In the short period of time, multiple firms have flexible inputs. Depending on time, flexibility part of firm is limited approximately to help in adapting the new technical developments in production process or increases or decreases its operation scale which will give change of economic conditions.
In contrast, in long period of time, a firm can easily change its inputs which will include the plant size. It will also decide on closing down or exiting the industry start producing the goods for first time which includes entry into industry.
We are mainly concerned with competitive markets, which will allow the firm for freely exiting or entering. So, firm can both entry or exit minus having any legal aspects or any kind of special cost which is associated with entry. When we recall from section 18 that this is the one of the keys that has assumptions which is havingstiffstruggle. After evaluating the output decision for long run of profit maximizing firm which is in competitive market, will analyze the extent of economicalequivalent state in the long-term basis. We will also discuss about the associationin between the entrance and exit part along with accounting and economic profit.
Note if the market price is higher, the profit will also be higher of the firm. Same as if price of a specific commodity falls from $40 to $30 there will be decrease in profit too. At the price of $30 the firms output which are in profit maximization field is at q2 the point at which there is an increase in minimum average cost curve in long run.
Entry and Exit-
Figure 8.13 states as how a $40 price will induceany firm to increase output and getting a positive profit. Since profit is calculated by deducting the cost of opportunity capital, a greater profit earns a high return on financial investment that can be easily gained by putting a lucrativemarket. This greater return will cause the investors to direct their capitals away from differentbusiness and in one concept which states that the entrance to the market will be very easy.
Eventually the production which has increased has come with any new entry which let the curve of market supply to tend rightward. Hence, output in terms of market range rises on one hand and the market price of the product falls on other side
We will not leave this matter here. If some firms exit the market, there will be decrease inproduction that let the curve of market supply to move leftwards. Output in terms of market will fall on the one hand while product rate will rise on the other side untilequilibrium is reached up to break-even value of $30. To make it précis:
In a given industry or a market which entirely depends on the free of cost entrance and exit of the firm, in that situation any given firm will only enter when it has the opportunity to earn profit in long term basis and it will come out from the market only when it will face losses on long term basis.
Firms involved in the process or the makers are left with no such incentive so that they can easily leave the market when they are earning the economic profit in 0. Along with that no other firms are any incentive to enter. There is the state of long term equilibrium which occurs on three conditions
- If the firms in the industries are earning profit
- The value of the selected article or a product is chosen as per the level of quantity provided by the makers and which is equivalent to the level of demanded quantity in the market.
- No firms are having any enticement to enter or exit from the market since most of the businesses are earning economic profit which is equivalent to 0.
Dynamic process which results in long run equilibrium will give puzzling effects. Firm has the full right to enter into the market with the hope of earning profit and can leave the industry any time in case of losses. Firm can earn zero profit in long term equilibrium. Why firms are entering the market as they still knows they will earn profit for same? Answer of this will be zero economic profit where the firm is not having any kind of incentive to go anywhere as it will not any kind of financial transactions. If the firm will enter into the market for short run in order to earn profit will give the best option to producers. Same way if the firm will exit from the market without earning profit quickly it will help the investors in saving of their money. This long term equilibrium will tells us about the direction of the firm behavior which they likely to take.
Firms Having Different Costs–
Let us consider the fact that most of the firms available in the market have nosimilar kind of cost curves. Still if any one of the firms is having the patent which allows its producer to produce at a cost which is lower to average as compared to all others then it is found reliable along with equivalent in the long run. It will also ensure greater profits for businesses as far as accounting profit is concerned. In addition it also allows the firms to enjoy maximum value of produce as compared to other firms available in the market.
Until and unless the patent is not acquired by any given manufacturer or any business which lowers theworth of production, all of them do not have any incentive to arriveinto the market. Until and unless the same process is applicable to this particular product along with this industry, the firm do not has incentive to exit from the market. The margin amongthe profit coming out from accounting as well as from the economic benefit is of great importantat this juncture. In this content it is crucial to mention that in case the given patent is beneficial then the other firms available in the market will also pay for the same to use it or even buying it.
So, it can be said that the maximizedcost of the patent reflects a cost of opportunity to different firms in the industry which they are holding it from earlier. In this context it is also true that they have the best way to sell all their exclusive rights to the patent instead of using the same by their own.
It is equally true that if all the firms available in the market are found purely efficient then the economic profit of the firm will be minimized to 0. If that firm where patent is much moreeffectiveas compared to different firms, it is obvious that they will be gaining a greaterrevenue. In case this patent holder is not as efficient, patent can be sold and industry can be left.
Businesseswhich are having Identical Costs–
In order to see all the situations equivalent positions in long-runwhich is hold by assuming this aspects as firms are having similar kind of costs. Now, let us consider a situation in which numbers of firms are entering into the business to gain the opportunity to have benefits. In that case supply curve of industry for market will shift to right extent and it is evident too, which will indicate the fall in price less than $30—suppose to $25.
The Opportunity Cost of Land–
It is important to note that there are some other ways also to earn positive for the market output. If profit from economic perspective is concerned, the value of the land will show the reflection of opportunity cost, which is in the case of present market worth of the land. In case the cost of opportunity of the land is involved, then theproductivity of the store is not greater than that of its competitors. This it is important that that the economic profit will be zero that is crucial for the industry to be in long-run equivalent scenario. Positive economic profit is an opportunity which is for investors along with having such kind of an incentive to arrive in the market. Greater accounting profit, may indicate that the firms are already inindustry whichpossess valuable assets along with ideas, that will not accordingly encourage entrance into the market.
