1
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[SQUEAKING]

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[RUSTLING]

3
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[CLICKING]

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JONATHAN GRUBER: OK, why
don't we get started?

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Since I had some problems
with the end of last lecture,

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I'm going to pick up
right where things

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got a little dicey
in the last lecture,

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00:00:19,590 --> 00:00:20,840
and we're going to start over.

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So we're looking back at figure
7-3, which, if you remember,

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was the cost curves for our cost
function 10 plus 5q squared.

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And you remember
where it came from.

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This cost function
we derived ourselves

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from the production function
and wages and rental rates.

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We derived this cost function.

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We're now graphing the
cost curves that come out

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of this cost function,
and we're talking

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about profit maximization.

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And we're talking
about measuring profit.

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So we're talking about
perfect competition.

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And remember, we
said that profits

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are revenues minus costs.

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That means the profits
per unit are revenues

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per unit minus costs per unit.

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Revenues per unit are price, and
cost per unit is average cost.

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So profits per unit is price
minus the average cost.

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So we just go to the diagram.

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You see the height of
the profit rectangle

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is price minus the average cost.

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So what do you do?

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You start by finding the point.

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So what are your steps here?

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Step one is you
find the point where

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price equals marginal cost.

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That gives you your
production level.

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That gives your optimal q star--

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we derived that last time--

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of 3.

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We derived that last time that
you want to optimize the price

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equals marginal cost.

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That gives our q star of 3.

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Then at that level, we
compute the average cost.

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Average cost at q
of 3 is simply going

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to be this cost
function divided by 3--

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so 10 over 3 plus 5q
squared over 3, or just 5q,

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plus 15, OK?

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So the average cost at
three is going to be $18.33.

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That's going to be the average
cost at production of three.

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That means that
the profits we're

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making for that third unit,
the profits on our third unit,

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is the price--

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profits per unit are the price,
which is a fixed level of 30,

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minus the average
cost, which is $18.33.

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So profits per
unit equals $11.67.

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So that's the profits.

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That's the height
of the rectangle.

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The profits per unit is $11.67.

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The price minus the
average cost is $11.67.

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We're selling three units, so
that means our total profit

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rectangle is 35, OK?

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00:03:03,720 --> 00:03:06,180
So our total profits
are 35, which

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is three units at a
profit of $11.67 each.

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And that's how we
get that rectangle.

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Questions about that?

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OK.

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So now, let's return to
what we did last time.

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Let's imagine there's
a tax of $10 per unit.

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That would shift the
cost curve to C equals 10

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plus 5q squared plus 10q.

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Remember, it's a tax
per unit, plus 10q.

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That would mean-- so that is
illustrated in figure 7-4.

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That means that the marginal
cost curve and the average cost

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curve both shift up.

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Marginal cost is now
equal to 10q plus 10.

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We want to set that equal to
the price to get the optimal q,

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and you solve this and you
get a new q star equals 2.

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So now your optimal
production level is two.

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You set your new marginal
cost equal to the price.

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Marginal cost equals price.

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Marginal cost equals price at
a new optimal quantity of two.

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What's the profits there?

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00:04:22,890 --> 00:04:27,570
Well, once again,
profits per unit

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are just price, which is
$30, minus average cost.

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Well, what's the
average cost at two?

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The average cost at two
is going to be 10 over q--

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so 5.

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10 over 2 is 5, OK?

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Plus 5q because we're dividing
this by q, 5q, which is 10, OK?

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00:04:47,280 --> 00:04:51,080
Plus 10, OK?

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00:04:51,080 --> 00:04:54,590
30 minus 25, which equals 5.

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So your profits per unit,
the height of that rectangle,

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has fallen from $11.67 to $5.

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00:05:04,300 --> 00:05:06,910
So you're now making
less profit per unit

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and you're selling fewer units.

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The height of the
rectangle has shrunk.

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The width of the
rectangle has shrunk.

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So the total profits have
fallen from $30 to $10.

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You used to make profits of
$11.67 on each of three units.

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Now you make profits of
$5 on each of two units.

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So that tax has lowered your
profits from $30 to $10, OK?

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Question about that?

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00:05:30,150 --> 00:05:30,650
Yeah.

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AUDIENCE: Is that by changing
the cost [INAUDIBLE]??

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JONATHAN GRUBER: Yes, exactly.

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Because you have a higher cost--

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now, it's not just
that your costs change.

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Your costs changing fed through
to your production as well.

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So because your
costs change, you

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produce at a different
level and you made

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different profit per unit, OK?

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All right.

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Now, let's go to
the other point I

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tried to cover last time that
I want to get straight on,

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which is the shutdown decision.

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Now remember, we are, in
the short run, shut down.

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We're in the short run.

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In the short run, there's
no entry and exit.

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The firm can't literally leave,
but it can just produce zero.

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That we call the short-run
shutdown decision.

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A short-run shutdown decision,
you're still in the market.

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You still paid your fixed costs.

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You just produce zero.

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That's what we mean by
shutdown, as opposed to exit,

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which is literally you
take your toys and leave.

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This is you're
still in the market.

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You've paid your fixed costs.

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You can't go
anywhere-- remember,

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those costs are fixed
in the short run--

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but you just produce zero.

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So now let's ask,
for example, what

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happens if the price
suddenly dropped to $10.

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Let's say the price
dropped from $30 to $10.

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Well, the fundamental
profit-maximization rule

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never changes.

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We're not having
the tax anymore.

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We're back to the
original cost function.

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So original cost function is C
equals 10 plus 5q squared, OK?

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So the marginal
cost equals 10q, and

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our profit-maximization
rule does not change.

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Our profit-maximization
rule is that price

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equals marginal cost.

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So we set 10q to 10,
marginal cost equal to price.

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$10 is the price.

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And we get that the optimal
quantity is now one.

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We now want to produce one unit.

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That's the optimal quantity.

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Well, what is our profits
if we produce one unit?

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Well, profits equals
revenues, $10, minus costs.

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Well, what's our cost
if we produce one unit?

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10 plus 5, 15.

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So profits are negative 5.

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I'm going fast, so jump in if
I get the math wrong here, OK?

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Profits are negative 5.

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So you might think that's
terrible, using money.

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You should get out
of there, shut down.

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But the answer is, as
we discussed last time,

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you should not shut down
because shutting down still

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means paying your fixed costs.

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No matter what you do, you
have to pay those fixed costs.

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So shutting down means
production of zero.

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What are your profits
at a production of zero?

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Your profits at a
production of zero

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are zero revenues minus
the fixed cost of $10.

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If you produce zero,
what's your cost?

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Plug 0 in here.

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Your costs are still 10.

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So if you produce zero,
your profits are minus 10.

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So you should
continue to sell even

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though you're losing money.

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Even though you're
losing money, you

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continue to sell that one unit.

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You don't go to zero.

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Because at zero,
you're even worse off.

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This is the key thing about
short-run shutdown decision.

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Yeah?

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AUDIENCE: What happens if you're
in a position where, like, you

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are afraid you're going
to keep selling one

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unit the next couple of months?

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JONATHAN GRUBER: Ah, but
that's the key thing.

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Once you move to the long run,
you can reoptimize your capital

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and you can exit.

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But in the short run,
you've already paid that.

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You've already laid down your
blanket, which cost you $10.

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You might as well
sell at a loss.

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If you just sell
zero, then you've

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laid down your blanket for $10
and gotten nothing out of it,

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OK?

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00:09:03,070 --> 00:09:04,653
That's the transition
to the long run.

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And so basically, that's how
you think about the short run

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versus the long run.

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00:09:12,440 --> 00:09:14,780
So what do we think
about how this works?

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So basically, the
shutdown rule, the way

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00:09:16,855 --> 00:09:19,210
you think of the math
of the shutdown rule

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is that basically you
only want to shut down

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00:09:23,420 --> 00:09:27,720
if your revenues are less
than your variable costs

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00:09:27,720 --> 00:09:29,970
because you got to pay your
fixed cost no matter what.

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00:09:29,970 --> 00:09:30,490
That's done.

197
00:09:30,490 --> 00:09:31,490
You're in the short run.

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00:09:31,490 --> 00:09:32,000
That's gone.

199
00:09:32,000 --> 00:09:32,510
Forget it.

200
00:09:32,510 --> 00:09:34,310
You laid your blanket
down in the bazaar.

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00:09:34,310 --> 00:09:35,390
That's done.

202
00:09:35,390 --> 00:09:38,840
So you only want to shut
down if your revenues are

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00:09:38,840 --> 00:09:41,510
less than your variable costs.

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00:09:41,510 --> 00:09:43,250
You don't care about
your fixed costs.

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00:09:43,250 --> 00:09:44,385
That's done.

206
00:09:44,385 --> 00:09:46,010
You only shut down
if your revenues are

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00:09:46,010 --> 00:09:47,450
less than your variable costs.

208
00:09:47,450 --> 00:09:50,030
Well, that's the same
as saying you only want

209
00:09:50,030 --> 00:09:52,610
to shut down if your price--

210
00:09:52,610 --> 00:09:54,860
variable costs are pq--

211
00:09:54,860 --> 00:09:56,390
I'm sorry, your variable cost.

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00:09:56,390 --> 00:09:58,130
You only shut down
if your price are

213
00:09:58,130 --> 00:10:01,410
less than your average
variable cost--

214
00:10:01,410 --> 00:10:02,930
so divide by q.

215
00:10:02,930 --> 00:10:05,000
You only shut down
if your price is

216
00:10:05,000 --> 00:10:08,430
less than your average
variable costs.

217
00:10:08,430 --> 00:10:09,660
That's the shutdown rule.

