IV. The perfectly competitive (PC) market (finish)

B. equilibrium in the long run

    Profits > 0 => entry until profits = 0 again
    Profits < 0 =>exit until profits = 0 again

    Example (worksheet): coffee after WWII (assume stable ATC => constant cost industry)
    1. D1: 1945: equilibrium w/ European market closed off since 1941 (40% of market)
    2. D2: 1950: Brazil out of stocks demand stable after (e_I = 0)
    3. S2: 1955-1970s: 4-5 years to get first crop, yields rise 'til tree is 10-15 years old =>
        overplanting (e = 0.3 => foreign exchange falls)
    4. S3: 1970s: Brazilian frost brought market into line

Industry	Firm

    Key simplification here: ATC remained the same as industry output changed.
    Not always true.

    Note: there are only 4 possible situations at MR=MC:
    (1) P>ATC => positive economic profits => operate at P=MC
    (2) P=ATC => breakeven situation => operate at P=MC
    (3) P<ATC, but >=AVC => operate at P=MC for now since you're covering TVC and part of TFC (ex: dot.com firms)
    (4) P<AVC => shut down => losses = TFC; you're making your situation worse by operating since TR doesn't even cover TVC. Exit unless you expect things to improve.

    Rule: if you choose to be an industry, as long as P>minAVC, operate where P=MC for maximum profits

    Industry supply in the short run:

    Industry supply (S) =horizontal summation of individual firms' supply curves (MC curves above minAVC).
    That's why we say that marginal costs underlie supply curves.

    Effects of entry due to profits>0 (the reasoning works in reverse for exit):
    (1) P falls: always true
    (2) ATC curves shift if industry size affects input prices.
    (No single firm affects input prices. But all firms together might)

    Possible impact of entry on unit costs--3 possibilities:

Industry	Firm

    Why does this matter? It determines whether industry prices remain stable, rise or fall as industry size changes over time

    V. General equilibrium with competitive markets

    We've looked at consumers and how they allocate their budgets.
    We've looked at producers and how they choose their inputs to cut costs.
    We've looked at competitive firms and how they choose how much to produce.

    Now time to put the pieces together

    Keep in mind the importance of comparing.
    Because of scarcity, we never have as much as we want. We must always value what we've got relative to what else we might have.

    An economist's most common response to a question: "Compared to what?"

    This is microeconomics at its most elegant

    Economic efficiency
    The goal we have the most to say about

    First, what is economic efficiency?
    Layperson: no waste.
    An allocation of goods or resources is efficient when it is...
    "Pareto optimal" => it is impossible to make anyone better off without making someone else worse off.

    We'll address the efficiency questions in a general equilibrium context.

    Recall what that means: Partial equilibrium analysis looks at one market at a time, using S&D, measuring welfare with CS and PS.
    Ex: sugar-free soda.
    Limitations of partial equilibrium (S&D) analysis:
        (1) What if the sugar-free market equilibrium we see is because of a tax on sugared sodas?
            We can't see that distortion with partial equilibrium analysis of the sugar-free soda market
        (2) Also, partial equilibrium shows only output. Doesn't get behind S&D. How do we know that minimum costs have been achieved?

    Recall: General equilibrium analysis considers the relationship between markets.
    >1 market at a time--most broadly, for all markets together

    Here, we'll move to a 2x2x2 market. 2 goods; 2 inputs, 2 consumers

    3 key relationships

    One from each part of course so far: X-game videos (X) and Yogurt (Y)

    Utility maximizing by consumers -->
        U-max:
        (1) MUx/MUy = MRS = Px/Py
    Relative value of X = relative cost of X
    Addresses for whom to produce.

    Cost minimizing by firms -->
        Cost-min:
        (2) MPL/MPK = MRTS = PL/PK
    Relative productivity of L = relative cost of L
    Addresses how to produce

    Profit maximizing by firms under perfect competition -->
        p-max w/PC:
        Px=MCx and Py=MCy =>
        (3) Px/Py = MCx/MCy
Relative price of X = relative cost of X.
    Addresses what to produce

A. Exchange efficiency (EE)

Urban water market	Water market for farmers

    What incentives does this situation create?

    Could efficiency improve if free market transactions were allowed?

This is a partial equilibrium illustration of what exchange efficiency is about.

Our goal now is to view situations like this in a general equilibrium framework that allows us to see the interconnectedness of markets.

Learning objectives: Diagram an Edgeworth box for exchange, and use it to illustrate alternative allocations. Define and illustrate key concepts related to exchange efficiency, including endowment, lens, contract curve, Pareto superior and Pareto optimal. Explain how competitive markets tend to ensure exchange efficiency.