The concept of Economic Rent
Some firms get easy access to the available factors related to production which are generally limited in their supply (these factors of production can be like natural resources, land, creative ability, skills related to entrepreneurship etc.) and thus they are able to enjoy the benefits of higher accounting profits as compared to the other firms. The existing factors of production which are generally limited in their supply are also used by the other firms in the long run, thus eventually it leads to a situation where there is a scenario of0profitin economic terms in the long run.
Thus when we convert the accounting profits which are positive in nature we sum it up as economic rent that is earned due to the availability of scarce factors. Rent that is economic can be described as the proportion that the firms are ready to pay for the input minus the least amount needed to buy it. In the long run as well as the short run in case of competitive markets the scenario is that even if the profit is at 0 levels then also the economic rent will often be seen as positive.
Let’s say the minimum cost is zero for obtaining the land, in case of 2 firms which are there in the industry and who are the owners of their land outright. Out of the two firms one is located near the river bank and gets an advantage that it is able to ship the products at a rate of 10,000 dollars less as compared to the other firm which is situated at the inland region. In such a situation the higher profit of 10,000 dollars for the first firm under consideration is because of the fact that this 10,000 dollar is the benefit accruing to it in the form of economic rent because of its location near the river bank. This condition of economic rent comes into picture because the land which is near the river area is important and the other firms will readily pay for such a location. Ultimately the competition that will get created due to this particular and special factor related to production will enhance its value by an amount of 10,000 dollars. When we talk about the case of land rent then it can be simply calculated as the difference occurring between 10,000 dollars and the cost of procuring the land which is zero for the firm thus it will eventually come out to be 10,000 dollars only.
It can be seen that the economic rent in such a case has increased but the associated economic profit of the firm situated near the river side has declined to zero. It is depicted through the situation of economic rent that the land has an opportunity cost associated with it and such an opportunity cost generally exists with all kinds of factors associated with production which normally have a limited supply. In this case the opportunity cost with the land is 10,000 dollars and this is depicted in the form of economic rent.
The condition of economic rent helps in explaining that why is it so that even if there are profit opportunities in certain markets then also the firms are unable to enter. In such type of markets one or more inputs is such that their supply remains to be fixed, there are certain firms that enjoy the benefits of economic rents, and in general all the firms are able to stay at the level of zero economic profits. Through the situation of zero economic profit it is conveyed that a firm should stay in the market only if it is at par in terms of production when compared to the other firms. This situation also conveys that all the possible entrants in the market will be able to earn the profits only when they are able to produce in a more efficient manner as compared to the already existing firms in the market.
Long run producer surplus
There is a condition such that a firm is able to earn accounting profit that is positive but where there is no incentive to enter or exit this industry at the same time the situation is that there is no incentive either to enter or to exit the industry for the other firms. So this profit accruing to a particular firm must be the economic rent. Then how does such a rent is related with the surplus of producer? To start with, you must note the feasibility that the condition of economic rent is attributable to the factor inputs while the producer surplus is associated with the output level. One should also take into account that the difference arising between the marginal cost of the production and the market price that is obtained by the producer is measured as the producer surplus. So it can be analyzed that in the case of competitive market producer surplus that is obtained at output standards and sold by firm includes economic rent it is able to enjoy with the help of the inputs which are scarce in nature.
Given a situation that there is a baseball team and it has a franchise that permits it to operate only within the limits of a specific city. There is a situation that the alternative location for this team is such a city that will drastically reduce the level of revenues for the team. So because of the current location the team is earning an economic rent which would not be possible on the other location. The economic rent will depict the difference that a firm is ready to pay for its present location and the sum that will be required to be paid if it shifts to the alternate city. In this case there will be benefits accruing to the firm in the form of producer surplus which will be obtained as a result of the sale generated from the tickets of baseball match and also due to other items of the franchise at the present location. In this surplus all the economic rent including the ones which are related to the other factor inputs of the firm (players and stadium) will be reflected.
It is illustrated through the figure 8.15 that the firms that are able to benefit from economic rent are able to earn the same level of economic profit when compared to the other firms which are not earning economic rent. The part (a) depicts baseball’s team economic profit that is located in the city that has a moderate size. Average price for each ticket is 7 dollars and attributing to the costs the team is able to earn zero economic profits. Through part (b) it is depicted the profits of a team having the similar cost curves despite the fact that it is located in a city which is larger.
The producer surplus will be reflecting the economic rent as well as the economic profit in case of a non competitive market.
The latter team can use the advantage of selling the tickets at a rate of 10 dollars for each because more people will wish to see the baseball games. In this case it can easily generate an accounting profit of 2.8 dollars which will be above the average cost of 7.2 dollars associated with each ticket. But it can be seen that the rent attributable to a better location is the representative opportunity cost for the firm as it can easily sell this franchise to any other team. Due to the consequences the economic profit that is arising in the bigger city will also be zero.
Links of Previous Main Topic:-
- Introduction Markets and Prices Preliminaries
- The Basics of Supply And Demand
- Consumer Behavior
- Appendix to Chapter 4 Demand Theory a Mathematical Treatment
- Uncertainty and Consumer Behavior
- The Cost of Production
- Production and Cost Theory A Mathematical Treatment
- Cost in the Long Run
- The Cost of Production Production with Two Outputs
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