218
00:10:09,660 --> 00:10:12,470
Shut down if the
price you get is less

219
00:10:12,470 --> 00:10:15,390
than, on average, what
you'll get unit for the units

220
00:10:15,390 --> 00:10:17,540
you sell.

221
00:10:17,540 --> 00:10:21,313
So in our example,
you never shut down.

222
00:10:21,313 --> 00:10:21,980
And why is that?

223
00:10:21,980 --> 00:10:23,680
Let's look at the
math of our example.

224
00:10:23,680 --> 00:10:25,960
Well, in our example,
what are variable costs?

225
00:10:25,960 --> 00:10:29,302
The variable cost is 5q squared.

226
00:10:29,302 --> 00:10:31,510
I'm going to put these down
here so I don't have to--

227
00:10:31,510 --> 00:10:35,710
the variable costs in our
example, variable costs

228
00:10:35,710 --> 00:10:39,120
are 5q squared.

229
00:10:39,120 --> 00:10:41,295
So what are average
variable costs?

230
00:10:41,295 --> 00:10:41,795
5q.

231
00:10:46,640 --> 00:10:50,140
Those are average
variable costs.

232
00:10:50,140 --> 00:10:55,960
Now, remember that you want to
shut down if variable costs are

233
00:10:55,960 --> 00:10:57,460
greater than the price.

234
00:10:57,460 --> 00:11:00,550
We can express the
price in terms of q.

235
00:11:00,550 --> 00:11:04,690
Because remember, marginal
cost equals price.

236
00:11:04,690 --> 00:11:07,540
So 10q equals p.

237
00:11:07,540 --> 00:11:14,290
So at the optimum, it is always
true that p equals q over 10.

238
00:11:14,290 --> 00:11:17,560
That's a profit-maximizing
condition,

239
00:11:17,560 --> 00:11:19,510
that p equals q over 10.

240
00:11:19,510 --> 00:11:21,940
We can just substitute
that in, and we

241
00:11:21,940 --> 00:11:26,710
have that average variable
costs equals 5 times q.

242
00:11:26,710 --> 00:11:35,010
So average variable costs equals
0.5 times p at the optimum.

243
00:11:35,010 --> 00:11:37,555
Because we know that the optimum
marginal cost equals price,

244
00:11:37,555 --> 00:11:39,930
we can plug that in and say,
at the optimum, average cost

245
00:11:39,930 --> 00:11:42,156
is 0.5 times p.

246
00:11:42,156 --> 00:11:43,092
Yeah?

247
00:11:43,092 --> 00:11:45,432
AUDIENCE: Do you mean
q equals p over 10?

248
00:11:45,432 --> 00:11:49,210
JONATHAN GRUBER: q-- let
me see if I got that wrong.

249
00:11:49,210 --> 00:11:50,320
Yes, I'm sorry.

250
00:11:50,320 --> 00:11:51,178
q equals p over 10.

251
00:11:51,178 --> 00:11:51,720
You're right.

252
00:11:55,328 --> 00:11:57,220
q equals p over 10, my bad.

253
00:11:57,220 --> 00:11:57,970
Sorry.

254
00:11:57,970 --> 00:12:02,950
So the average variable
cost is 0.5 times p.

255
00:12:02,950 --> 00:12:04,870
What's the shutdown rule?

256
00:12:04,870 --> 00:12:07,030
The shutdown rule is
that price is less

257
00:12:07,030 --> 00:12:11,500
than average variable cost or
price is less than 0.5 price,

258
00:12:11,500 --> 00:12:13,580
which can never be true.

259
00:12:13,580 --> 00:12:16,280
So you'd never shut down
with this cost function.

260
00:12:16,280 --> 00:12:18,610
To say it again,
you only shut down

261
00:12:18,610 --> 00:12:21,718
if price is less than
average variable cost.

262
00:12:21,718 --> 00:12:24,010
We've computed average variable
cost in terms of price,

263
00:12:24,010 --> 00:12:25,780
and it's 0.5 times price.

264
00:12:25,780 --> 00:12:28,630
Therefore, you never shut down.

265
00:12:28,630 --> 00:12:33,790
And you could see this
when we actually go to--

266
00:12:33,790 --> 00:12:36,420
so you can actually
see this in figure 7-5

267
00:12:36,420 --> 00:12:39,130
when we look at the
firm's supply decision.

268
00:12:39,130 --> 00:12:42,280
So what figure 7-5
does is show you,

269
00:12:42,280 --> 00:12:44,890
at every price,
what the firm wants

270
00:12:44,890 --> 00:12:47,160
to produce in the short run.

271
00:12:47,160 --> 00:12:49,920
At a price of $10, it
wants to produce one.

272
00:12:49,920 --> 00:12:51,680
We showed you that.

273
00:12:51,680 --> 00:12:53,780
At a price of $20, it
wants to produce two.

274
00:12:53,780 --> 00:12:56,690
At a price of $30, it wants
to produce three, and so on.

275
00:12:56,690 --> 00:13:00,702
That dash-- that line that runs
from 0, 0 all the way up to 4,

276
00:13:00,702 --> 00:13:04,980
40, that's the
marginal cost line.

277
00:13:04,980 --> 00:13:07,290
At each point, price
equals marginal cost,

278
00:13:07,290 --> 00:13:10,660
the optimal production decision.

279
00:13:10,660 --> 00:13:13,200
And you never shut down.

280
00:13:13,200 --> 00:13:16,630
As long as price is
positive, you produce.

281
00:13:16,630 --> 00:13:17,130
Yeah?

282
00:13:17,130 --> 00:13:21,660
AUDIENCE: So in this case, we
don't set price to 10 minus p?

283
00:13:21,660 --> 00:13:24,550
Because if it's 10,
then [INAUDIBLE]

284
00:13:24,550 --> 00:13:25,770
will be higher than 10.

285
00:13:27,945 --> 00:13:29,070
JONATHAN GRUBER: I'm sorry.

286
00:13:29,070 --> 00:13:30,510
I don't understand.

287
00:13:30,510 --> 00:13:31,748
AUDIENCE: So--

288
00:13:31,748 --> 00:13:34,290
JONATHAN GRUBER: Price is always
above average variable cost,

289
00:13:34,290 --> 00:13:37,470
so you'd never shut down, right?

290
00:13:37,470 --> 00:13:38,920
That's the shutdown rule.

291
00:13:38,920 --> 00:13:40,670
This can never be true
with this function.

292
00:13:40,670 --> 00:13:42,545
Price is forever above
average variable cost.

293
00:13:42,545 --> 00:13:44,950
You can see that in
this graph, right?

294
00:13:44,950 --> 00:13:47,100
The price equals
the marginal cost,

295
00:13:47,100 --> 00:13:50,610
and that is always above the
average variable cost, OK?

296
00:13:50,610 --> 00:13:53,117
So the bottom line is
you'd never shut down.

297
00:13:53,117 --> 00:13:54,450
But here's the other cool thing.

298
00:13:54,450 --> 00:13:57,060
After all this confusing
math, guess what this line

299
00:13:57,060 --> 00:13:59,540
is, this marginal cost line.

300
00:13:59,540 --> 00:14:00,837
What else do we call that?

301
00:14:00,837 --> 00:14:02,170
That's the supply curve, people.

302
00:14:02,170 --> 00:14:04,220
We just derived
the supply curve.

303
00:14:04,220 --> 00:14:05,450
What's the supply curve?

304
00:14:05,450 --> 00:14:08,440
The supply curve
is the relationship

305
00:14:08,440 --> 00:14:10,690
between the price in the
market and the amount

306
00:14:10,690 --> 00:14:12,460
the producer desires to produce.

307
00:14:12,460 --> 00:14:14,710
Well, that's what this
marginal cost curve is.

308
00:14:14,710 --> 00:14:18,280
So we've just shown you that the
firm's supply curve is simply

309
00:14:18,280 --> 00:14:20,660
its marginal cost curve.

310
00:14:20,660 --> 00:14:24,600
So all you need to know to
derive what a firm's supply

311
00:14:24,600 --> 00:14:28,140
curve looks like is what its
marginal cost curve looks like,

312
00:14:28,140 --> 00:14:29,200
and you're done.

313
00:14:29,200 --> 00:14:33,540
So literally, you take
production plus input prices,

314
00:14:33,540 --> 00:14:35,900
and that gives you
the supply curve.

315
00:14:35,900 --> 00:14:36,450
Why?

316
00:14:36,450 --> 00:14:37,950
Because production
plus input prices

317
00:14:37,950 --> 00:14:40,652
gives you the cost function.

318
00:14:40,652 --> 00:14:42,860
Take the derivative of the
cost function with respect

319
00:14:42,860 --> 00:14:43,340
to quantity.

320
00:14:43,340 --> 00:14:45,090
That gives you the
marginal cost function.

321
00:14:45,090 --> 00:14:46,920
That's the supply curve.

322
00:14:46,920 --> 00:14:50,750
So just like I could give you
a utility function and a budget

323
00:14:50,750 --> 00:14:54,080
constraint and you got
the demand curve, here, I

324
00:14:54,080 --> 00:14:56,450
can give you a production
function and input prices

325
00:14:56,450 --> 00:14:58,490
and it gets the supply curve--

326
00:14:58,490 --> 00:15:02,710
however, only under
perfect competition, OK?

327
00:15:02,710 --> 00:15:04,770
This is only for the case
of perfect competition.

328
00:15:04,770 --> 00:15:06,353
That's different
from consumer theory.

329
00:15:06,353 --> 00:15:07,880
That was an everywhere rule.

330
00:15:07,880 --> 00:15:10,400
Because I've given you an
extra constraint, which

331
00:15:10,400 --> 00:15:12,020
is a constraint on
the market, I've

332
00:15:12,020 --> 00:15:14,670
allowed you to derive the
supply curve just like we easily

333
00:15:14,670 --> 00:15:17,000
derived the demand curve.

