(8th edition) (the pearson series in economics) robert pindyck, daniel rubinfeld microecon 339

314 PART 2 • Producers, Consumers, and Competitive Markets
restricted by local zoning laws. Many communities
outlaw it entirely, while others limit it to certain areas.
Because urban land on which most rental housing
is located is restricted and valuable, the long-run
elasticity of supply of rental housing is much lower
than the elasticity of supply of owner-occupied housing. As the price of rental-housing services rises, new
high-rise rental units are built and older units are

renovated—a practice that increases the quantity
of rental services. With urban land becoming more
valuable as housing density increases, and with the
cost of construction soaring with the height of buildings, increased demand causes the input costs of
rental housing to rise. In this increasing-cost case,
the elasticity of supply can be much less than 1; in
one study, the authors found it to be 0.36.11

SUMMARY
1. Managers can operate in accordance with a complex set of objectives and under various constraints.
However, we can assume that firms act as if they are
maximizing long-run profit.
2. Many markets may approximate perfect competition
in that one or more firms act as if they face a nearly
horizontal demand curve. In general, the number of
firms in an industry is not always a good indicator of
the extent to which that industry is competitive.
3. Because a firm in a competitive market accounts for a
small share of total industry output, it makes its output choice under the assumption that its production
decision will have no effect on the price of the product.
In this case, the demand curve and the marginal revenue curve are identical.
4. In the short run, a competitive firm maximizes its

profit by choosing an output at which price is equal
to (short-run) marginal cost. Price must, however, be
greater than or equal to the firm’s minimum average
variable cost of production.
5. The short-run market supply curve is the horizontal
summation of the supply curves of the firms in an
industry. It can be characterized by the elasticity of
supply: the percentage change in quantity supplied in
response to a percentage change in price.
6. The producer surplus for a firm is the difference
between its revenue and the minimum cost that would

7.

8.

9.

10.

be necessary to produce the profit-maximizing output. In both the short run and the long run, producer
surplus is the area under the horizontal price line and
above the marginal cost of production.
Economic rent is the payment for a scarce factor of production less the minimum amount necessary to hire
that factor. In the long run in a competitive market,
producer surplus is equal to the economic rent generated by all scarce factors of production.
In the long run, profit-maximizing competitive firms
choose the output at which price is equal to long-run
marginal cost.
A long-run competitive equilibrium occurs under

these conditions: (a) when firms maximize profit; (b)
when all firms earn zero economic profit, so that there
is no incentive to enter or exit the industry; and (c)
when the quantity of the product demanded is equal
to the quantity supplied.
The long-run supply curve for a firm is horizontal
when the industry is a constant-cost industry in which
the increased demand for inputs to production (associated with an increased demand for the product) has no
effect on the market price of the inputs. But the longrun supply curve for a firm is upward sloping in an
increasing-cost industry, where the increased demand
for inputs causes the market price of some or all inputs
to rise.

QUESTIONS FOR REVIEW
1. Why would a firm that incurs losses choose to produce
rather than shut down?
2. Explain why the industry supply curve is not the longrun industry marginal cost curve.
3. In long-run equilibrium, all firms in the industry earn
zero economic profit. Why is this true?
4. What is the difference between economic profit and
producer surplus?
11

5. Why do firms enter an industry when they know that
in the long run economic profit will be zero?
6. At the beginning of the twentieth century, there were
many small American automobile manufacturers. At
the end of the century, there were only three large ones.
Suppose that this situation is not the result of lax federal enforcement of antimonopoly laws. How do you
explain the decrease in the number of manufacturers?

John M. Quigley and Stephen S. Raphael, “Regulation and the High Cost of Housing in California,”
American Economic Review, Vol. 95(2), 2005: 323–328.