(8th edition) (the pearson series in economics) robert pindyck, daniel rubinfeld microecon 325

300 PART 2 • Producers, Consumers, and Competitive Markets

S

Price
(dollars per
unit of
output)

F IGURE 8.12

PRODUCER SURPLUS FOR
A MARKET

P*

The producer surplus for a market is the
area below the market price and above
the market supply curve, between 0 and
output Q*.

Producer
Surplus
D

0

Q*

Output

surplus for a market. This can be seen in Figure 8.12. The market supply curve begins
at the vertical axis at a point representing the average variable cost of the lowest-cost
firm in the market. Producer surplus is the area that lies below the market price of the
product and above the supply curve between the output levels 0 and Q*.

8.7 Choosing Output in the Long Run
In the short run, one or more of the firm’s inputs are fixed. Depending on the time
available, this may limit the flexibility of the firm to adapt its production process
to new technological developments, or to increase or decrease its scale of operation
as economic conditions change. In contrast, in the long run, a firm can alter all its
inputs, including plant size. It can decide to shut down (i.e., to exit the industry) or
to begin producing a product for the first time (i.e., to enter an industry). Because
we are concerned here with competitive markets, we allow for free entry and free
exit. In other words, we are assuming that firms may enter or exit without legal
restriction or any special costs associated with entry. (Recall from Section 8.1 that
this is one of the key assumptions underlying perfect competition.) After analyzing
the long-run output decision of a profit-maximizing firm in a competitive market,
we discuss the nature of competitive equilibrium in the long run. We also discuss
the relationship between entry and exit, and economic and accounting profits.

Long-Run Profit Maximization

In §7.4, we explain that
economies of scale arise
when a firm can double its
output for less than twice
the cost.

Figure 8.13 shows how a competitive firm makes its long-run, profit-maximizing
output decision. As in the short run, the firm faces a horizontal demand curve. (In

Figure 8.13 the firm takes the market price of $40 as given.) Its short-run average
(total) cost curve SAC and short-run marginal cost curve SMC are low enough
for the firm to make a positive profit, given by rectangle ABCD, by producing an
output of q1, where SMC ϭ P ϭ MR. The long-run average cost curve LAC reflects
the presence of economies of scale up to output level q2 and diseconomies of scale
at higher output levels. The long-run marginal cost curve LMC cuts the long-run
average cost from below at q2, the point of minimum long-run average cost.