334
00:15:17,000 --> 00:15:21,830
So we have now derived
a firm's supply curve.

335
00:15:21,830 --> 00:15:24,420
Questions about that?

336
00:15:24,420 --> 00:15:25,880
So let's go back one more time.

337
00:15:25,880 --> 00:15:30,100
Just like if I give you on,
say, a problem set or an exam

338
00:15:30,100 --> 00:15:32,060
a utility function and
a budget constraint,

339
00:15:32,060 --> 00:15:34,670
you should be able to
draw a demand curve.

340
00:15:34,670 --> 00:15:39,200
If I give you a production
function and input prices

341
00:15:39,200 --> 00:15:41,903
and I tell you you're
in perfect competition,

342
00:15:41,903 --> 00:15:43,820
then you should be able
to draw a supply curve

343
00:15:43,820 --> 00:15:47,490
because it's just the
marginal cost curve, OK?

344
00:15:47,490 --> 00:15:50,922
Now, that's the
firm's supply curve.

345
00:15:50,922 --> 00:15:52,630
What we care about,
actually, in the end,

346
00:15:52,630 --> 00:15:54,820
is the market
supply curve, right?

347
00:15:54,820 --> 00:15:56,038
I've been doing little q.

348
00:15:56,038 --> 00:15:58,330
We care about big Q. That's
what I drew in the lecture,

349
00:15:58,330 --> 00:16:00,040
was a big Q diagram.

350
00:16:00,040 --> 00:16:01,640
So how do we get there?

351
00:16:01,640 --> 00:16:04,840
Well, all you do to
get the market supply

352
00:16:04,840 --> 00:16:09,010
is to horizontally sum
each firm's supply.

353
00:16:09,010 --> 00:16:12,430
So we can see that
in figure 7-7, OK?

354
00:16:12,430 --> 00:16:16,480
What figure 7-7 does is take
multiple identical firms

355
00:16:16,480 --> 00:16:18,050
and put them in the market.

356
00:16:18,050 --> 00:16:21,480
So for example, if there's
one firm in the market,

357
00:16:21,480 --> 00:16:24,440
the supply curve is
what we just drew.

358
00:16:24,440 --> 00:16:26,360
At a price of $10, you get 10.

359
00:16:26,360 --> 00:16:28,310
At a price of $10, you get one.

360
00:16:28,310 --> 00:16:31,370
At a price of $30,
you get three.

361
00:16:31,370 --> 00:16:34,340
Now let's add a
second identical firm.

362
00:16:34,340 --> 00:16:36,980
Well, that firm
behaves the same way.

363
00:16:36,980 --> 00:16:39,240
At a price of $10,
it produces one.

364
00:16:39,240 --> 00:16:41,630
And at a price of $30,
it produces three.

365
00:16:41,630 --> 00:16:44,960
So the market now suddenly
has twice as much.

366
00:16:44,960 --> 00:16:46,680
At a price of $10, it has two.

367
00:16:46,680 --> 00:16:48,650
At a price of $30, it has six.

368
00:16:48,650 --> 00:16:50,090
Now let's add a third firm.

369
00:16:50,090 --> 00:16:51,612
It behaves the same way.

370
00:16:51,612 --> 00:16:53,070
At a price of $10,
it produces one.

371
00:16:53,070 --> 00:16:54,800
At a price of $3,
it produces three.

372
00:16:54,800 --> 00:16:59,360
So each additional firm
you add just literally

373
00:16:59,360 --> 00:17:00,950
shifts the supply curve down.

374
00:17:03,530 --> 00:17:06,980
So in other words, the point
is that a market supply curve,

375
00:17:06,980 --> 00:17:10,130
as you add more and more
firms, the market supply curve

376
00:17:10,130 --> 00:17:13,310
is always more elastic
than the firm's supply

377
00:17:13,310 --> 00:17:17,089
curve because any
given increase in price

378
00:17:17,089 --> 00:17:20,270
calls for, from each firm,
an increase in quantity.

379
00:17:20,270 --> 00:17:21,723
As long as there's
multiple firms,

380
00:17:21,723 --> 00:17:23,390
that means a flatter
market supply curve

381
00:17:23,390 --> 00:17:24,515
than a firm's supply curve.

382
00:17:26,785 --> 00:17:28,660
So that's how we get
the market supply curve.

383
00:17:28,660 --> 00:17:30,520
We solve for the
firm's supply curve.

384
00:17:30,520 --> 00:17:32,650
We then just horizontally
sum it over the number

385
00:17:32,650 --> 00:17:34,690
of firms in the market.

386
00:17:34,690 --> 00:17:37,330
Get the firm supply curve,
horizontally sum, OK?

387
00:17:37,330 --> 00:17:39,800
Questions about that?

388
00:17:39,800 --> 00:17:43,500
Now, now we have
everything we need

389
00:17:43,500 --> 00:17:46,740
to go back to the first
lecture, back to the future,

390
00:17:46,740 --> 00:17:48,210
back to the first lecture.

391
00:17:48,210 --> 00:17:52,200
And we can actually get
to market equilibrium.

392
00:17:52,200 --> 00:17:54,330
In the first lecture,
we started with a supply

393
00:17:54,330 --> 00:17:56,280
curve and a demand curve
and got equilibrium.

394
00:17:56,280 --> 00:17:58,488
Well, we derived the demand
curve a few lectures ago.

395
00:17:58,488 --> 00:18:00,100
We've just derived
the supply curve.

396
00:18:00,100 --> 00:18:02,187
So let's do short-run
equilibrium.

397
00:18:05,320 --> 00:18:08,760
Let's do short-run
equilibrium, OK?

398
00:18:08,760 --> 00:18:12,910
Now, the key thing is that--

399
00:18:12,910 --> 00:18:15,180
so how do we do
short-run equilibrium?

400
00:18:15,180 --> 00:18:16,630
Let's go through the steps.

401
00:18:16,630 --> 00:18:20,310
Step one, each firm picks
a fixed amount of capital

402
00:18:20,310 --> 00:18:23,120
it's going to have
in the short run.

403
00:18:23,120 --> 00:18:26,840
So each firm has a K bar.

404
00:18:26,840 --> 00:18:30,430
And based on that, it has
a production function.

405
00:18:30,430 --> 00:18:32,690
Each firm has a
production function,

406
00:18:32,690 --> 00:18:42,140
q equals f of k, K bar, L.
And we have some input prices.

407
00:18:42,140 --> 00:18:45,060
We have some w and some r.

408
00:18:45,060 --> 00:18:48,940
Taken together, we can use
those to create a cost function,

409
00:18:48,940 --> 00:18:50,820
which, in our example,
was C equals 10

410
00:18:50,820 --> 00:18:54,740
plus 5q squared, step one.

411
00:18:54,740 --> 00:18:55,390
Step two.

412
00:19:00,390 --> 00:19:04,650
Step two, based on this, we can
get optimal production levels

413
00:19:04,650 --> 00:19:06,900
from the fundamental
profit-maximization rule,

414
00:19:06,900 --> 00:19:10,360
MC equals p.

415
00:19:10,360 --> 00:19:17,090
So this yields-- so here,
we say 10q equals p.

416
00:19:17,090 --> 00:19:19,980
And this yields
a supply function

417
00:19:19,980 --> 00:19:25,858
which is q equals p over 10,
and that's our supply curve.

418
00:19:25,858 --> 00:19:27,650
That's what I drew
here. q equals p over 10

419
00:19:27,650 --> 00:19:28,840
is the firm's supply curve.

420
00:19:31,810 --> 00:19:33,055
That's step two.

421
00:19:33,055 --> 00:19:36,590
Step three is to create
a market supply curve.

422
00:19:36,590 --> 00:19:38,590
Well, let's say there's
six firms in the market.

423
00:19:38,590 --> 00:19:39,880
I'm just pulling
this out of thin air.

424
00:19:39,880 --> 00:19:42,005
In a minute, we'll get to
how many firms there are.

425
00:19:42,005 --> 00:19:44,665
But for now, in the short run,
there's no entry and exit.

426
00:19:44,665 --> 00:19:47,165
So whatever number of firms I
tell you, that's what's there.

427
00:19:47,165 --> 00:19:48,970
It's just given.

428
00:19:48,970 --> 00:19:50,470
So let's say n equals 6.

429
00:19:50,470 --> 00:19:52,767
Let's say there's six firms.

430
00:19:52,767 --> 00:19:54,850
And I'll come in a minute
to where six comes from.

431
00:19:54,850 --> 00:19:57,400
But for now, let's
just assume it.

432
00:19:57,400 --> 00:20:01,570
That means that the total
market supply, big Q,

433
00:20:01,570 --> 00:20:09,090
is just equal to 6 little
q, 6 little q, which

434
00:20:09,090 --> 00:20:15,720
equals 3/5 p or 6/10 p.

435
00:20:15,720 --> 00:20:17,580
That is our market supply curve.

436
00:20:17,580 --> 00:20:18,220
Yeah?

437
00:20:18,220 --> 00:20:20,490
AUDIENCE: Would
firms that change

438
00:20:20,490 --> 00:20:23,610
[INAUDIBLE] who are out there?

439
00:20:23,610 --> 00:20:24,960
Would that change the overall--

440
00:20:24,960 --> 00:20:26,340
JONATHAN GRUBER: The number
of firms that are out there?

441
00:20:26,340 --> 00:20:28,860
Yeah, but once again, once
they're in, they're done.

442
00:20:28,860 --> 00:20:30,780
They know there's six firms.

443
00:20:30,780 --> 00:20:31,530
So they're done.

