Supply

The total quantity of a good or service that firms in an industry are willing and able to produce at various price levels, considering both short-run and long-run adjustments.

Short-Run Supply

The period in which some production factors are fixed, limiting the ability of firms to fully adjust production in response to market changes.

Long-Run Supply

The period in which all factors of production are variable, allowing firms to fully adjust production levels, entry, and exit until zero economic profits are achieved.

Zero Economic Profit

A situation where firms earn just enough revenue to cover all opportunity costs, indicating that no extra economic profits are available in the long-run equilibrium.

Economic Rent

The surplus payment made to a factor of production, above its opportunity cost, often seen in cases of limited supply or regulatory constraints.

Fixed Factors

Inputs in production that cannot be easily adjusted in the short-run, affecting a firm's ability to change output levels quickly.

Example Problems

Example 1

If $S_{1}(p)=p-10$ and $S_{2}(p)=p-15,$ then at what price does the industry supply curve have a kink in it?

Example 2

In the short run the demand for cigarettes is totally inelastic. In the long run, suppose that it is perfectly elastic. What is the impact of a cigarette $\operatorname{tax}$ on the price that consumers pay in the short run and in the long run?

Example 3

True or false? Convenience stores near the campus have high prices because they have to pay high rents.

Example 4

True or false? In long-run industry equilibrium no firm will be losing money.

Example 5

According to the model presented in this chapter, what determines the amount of entry or exit a given industry experiences?
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Step-by-Step Explanations

QUESTION

How is long-run industry equilibrium achieved with zero economic profits?

STEP-BY-STEP ANSWER:

Step 1: Recognize that in the long-run, all production factors become variable, allowing firms to enter or exit the industry.
Step 2: Understand that entry of new firms occurs if existing firms are making economic profits, increasing industry supply.
Step 3: As supply increases, market prices adjust downward until profits are driven to zero.
Step 4: Realize that when economic profits are zero, firms cover their opportunity costs, and there is no incentive for new firms to enter or for existing firms to exit.
Final Answer: Long-run industry equilibrium is reached when market forces adjust firm entries and exits, bringing profits to the point where they equal zero economic profits.

Long-Run Industry Equilibrium

QUESTION

How do taxation and price controls affect industry supply?

STEP-BY-STEP ANSWER:

Step 1: Identify that government policies such as taxes and price controls directly impact the cost structures for firms.
Step 2: Understand that taxes can increase the cost of production, reducing the quantity supplied at any given price.
Step 3: Recognize that price controls, by setting minimum or maximum prices, can distort market signals, potentially leading to shortages or surpluses.
Step 4: Analyze how these policies force adjustments in output levels and alter long-term industry dynamics.
Final Answer: Government policies like taxation and price controls modify industry supply by changing cost conditions and market incentives, thereby altering both short-run and long-run equilibrium outcomes.

Impact of Government Policies

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Common Mistakes

  • Confusing short-run constraints with long-run adjustments; students may not recognize that all inputs become variable over time.
  • Misunderstanding zero economic profit as zero revenue instead of covering all opportunity costs.
  • Overlooking the role of economic rent and fixed factors when analyzing market supply dynamics in regulated industries.
  • Failing to appreciate the impact of government interventions on both cost structures and market equilibrium.