444
00:20:31,530 --> 00:20:32,613
I'm going to come to this.

445
00:20:32,613 --> 00:20:34,200
You're talking about
the long run, OK?

446
00:20:34,200 --> 00:20:35,260
Other questions?

447
00:20:35,260 --> 00:20:36,510
Yeah-- OK.

448
00:20:36,510 --> 00:20:39,270
So that gives you
your market supply.

449
00:20:39,270 --> 00:20:44,220
Finally, we go back to lecture
one and the first recitation

450
00:20:44,220 --> 00:20:46,560
where you solved
mathematically for equilibrium.

451
00:20:46,560 --> 00:20:47,668
We have a demand curve.

452
00:20:47,668 --> 00:20:48,960
I'm just going to make this up.

453
00:20:48,960 --> 00:20:53,790
Let's say the demand curve
is Q equals 40 minus p.

454
00:20:53,790 --> 00:20:55,867
I just made that up
to make the math easy.

455
00:20:55,867 --> 00:20:56,950
Where does this come from?

456
00:20:56,950 --> 00:20:57,900
Well, you know where
that comes from.

457
00:20:57,900 --> 00:20:59,275
You solved where
that comes from.

458
00:20:59,275 --> 00:21:03,210
That comes from consumer
maximization, 48 minus p.

459
00:21:03,210 --> 00:21:04,680
So to get equilibrium,
we just set

460
00:21:04,680 --> 00:21:12,510
48 minus p equal to 3/5
p, demand equal to supply.

461
00:21:12,510 --> 00:21:20,100
And we end up with p equals 30,
conveniently familiar number,

462
00:21:20,100 --> 00:21:24,900
which means that the
total demand, big Q,

463
00:21:24,900 --> 00:21:32,630
is 48 minus 30 equals 18,
also convenient number.

464
00:21:32,630 --> 00:21:34,810
And I'll show you why.

465
00:21:34,810 --> 00:21:39,250
The fifth step, each firm
says, given this price,

466
00:21:39,250 --> 00:21:41,020
what do I want to produce?

467
00:21:41,020 --> 00:21:45,360
Well, we know that
given a price of 30,

468
00:21:45,360 --> 00:21:50,440
each firm's little
q star is 3, right?

469
00:21:50,440 --> 00:21:51,700
That's what we solved.

470
00:21:51,700 --> 00:21:55,990
Each firm's little q star
is 3 given a price of 30.

471
00:21:55,990 --> 00:21:58,030
So each firm
produces three units.

472
00:21:58,030 --> 00:21:59,439
How many firms are there?

473
00:21:59,439 --> 00:22:00,022
AUDIENCE: Six.

474
00:22:00,022 --> 00:22:00,605
AUDIENCE: Six.

475
00:22:00,605 --> 00:22:02,610
JONATHAN GRUBER:
What's 6 times 3?

476
00:22:02,610 --> 00:22:03,810
Supply equals demand.

477
00:22:06,800 --> 00:22:11,210
Six firms produce three
each at a price of 30.

478
00:22:11,210 --> 00:22:12,380
That's 18.

479
00:22:12,380 --> 00:22:18,390
At a price of 30, people
want 18, equilibrium.

480
00:22:18,390 --> 00:22:21,880
That's how it all works.

481
00:22:21,880 --> 00:22:25,200
So leaving aside where
the six came from,

482
00:22:25,200 --> 00:22:28,620
everything else you see here
is just taking what we did

483
00:22:28,620 --> 00:22:30,390
and working out the math.

484
00:22:30,390 --> 00:22:32,835
And we get six
firms in the market.

485
00:22:32,835 --> 00:22:34,570
They each want to produce three.

486
00:22:34,570 --> 00:22:35,970
That's the 18 that people want.

487
00:22:39,360 --> 00:22:42,620
So to get equilibrium,
you just need--

488
00:22:42,620 --> 00:22:45,390
to get equilibrium, you
need a demand curve,

489
00:22:45,390 --> 00:22:47,640
you need a cost function,
and you need the number

490
00:22:47,640 --> 00:22:49,350
of firms in the market.

491
00:22:49,350 --> 00:22:50,492
You need a demand curve.

492
00:22:50,492 --> 00:22:52,200
You need the cost
function and the number

493
00:22:52,200 --> 00:22:53,340
of firms in the market.

494
00:22:53,340 --> 00:22:56,490
Given that, you can solve
for the equilibrium.

495
00:22:56,490 --> 00:22:57,750
Questions about that?

496
00:22:57,750 --> 00:22:58,620
Yeah.

497
00:22:58,620 --> 00:23:00,833
AUDIENCE: So thinking
about this in terms

498
00:23:00,833 --> 00:23:02,250
of the intersection
of the graphs,

499
00:23:02,250 --> 00:23:05,540
would intersecting the demand
curve with the whole market's

500
00:23:05,540 --> 00:23:06,130
supply curve--

501
00:23:06,130 --> 00:23:07,080
JONATHAN GRUBER: Yeah, because
it's the whole market demand

502
00:23:07,080 --> 00:23:07,820
curve.

503
00:23:07,820 --> 00:23:08,473
AUDIENCE: OK.

504
00:23:08,473 --> 00:23:09,390
JONATHAN GRUBER: Yeah?

505
00:23:09,390 --> 00:23:12,035
AUDIENCE: Q equals 48 minus
p is the demand curve.

506
00:23:12,035 --> 00:23:14,410
JONATHAN GRUBER: Q equals 48
minus p is the demand curve.

507
00:23:18,040 --> 00:23:19,145
Other questions?

508
00:23:19,145 --> 00:23:19,770
Good questions.

509
00:23:19,770 --> 00:23:21,312
Those are good,
clarifying questions.

510
00:23:21,312 --> 00:23:24,810
OK, so now let's ask where
the hell six comes from.

511
00:23:27,320 --> 00:23:30,110
And where six comes
from is the fact--

512
00:23:33,180 --> 00:23:36,700
where six comes from
is from the long run.

513
00:23:36,700 --> 00:23:46,552
So now we get to
long-run competition,

514
00:23:46,552 --> 00:23:48,010
which is, in the
short run, there's

515
00:23:48,010 --> 00:23:49,750
a certain number of
firms in the market.

516
00:23:49,750 --> 00:23:51,218
But where those firms come from?

517
00:23:51,218 --> 00:23:53,260
Well, they come from the
fact that each short run

518
00:23:53,260 --> 00:23:57,140
is a repeated exercise
that makes up the long run.

519
00:23:57,140 --> 00:24:01,090
So in the long run, perfect
competition in the long run

520
00:24:01,090 --> 00:24:03,370
looks just like perfect
competition in the short run--

521
00:24:03,370 --> 00:24:07,780
full information, no
transaction cost, lots of firms,

522
00:24:07,780 --> 00:24:09,160
with one difference.

523
00:24:09,160 --> 00:24:12,100
We're now going to
allow entry and exit.

524
00:24:12,100 --> 00:24:14,500
Nothing else is going to
change in the short run

525
00:24:14,500 --> 00:24:17,170
except we're now going
to allow entry and exit.

526
00:24:20,690 --> 00:24:22,950
So now, what-- and
one other thing.

527
00:24:22,950 --> 00:24:23,450
I'm sorry.

528
00:24:23,450 --> 00:24:25,070
One other thing changes.

529
00:24:25,070 --> 00:24:29,440
Since all costs are variable,
there's no shutdown decision.

530
00:24:29,440 --> 00:24:31,660
There's no issue of
this shutdown rule.

531
00:24:31,660 --> 00:24:33,440
There's no more fixed costs.

532
00:24:33,440 --> 00:24:35,850
So if you lose money, in
the long run, you shut down.

533
00:24:35,850 --> 00:24:37,600
So all you have to
worry about is profits.

534
00:24:37,600 --> 00:24:39,490
You don't have to worry
about this extra shut--

535
00:24:39,490 --> 00:24:41,680
so in the short run, we had
an extra shutdown condition.

536
00:24:41,680 --> 00:24:42,730
You don't worry about
that in the long run.

537
00:24:42,730 --> 00:24:44,770
You just worry about if you're
making money or losing money.

538
00:24:44,770 --> 00:24:46,895
In the long run, if you're
making money, you're in.

539
00:24:46,895 --> 00:24:49,230
If you're losing
money, you're out.

540
00:24:49,230 --> 00:24:52,670
So now let's ask
how that pins down

541
00:24:52,670 --> 00:24:55,680
the number of firms
in the market.

542
00:24:55,680 --> 00:24:58,157
This is complicated, so the
best way to do it, I think,

543
00:24:58,157 --> 00:24:58,740
is an example.

544
00:25:03,160 --> 00:25:04,435
And think about our--

545
00:25:04,435 --> 00:25:06,060
the fundamental rule
I want you to keep

546
00:25:06,060 --> 00:25:07,977
in mind-- and the example
gives you this rule.

547
00:25:07,977 --> 00:25:12,180
The simple rule is if there's
profits to be made, you enter.

548
00:25:15,270 --> 00:25:18,080
If there's losses, you exit.

549
00:25:18,080 --> 00:25:23,280
And these two things together
imply the fundamental rule

550
00:25:23,280 --> 00:25:26,340
of competitive equilibrium--
that in the long run,

551
00:25:26,340 --> 00:25:27,480
profits are zero.

552
00:25:30,550 --> 00:25:32,830
Because if there's ever
profit in the market,

553
00:25:32,830 --> 00:25:34,247
firms will come in.

554
00:25:34,247 --> 00:25:36,580
And if there's ever loss in
the market, firms will exit.

555
00:25:36,580 --> 00:25:40,090
And that process will continue
until profits are zero.

556
00:25:40,090 --> 00:25:43,150
So our fundamental conclusion
is the long-run competitive

557
00:25:43,150 --> 00:25:46,040
equilibrium features
zero profits.

558
00:25:46,040 --> 00:25:47,650
Now let's see why.

559
00:25:47,650 --> 00:25:50,750
Let's go to figure 8-1.

560
00:25:50,750 --> 00:25:54,480
I want to talk about the
market for personal computers.

561
00:25:54,480 --> 00:25:54,980
Let's see.

562
00:25:54,980 --> 00:25:56,210
You guys were born what year?

563
00:25:56,210 --> 00:25:58,030
So you're now, like, 18.

564
00:25:58,030 --> 00:25:59,610
So you're born, like, 1990.

565
00:25:59,610 --> 00:26:02,060
This is about when
you guys are born, OK?

566
00:26:02,060 --> 00:26:05,570
1990 was a very interesting
time for PC market.

567
00:26:05,570 --> 00:26:10,610
You all grew up in a PC world,
a personal computer world.

568
00:26:10,610 --> 00:26:14,180
But basically, in 1990, we're
in a very different world.

569
00:26:14,180 --> 00:26:16,490
We're in a world that was
dominated by giant mainframe

570
00:26:16,490 --> 00:26:18,970
computers.

571
00:26:18,970 --> 00:26:22,250
My graduation speaker
from MIT in 1987

572
00:26:22,250 --> 00:26:25,020
was Ken Olsen, the
chairman of DEC,

573
00:26:25,020 --> 00:26:26,900
which was one of the
premier manufacturer

574
00:26:26,900 --> 00:26:28,550
of giant computers.

575
00:26:28,550 --> 00:26:30,470
He gave the worst
fucking graduation speech

576
00:26:30,470 --> 00:26:32,528
you've ever seen.

577
00:26:32,528 --> 00:26:34,820
If you ever become famous
and give a graduation speech,

578
00:26:34,820 --> 00:26:36,945
the number one rule is
don't spend the whole speech

579
00:26:36,945 --> 00:26:38,060
talking about yourself.

580
00:26:38,060 --> 00:26:40,393
He spent the whole speech
talking about how wonderful he

581
00:26:40,393 --> 00:26:41,840
was, how DEC was everything.

582
00:26:41,840 --> 00:26:44,120
And five years later,
he was bankrupt.

583
00:26:44,120 --> 00:26:45,710
So take that, Ken Olsen.

584
00:26:45,710 --> 00:26:47,460
That's why you don't
give a speech talking

585
00:26:47,460 --> 00:26:48,830
about how wonderful you are.

586
00:26:48,830 --> 00:26:49,520
What happened?

587
00:26:49,520 --> 00:26:51,590
Well, let's talk
about what happened.

588
00:26:51,590 --> 00:26:53,970
Let's talk about
the PC market, OK?

589
00:26:53,970 --> 00:26:55,840
I hope Ken Olsen
doesn't watch this.

590
00:26:55,840 --> 00:26:57,492
[LAUGHTER]

591
00:26:58,376 --> 00:27:01,040
Let's talk about the PC market.

592
00:27:01,040 --> 00:27:05,332
Let's talk about Dell, who
was an early PC manufacturer.

593
00:27:05,332 --> 00:27:07,040
And what we're going
to do in figure 8-1,

594
00:27:07,040 --> 00:27:08,970
there's going to be two
side-by-side graphs.

595
00:27:08,970 --> 00:27:10,978
I'm going to go back
and forth between them.

596
00:27:10,978 --> 00:27:13,520
If you're ever not clear about
which graph I'm talking about,

597
00:27:13,520 --> 00:27:14,242
stop me.

598
00:27:14,242 --> 00:27:15,950
But I'll try to be
very clear because you

599
00:27:15,950 --> 00:27:18,650
have to think about both
these graphs in tandem.

600
00:27:18,650 --> 00:27:21,530
On the right-hand
side is the market

601
00:27:21,530 --> 00:27:24,320
for PCs, the market graph.

602
00:27:24,320 --> 00:27:28,090
On the left-hand side
is Dell's cost curves.

603
00:27:28,090 --> 00:27:32,030
So the left-hand side graph is
firm-specific Dell information.

604
00:27:32,030 --> 00:27:34,870
The right-hand side
graph is the market.

605
00:27:34,870 --> 00:27:39,130
In the short run, we
were at a position

606
00:27:39,130 --> 00:27:41,590
where people wanted
PCs, and there weren't

607
00:27:41,590 --> 00:27:43,390
many people making them.

608
00:27:43,390 --> 00:27:45,310
You guys, PCs were super cool.

609
00:27:45,310 --> 00:27:47,620
I mean, I guess, you're on
laptops and everything now.

610
00:27:47,620 --> 00:27:50,495
But a desktop PC was an
amazing thing at this point.

611
00:27:50,495 --> 00:27:52,120
Everyone wanted them,
and there weren't

612
00:27:52,120 --> 00:27:54,340
that many people making them.

613
00:27:54,340 --> 00:27:57,880
So at that point, Dell could--

614
00:28:00,790 --> 00:28:05,400
the short-run market
cost curve was SR1,

615
00:28:05,400 --> 00:28:08,970
and the demand was D.
That was the short--

616
00:28:08,970 --> 00:28:10,910
so we're starting on the right.

617
00:28:10,910 --> 00:28:12,120
We're going to go from
the right to the left.

618
00:28:12,120 --> 00:28:12,912
Start in the right.

619
00:28:12,912 --> 00:28:16,590
The initial market in 1990
was the short-run cost curve

620
00:28:16,590 --> 00:28:19,210
SR1 and the demand curve of D.

621
00:28:19,210 --> 00:28:23,010
At that intersection,
the price was p1.

622
00:28:23,010 --> 00:28:25,500
Meanwhile, Dell,
in the short run,

623
00:28:25,500 --> 00:28:27,450
had a marginal cost curve such--

624
00:28:27,450 --> 00:28:29,820
now shift to the
left-hand diagram.

625
00:28:29,820 --> 00:28:35,350
At a price of p1, Dell wants
to produce little q1 PCs--

626
00:28:35,350 --> 00:28:36,940
marginal cost
equals price, right?

627
00:28:36,940 --> 00:28:39,482
So find the intersection of that
price with its marginal cost

628
00:28:39,482 --> 00:28:40,060
curve.

629
00:28:40,060 --> 00:28:41,518
Once again, this
is very important.

630
00:28:41,518 --> 00:28:42,938
So stop me if I'm
going too fast.

631
00:28:42,938 --> 00:28:44,980
Find where the price
intersects the marginal cost

632
00:28:44,980 --> 00:28:46,120
curve on the left.

633
00:28:46,120 --> 00:28:48,580
Dell wants to produce little q1.

634
00:28:48,580 --> 00:28:50,300
Well, what's its profits?

635
00:28:50,300 --> 00:28:53,030
Profits are price
minus average cost.

636
00:28:53,030 --> 00:28:56,220
Well, its average cost
was way below that.

637
00:28:56,220 --> 00:29:01,180
So Dell made this huge profit
of the lightly shaded rectangle.

638
00:29:01,180 --> 00:29:04,660
That was its profit because
it produced little q1.

639
00:29:04,660 --> 00:29:07,120
At little q1, average
cost was way below price.

640
00:29:07,120 --> 00:29:10,410
So it made this lighted
dot rectangle on profits.

641
00:29:10,410 --> 00:29:11,840
Now what happens?

642
00:29:11,840 --> 00:29:15,240
Other companies see this
and say, hey, we want in.

643
00:29:15,240 --> 00:29:18,100
What happens as more
companies enter a market?

644
00:29:18,100 --> 00:29:20,180
The supply curve flattens.

645
00:29:20,180 --> 00:29:22,500
You're horizontally
summing firm supply curve.

646
00:29:22,500 --> 00:29:24,240
Supply curve flattens.

647
00:29:24,240 --> 00:29:28,170
As it flattens, you
move from SR1 to SR2.

648
00:29:28,170 --> 00:29:30,360
So now we're back on the right.

649
00:29:30,360 --> 00:29:33,007
In the market, as
more firms enter--

650
00:29:33,007 --> 00:29:35,340
and let's assume there are
more firms identical to Dell.

651
00:29:35,340 --> 00:29:37,120
That's our perfect
competition assumption,

652
00:29:37,120 --> 00:29:39,420
that each firm that enters
is sort of identical.

653
00:29:39,420 --> 00:29:41,130
So more firms just
like Dell enter.

654
00:29:41,130 --> 00:29:44,490
Gateway and all these
guys start entering.

655
00:29:44,490 --> 00:29:48,690
And you shift to
SR2, a flatter curve.

656
00:29:48,690 --> 00:29:53,530
That intersects the demand
curve at the new price p2.

657
00:29:53,530 --> 00:29:56,110
Now shift to the
left-hand diagram.

658
00:29:56,110 --> 00:29:58,810
The price facing
Dell falls to p2,

659
00:29:58,810 --> 00:30:01,090
but their cost function
hasn't changed.

660
00:30:01,090 --> 00:30:02,040
They're still Dell.

661
00:30:02,040 --> 00:30:04,120
They're still the same
underlying technology,

662
00:30:04,120 --> 00:30:08,220
paying the same wages
and rental rates.

663
00:30:08,220 --> 00:30:11,030
So now, their marginal
cost curve is the same.

664
00:30:11,030 --> 00:30:13,350
So at this new lower
price, their production

665
00:30:13,350 --> 00:30:16,960
drops to little q2.

666
00:30:16,960 --> 00:30:19,540
Their production
drops to little q2

667
00:30:19,540 --> 00:30:25,430
and their profits fall to the
darkly shaded rectangle, pi 2.

668
00:30:25,430 --> 00:30:28,200
They make less money
as firms enter.

669
00:30:28,200 --> 00:30:33,950
And this process will continue
until profits go to zero.

670
00:30:33,950 --> 00:30:36,400
Even at pi 2, another firm--

671
00:30:36,400 --> 00:30:38,090
I forget what the
third PC firm was.

672
00:30:38,090 --> 00:30:39,650
Some other firm will come
in and say, wait a second.

673
00:30:39,650 --> 00:30:40,942
There's still money to be made.

674
00:30:40,942 --> 00:30:41,780
I want to come in.

675
00:30:41,780 --> 00:30:44,270
And it'll keep going
till profits go to zero.

676
00:30:44,270 --> 00:30:46,160
These are repeated short runs.

677
00:30:46,160 --> 00:30:49,420
So SR1 was a short run.

678
00:30:49,420 --> 00:30:51,430
Dell made a ton of money.

679
00:30:51,430 --> 00:30:53,140
Then we get to the
next short run.

680
00:30:53,140 --> 00:30:53,890
Gateway enters.

681
00:30:53,890 --> 00:30:55,390
SR2's the new short run.

682
00:30:55,390 --> 00:30:57,040
Gateway and Dell
still make money.

683
00:30:57,040 --> 00:30:59,335
So the third period, another
firm's going to enter.

684
00:30:59,335 --> 00:31:01,210
And it's going to go
till profits equal zero.

685
00:31:01,210 --> 00:31:03,470
Yeah?

686
00:31:03,470 --> 00:31:06,010
AUDIENCE: Does this assume
that the manufacturers or all

687
00:31:06,010 --> 00:31:09,247
the different companies produce
the same amount of quantity

688
00:31:09,247 --> 00:31:11,110
and that they're the
same quality, right?

689
00:31:11,110 --> 00:31:11,960
JONATHAN GRUBER:
Yes, absolutely.

690
00:31:11,960 --> 00:31:13,360
I'm going to come to those--

691
00:31:13,360 --> 00:31:15,277
there's a large set of
assumptions under this.

692
00:31:15,277 --> 00:31:18,370
But once again, think
of Dell and Gateway

693
00:31:18,370 --> 00:31:21,580
selling their computers on rugs
in front of the Eiffel Tower.

694
00:31:21,580 --> 00:31:22,330
It's all the same.

695
00:31:22,330 --> 00:31:22,730
You just go.

696
00:31:22,730 --> 00:31:23,760
You can compare equally.

697
00:31:23,760 --> 00:31:24,950
They're all the same thing.

698
00:31:24,950 --> 00:31:27,700
So it's that kind of market, OK?

699
00:31:27,700 --> 00:31:30,700
Now let's think
about poor, old IBM.

700
00:31:30,700 --> 00:31:32,050
Flip the page.

701
00:31:32,050 --> 00:31:35,500
IBM dominated-- despite
Ken Olsen's claims,

702
00:31:35,500 --> 00:31:39,610
IBM dominated the
big computer market.

703
00:31:39,610 --> 00:31:43,840
And so they were initially,
on the right-hand side,

704
00:31:43,840 --> 00:31:45,970
in equilibrium with
supply curve SR1.

705
00:31:49,280 --> 00:31:52,560
That intersected demand-- now
we're on the mainframe market.

706
00:31:52,560 --> 00:31:55,870
So in figure 8-1,
we're in the PC market.

707
00:31:55,870 --> 00:31:58,130
Figure 8-1 is the PC market.

708
00:31:58,130 --> 00:32:02,600
Figure 8-2 is the
mainframe market.

709
00:32:02,600 --> 00:32:04,880
The mainframe market,
they're initially

710
00:32:04,880 --> 00:32:07,970
at supply curve one, which is
very flat because there's lots

711
00:32:07,970 --> 00:32:09,590
of firms making mainframes.

712
00:32:09,590 --> 00:32:14,140
It intersects demand
at a price p1, OK?

713
00:32:14,140 --> 00:32:16,460
Now we go to the left.

714
00:32:16,460 --> 00:32:19,070
Well, remember, IBM
has to produce where

715
00:32:19,070 --> 00:32:20,980
its marginal cost equals price.

716
00:32:20,980 --> 00:32:24,586
That occurs at
production level q1.

717
00:32:24,586 --> 00:32:28,340
At production level of
q1, it is losing money.

718
00:32:28,340 --> 00:32:29,990
IBM is losing money.

719
00:32:29,990 --> 00:32:33,300
It is losing that
entire rectangle,

720
00:32:33,300 --> 00:32:36,270
the entire large rectangle.

721
00:32:36,270 --> 00:32:39,060
Now, does IBM exit?

722
00:32:39,060 --> 00:32:42,140
It can't in the short
run, but in the long run,

723
00:32:42,140 --> 00:32:44,643
the next period,
some firms will exit.

724
00:32:44,643 --> 00:32:47,060
Some firms will say, yeah, we
lost money in the short run.

725
00:32:47,060 --> 00:32:47,460
We're stuck.

726
00:32:47,460 --> 00:32:48,470
But in the long
run, we just don't

727
00:32:48,470 --> 00:32:49,700
think this is a winning game.

728
00:32:49,700 --> 00:32:52,703
In particular, firms with
high fixed costs will exit.

729
00:32:52,703 --> 00:32:54,620
They don't want to pay
those fixed costs again

730
00:32:54,620 --> 00:32:55,680
in the second period.

731
00:32:55,680 --> 00:32:57,080
They know they have to
build a new factory.

732
00:32:57,080 --> 00:32:58,205
They're not going to do it.

733
00:32:58,205 --> 00:32:58,900
They exit.

734
00:32:58,900 --> 00:32:59,558
Yeah?

735
00:32:59,558 --> 00:33:00,902
AUDIENCE: What
constitutes as a period?

736
00:33:00,902 --> 00:33:02,250
I know we said the
long run is when--

737
00:33:02,250 --> 00:33:04,333
JONATHAN GRUBER: I told
you I can't tell you that.

738
00:33:04,333 --> 00:33:06,340
It's just some period of
time more than a month,

739
00:33:06,340 --> 00:33:08,170
less than 10 years, OK?

740
00:33:08,170 --> 00:33:10,270
It's the period over
which capital is variable.

741
00:33:10,270 --> 00:33:11,380
Think of it as a period
of time over which you can

742
00:33:11,380 --> 00:33:13,210
build a new plant to make PCs.

743
00:33:13,210 --> 00:33:14,140
Think of it that way.

744
00:33:14,140 --> 00:33:17,150
So it's years, OK?

745
00:33:17,150 --> 00:33:20,660
So what happens, then, somebody
exits, says, I'm out of this.

746
00:33:20,660 --> 00:33:23,150
I'm shutting down the plant
and moving somewhere else.

747
00:33:23,150 --> 00:33:26,680
That's steepens the market
supply curve because now fewer

748
00:33:26,680 --> 00:33:28,660
firms are in the market.

749
00:33:28,660 --> 00:33:30,940
As that steepens
the supply curve,

750
00:33:30,940 --> 00:33:33,100
the new intersection
of supply and demand

751
00:33:33,100 --> 00:33:35,930
is at the higher price p2.

752
00:33:35,930 --> 00:33:38,750
IBM stayed in the market.

753
00:33:38,750 --> 00:33:41,450
They just built a new plant.

754
00:33:41,450 --> 00:33:47,720
At p2, they now
produce an amount q2.

755
00:33:47,720 --> 00:33:52,710
And at that combination, they
are literally zero profit.

756
00:33:52,710 --> 00:33:56,480
That's the point where marginal
cost equals average cost, which

757
00:33:56,480 --> 00:33:58,460
is a zero-profit point.

758
00:33:58,460 --> 00:34:00,500
Why is that zero profits?

759
00:34:00,500 --> 00:34:02,000
It's zero profits
because, remember,

760
00:34:02,000 --> 00:34:04,670
profits are price
minus average cost.

761
00:34:04,670 --> 00:34:05,780
What's price?

762
00:34:05,780 --> 00:34:07,350
Marginal cost.

763
00:34:07,350 --> 00:34:11,000
So when marginal cost equals
average cost, profits are zero.

764
00:34:11,000 --> 00:34:14,260
You should be able to see that
from the math we did before.

765
00:34:14,260 --> 00:34:17,670
So what that means
is that basically,

766
00:34:17,670 --> 00:34:20,280
when firms are losing
money, they will leave

767
00:34:20,280 --> 00:34:22,883
and drive profits from
below zero toward zero.

768
00:34:22,883 --> 00:34:24,300
So when they're
making money, they

769
00:34:24,300 --> 00:34:27,810
enter and drive profits from
above zero towards zero.

770
00:34:27,810 --> 00:34:30,750
When they're losing money,
they leave and drive

771
00:34:30,750 --> 00:34:34,920
profits from below
zero towards zero.

772
00:34:34,920 --> 00:34:36,460
What does that mean?

773
00:34:36,460 --> 00:34:39,120
That means that our long-run
perfectly competitive supply

774
00:34:39,120 --> 00:34:41,730
curve is in figure 8-3.

775
00:34:41,730 --> 00:34:43,820
It's flat.

776
00:34:43,820 --> 00:34:47,570
Long-run perfectly
competitive market supply

777
00:34:47,570 --> 00:34:52,130
is flat at the price level.

778
00:34:52,130 --> 00:34:54,980
The market long-run
supply is the point

779
00:34:54,980 --> 00:34:56,989
where marginal cost
equals average cost

780
00:34:56,989 --> 00:35:02,230
or where supply equals
average cost, OK?

781
00:35:02,230 --> 00:35:03,790
And why is this?

782
00:35:03,790 --> 00:35:08,380
This is true because at
any price above that point,

783
00:35:08,380 --> 00:35:11,620
if any firm tries to
charge more than $10,

784
00:35:11,620 --> 00:35:14,560
they'll be driven
out of business.

785
00:35:14,560 --> 00:35:17,230
If any firm tries
to charge below $10,

786
00:35:17,230 --> 00:35:19,060
they won't make any money.

787
00:35:19,060 --> 00:35:20,590
Remember before,
I said earlier--

788
00:35:20,590 --> 00:35:22,300
you said, well, gee why
don't firms just-- somebody

789
00:35:22,300 --> 00:35:24,883
asked, why don't firms just come
in and take the whole market?

790
00:35:24,883 --> 00:35:25,990
This is why.

791
00:35:25,990 --> 00:35:27,700
Because cost is upward sloping.

792
00:35:27,700 --> 00:35:29,742
You don't want to come
and take the whole market.

793
00:35:29,742 --> 00:35:30,855
You'll lose money.

794
00:35:30,855 --> 00:35:32,730
That's why firms don't
want the whole market.

795
00:35:32,730 --> 00:35:35,280
If marginal cost was flat, then
you would then be undefined.

796
00:35:35,280 --> 00:35:36,220
You would want the whole market.

797
00:35:36,220 --> 00:35:36,803
But you don't.

798
00:35:36,803 --> 00:35:38,790
Marginal cost is rising.

799
00:35:38,790 --> 00:35:41,850
So you never want to
produce at a price above $10

800
00:35:41,850 --> 00:35:43,890
because no one
will buy from you.

801
00:35:43,890 --> 00:35:46,150
You never want to
set a price below $10

802
00:35:46,150 --> 00:35:47,610
because you'll lose money.

803
00:35:47,610 --> 00:35:51,700
Therefore, supply is perfectly
elastic at a price of $10.

804
00:35:51,700 --> 00:35:52,412
Yeah?

805
00:35:52,412 --> 00:35:54,340
AUDIENCE: Thinking about
this long-run logic

806
00:35:54,340 --> 00:35:56,268
then, wouldn't [INAUDIBLE]?

807
00:35:59,910 --> 00:36:01,200
JONATHAN GRUBER: No, no, no.

808
00:36:01,200 --> 00:36:03,900
Once again, there's a lot
of assumptions under this.

809
00:36:03,900 --> 00:36:06,287
But under these
assumptions, you never

810
00:36:06,287 --> 00:36:08,370
make money in the long run
because they shut down.

811
00:36:08,370 --> 00:36:09,537
There are short-run periods.

812
00:36:09,537 --> 00:36:11,580
So let's say what happened was--

813
00:36:11,580 --> 00:36:13,867
let's go back to figure 8-2.

814
00:36:13,867 --> 00:36:16,200
Let's say that another firm
shut down in the next period

815
00:36:16,200 --> 00:36:18,420
and suddenly IBM
started making money.

816
00:36:18,420 --> 00:36:20,970
What would happen?

817
00:36:20,970 --> 00:36:23,930
Someone would enter and
drive profits back to zero.

818
00:36:23,930 --> 00:36:25,960
So under the assumptions
we've laid out here,

819
00:36:25,960 --> 00:36:27,070
profits are zero.

820
00:36:27,070 --> 00:36:32,350
Because in the long run, we've
achieved cost minimization.

821
00:36:32,350 --> 00:36:36,010
Firms minimize their
costs where marginal cost

822
00:36:36,010 --> 00:36:37,540
equals average cost.

823
00:36:37,540 --> 00:36:39,700
Look at the average cost curve.

824
00:36:39,700 --> 00:36:43,020
Firms are producing
at the minimum.

825
00:36:43,020 --> 00:36:46,380
The minimum of average
cost is where average cost

826
00:36:46,380 --> 00:36:47,910
equals marginal cost.

827
00:36:47,910 --> 00:36:51,483
That is, competition has
forced cost minimization.

828
00:36:51,483 --> 00:36:53,400
I'm just doing all sorts
of mind-blowing stuff

829
00:36:53,400 --> 00:36:54,150
here for you guys.

830
00:36:54,150 --> 00:36:57,210
It can take hours to
recover from this.

831
00:36:57,210 --> 00:37:00,570
Competition forces
cost minimization.

832
00:37:00,570 --> 00:37:01,260
Why?

833
00:37:01,260 --> 00:37:04,050
Because competition
forces each firm

834
00:37:04,050 --> 00:37:06,990
to produce where price
equals marginal cost,

835
00:37:06,990 --> 00:37:09,960
and it forces entry and
exit until marginal cost

836
00:37:09,960 --> 00:37:11,950
equals average cost.

837
00:37:11,950 --> 00:37:14,280
Therefore, it forces
each firm to produce

838
00:37:14,280 --> 00:37:16,230
at the most efficient
point, which

839
00:37:16,230 --> 00:37:18,353
is where marginal cost
equals average cost,

840
00:37:18,353 --> 00:37:19,770
because that is
the point at where

841
00:37:19,770 --> 00:37:22,260
average cost is minimized.

842
00:37:22,260 --> 00:37:24,830
So under competition,
in the long run,

843
00:37:24,830 --> 00:37:27,080
every firm is cost-minimizing.

844
00:37:27,080 --> 00:37:31,370
They're producing the minimum
of their average costs.

845
00:37:31,370 --> 00:37:34,550
And therefore, the
supply curve is elastic,

846
00:37:34,550 --> 00:37:38,150
and it's defined purely by
the minimum of average costs.

847
00:37:38,150 --> 00:37:39,950
That is, if you know--

848
00:37:39,950 --> 00:37:41,370
here's a cheat.

849
00:37:41,370 --> 00:37:44,630
If you know you're in a
perfectly competitive market

850
00:37:44,630 --> 00:37:49,442
and I give you a cost
function, then you know--

851
00:37:49,442 --> 00:37:51,400
I guess you still need
the demand function too.

852
00:37:51,400 --> 00:37:54,693
If I give a cost function
and a demand function,

853
00:37:54,693 --> 00:37:56,610
you know you don't need
to know how many firms

854
00:37:56,610 --> 00:37:57,420
are going to be in the market.

855
00:37:57,420 --> 00:37:59,070
You don't need to know little n.

856
00:37:59,070 --> 00:38:01,685
You know, in the long run,
profits are going to be zero.

857
00:38:01,685 --> 00:38:03,060
So long run, firms
are just going

858
00:38:03,060 --> 00:38:06,460
to produce at the
minimum of average cost.

859
00:38:06,460 --> 00:38:08,460
You find that, use the
demand to find the price,

860
00:38:08,460 --> 00:38:11,010
and you're done, OK?

861
00:38:11,010 --> 00:38:16,620
So competition leads
to cost minimization.

862
00:38:16,620 --> 00:38:19,360
Questions about that?

863
00:38:19,360 --> 00:38:20,390
OK.

864
00:38:20,390 --> 00:38:24,580
Now, you're all thinking,
well, wait a second.

865
00:38:24,580 --> 00:38:26,220
We've got rich
parents, many of us who

866
00:38:26,220 --> 00:38:28,688
make money in these businesses.

867
00:38:28,688 --> 00:38:29,730
I don't see zero profits.

868
00:38:29,730 --> 00:38:32,310
There's a stock market
that's been booming.

869
00:38:32,310 --> 00:38:33,990
Where's the zero profits, buddy?

870
00:38:33,990 --> 00:38:36,580
I don't see zero profits.

871
00:38:36,580 --> 00:38:39,640
Well, the answer is twofold.

872
00:38:39,640 --> 00:38:42,330
First of all, remember,
firms can make money

873
00:38:42,330 --> 00:38:44,690
in the short run in this model.

874
00:38:44,690 --> 00:38:46,440
But that doesn't explain
the stock market.

875
00:38:46,440 --> 00:38:48,732
The stock market's supposed
to be forward-looking-- not

876
00:38:48,732 --> 00:38:50,590
months, but years and decades.

877
00:38:50,590 --> 00:38:53,190
So firms-- really,
long run profit's zero.

878
00:38:53,190 --> 00:38:55,650
Why would stocks be expensive?

879
00:38:55,650 --> 00:38:57,840
Why would people want to
invest in these companies?

880
00:38:57,840 --> 00:39:01,190
And the answer is because these
assumptions are unrealistic--

881
00:39:01,190 --> 00:39:04,160
that this is an extreme
version of the model that

882
00:39:04,160 --> 00:39:06,530
delivers some nice
intuition, but doesn't

883
00:39:06,530 --> 00:39:07,677
apply to the real world.

884
00:39:07,677 --> 00:39:09,260
So I want to take
the last few minutes

885
00:39:09,260 --> 00:39:11,510
to talk about the
assumptions that we've

886
00:39:11,510 --> 00:39:13,660
made that don't really
work in the real world

887
00:39:13,660 --> 00:39:14,660
to make this model work.

888
00:39:14,660 --> 00:39:16,180
It doesn't mean the
model's invalid.

889
00:39:16,180 --> 00:39:17,880
We learn a huge amount.

890
00:39:17,880 --> 00:39:19,430
And the key lesson
from this model

891
00:39:19,430 --> 00:39:23,420
is competition pushes you
towards cost minimization.

892
00:39:23,420 --> 00:39:28,230
Always think about these models
as not delivering a level

893
00:39:28,230 --> 00:39:30,810
truth, but a directional truth.

894
00:39:30,810 --> 00:39:33,870
The directional lesson is this
is why competition forces firms

895
00:39:33,870 --> 00:39:37,400
towards cost minimization,
but firms won't actually

896
00:39:37,400 --> 00:39:39,740
necessarily get to zero profits.

897
00:39:39,740 --> 00:39:43,070
And there's at least
three complications.

898
00:39:43,070 --> 00:39:45,290
The first one is limited entry.

899
00:39:48,850 --> 00:39:54,530
I assumed that firms could
costlessly enter and exit

900
00:39:54,530 --> 00:39:57,460
in this market.

901
00:39:57,460 --> 00:40:02,080
But in fact, that might be
hard because, in reality, we

902
00:40:02,080 --> 00:40:05,920
have sunk costs, which I
talked about last time.

903
00:40:05,920 --> 00:40:09,340
We have sunk costs--
or two times ago--

904
00:40:09,340 --> 00:40:12,780
costs which, once paid,
can never be recovered.

905
00:40:12,780 --> 00:40:14,400
And therefore, firms
might say, look,

906
00:40:14,400 --> 00:40:15,900
I don't want to get
into this market

907
00:40:15,900 --> 00:40:17,983
because it's not like I
can get my fixed cost back

908
00:40:17,983 --> 00:40:19,540
out next period.

909
00:40:19,540 --> 00:40:21,510
So if my fixed costs
are building a building,

910
00:40:21,510 --> 00:40:24,000
next period, I can just sell
that building to someone else.

911
00:40:24,000 --> 00:40:25,920
But my fixed costs are
going to med school.

912
00:40:25,920 --> 00:40:28,990
I can't sell that
med school degree.

913
00:40:28,990 --> 00:40:31,150
Therefore, if doctors aren't
going to be profitable

914
00:40:31,150 --> 00:40:33,608
in the long run-- there'll be
zero profit in the long run--

915
00:40:33,608 --> 00:40:35,200
I'm going to go be
a lawyer instead.

916
00:40:35,200 --> 00:40:37,270
There are sunk costs,
and those sunk costs

917
00:40:37,270 --> 00:40:39,970
create what we call
barriers to entry.

918
00:40:44,510 --> 00:40:47,180
There are barriers to
entry that come from costs

919
00:40:47,180 --> 00:40:50,570
that are sunk in the long run--

920
00:40:50,570 --> 00:40:51,530
med schools.

921
00:40:51,530 --> 00:40:55,160
But there are other sorts
of barriers to entry.

922
00:40:55,160 --> 00:40:57,600
Take our vendor market.

923
00:40:57,600 --> 00:40:59,850
Even in vendor markets,
they're not perfectly elastic.

924
00:40:59,850 --> 00:41:00,800
One barrier to
entry could be they

925
00:41:00,800 --> 00:41:03,217
could come in the middle of
the night and steal your stuff

926
00:41:03,217 --> 00:41:05,810
and beat you up if you
tried to enter the market.

927
00:41:05,810 --> 00:41:09,560
There's lots of reasons
why entry and exit is not

928
00:41:09,560 --> 00:41:11,840
costless and easy.

929
00:41:11,840 --> 00:41:13,670
There's lots of
barriers to entry.

930
00:41:13,670 --> 00:41:17,840
Once there's a barrier to
entry, this graph goes away.

931
00:41:17,840 --> 00:41:19,270
Because go back to figure 8-1.

932
00:41:22,370 --> 00:41:23,870
In the second
short-run equilibrium,

933
00:41:23,870 --> 00:41:26,750
we've got these small
profits, this small, dark gray

934
00:41:26,750 --> 00:41:29,270
rectangle, right?

935
00:41:29,270 --> 00:41:31,880
I then told you another firm
would enter and squeeze those

936
00:41:31,880 --> 00:41:35,637
away, but another firm
will enter only if what?

937
00:41:35,637 --> 00:41:37,970
Only under what-- somebody
raise their hand and tell me.

938
00:41:37,970 --> 00:41:41,993
Under what condition would
that third firm enter?

939
00:41:41,993 --> 00:41:42,955
Yeah?

940
00:41:42,955 --> 00:41:44,880
AUDIENCE: Profits are
greater than zero.

941
00:41:44,880 --> 00:41:47,430
JONATHAN GRUBER: No, not
profits are greater than zero.

942
00:41:47,430 --> 00:41:48,630
In the model, that was true.

943
00:41:48,630 --> 00:41:50,658
But in reality,
what has to be true?

944
00:41:50,658 --> 00:41:52,200
Profits have to be
greater than what?

945
00:41:52,200 --> 00:41:53,613
AUDIENCE: Sunk cost.

946
00:41:53,613 --> 00:41:54,780
JONATHAN GRUBER: Sunk costs.

947
00:41:54,780 --> 00:41:56,000
Raise your hand, people.

948
00:41:56,000 --> 00:41:56,940
I'm going to give you
credit because you

949
00:41:56,940 --> 00:41:59,315
raised your hand regardless
of who yelled out the answer.

950
00:41:59,315 --> 00:42:00,590
I'll assume you were right.

951
00:42:00,590 --> 00:42:01,560
Sunk costs.

952
00:42:01,560 --> 00:42:05,370
Profits have to be greater
than the barriers to entry.

953
00:42:05,370 --> 00:42:07,090
So in the short run,
you enter if profits

954
00:42:07,090 --> 00:42:08,007
are greater than zero.

955
00:42:08,007 --> 00:42:10,530
In the long run, you
only enter if profits

956
00:42:10,530 --> 00:42:14,930
are greater than the barriers to
entry, which might not be true.

957
00:42:14,930 --> 00:42:18,220
There's always some
cost to starting a firm.

958
00:42:18,220 --> 00:42:20,440
So profits will never
really go to zero.

959
00:42:20,440 --> 00:42:23,980
They'll only go down to
the barriers to entry.

960
00:42:23,980 --> 00:42:27,090
So that's problem one.

961
00:42:27,090 --> 00:42:30,450
Problem two with this
model, problem two

962
00:42:30,450 --> 00:42:32,970
is firms may differ.

963
00:42:32,970 --> 00:42:36,000
I've assumed-- and this
was raised in one question.

964
00:42:36,000 --> 00:42:38,500
I've assumed
identical firms here.

965
00:42:38,500 --> 00:42:40,440
But in fact, firms differ.

966
00:42:40,440 --> 00:42:42,750
And in particular,
different firms

967
00:42:42,750 --> 00:42:45,740
have different cost functions.

968
00:42:45,740 --> 00:42:47,780
And with different
cost functions,

969
00:42:47,780 --> 00:42:52,330
you can get some firms
making long-run profits.

970
00:42:52,330 --> 00:42:58,320
So for example, let's
consider, in figure 8-4,

971
00:42:58,320 --> 00:43:00,870
the long-run market
supply for cotton.

972
00:43:00,870 --> 00:43:04,410
This is from a textbook example.

973
00:43:04,410 --> 00:43:07,440
And this is from
estimates that people

974
00:43:07,440 --> 00:43:12,240
have made of the minimum
average cost of producing cotton

975
00:43:12,240 --> 00:43:14,280
by country.

976
00:43:14,280 --> 00:43:17,278
So in other words, this is old
now, but it doesn't matter.

977
00:43:17,278 --> 00:43:18,570
The country names don't matter.

978
00:43:18,570 --> 00:43:19,920
The example's what matters.

979
00:43:19,920 --> 00:43:21,750
In the period of time
this study was done,

980
00:43:21,750 --> 00:43:24,330
the cheapest place to
produce cotton was Pakistan.

981
00:43:24,330 --> 00:43:29,230
You produce cotton in
Pakistan for $0.71 per--

982
00:43:29,230 --> 00:43:34,200
I don't know-- kilogram,
$0.71 per kilogram, OK?

983
00:43:34,200 --> 00:43:37,480
However, that was only
for a certain amount.

984
00:43:37,480 --> 00:43:40,717
At some point, Pakistan
ran out of cheap cotton

985
00:43:40,717 --> 00:43:42,550
and they had to start
producing cotton using

986
00:43:42,550 --> 00:43:43,727
more expensive methods.

987
00:43:43,727 --> 00:43:46,060
Remember, marginal cost, at
some point, has to slope up.

988
00:43:46,060 --> 00:43:47,890
So the point is
marginal cost was flat

989
00:43:47,890 --> 00:43:51,160
for a while in Pakistan,
then has to slope up.

990
00:43:51,160 --> 00:43:55,000
And suddenly, it becomes cheaper
to produce cotton in Argentina

991
00:43:55,000 --> 00:43:57,728
at $1.08.

992
00:43:57,728 --> 00:44:00,145
And then it becomes cheaper
to produce cotton in Australia

993
00:44:00,145 --> 00:44:01,070
at $1.15.

994
00:44:01,070 --> 00:44:03,408
And eventually, if the
price gets to $1.56,

995
00:44:03,408 --> 00:44:05,200
it's finally cheap
enough to produce cotton

996
00:44:05,200 --> 00:44:07,410
in the United States.

997
00:44:07,410 --> 00:44:09,870
The point is these
flat segments represent

998
00:44:09,870 --> 00:44:12,060
the minimum average
cost in each country.

999
00:44:12,060 --> 00:44:13,920
It's just, instead
of making it a point,

1000
00:44:13,920 --> 00:44:15,712
there's an amount of
production they can do

1001
00:44:15,712 --> 00:44:18,130
with that minimum average cost.

1002
00:44:18,130 --> 00:44:21,270
Now, let's say world
demand for cotton

1003
00:44:21,270 --> 00:44:24,540
was 1 billion
kilograms per year.

1004
00:44:24,540 --> 00:44:27,900
Then what would happen
would be what I taught.

1005
00:44:27,900 --> 00:44:29,970
You would have Pakistan--

1006
00:44:29,970 --> 00:44:34,230
competitors in Pakistan would
compete, driving profits down

1007
00:44:34,230 --> 00:44:35,610
to zero.

1008
00:44:35,610 --> 00:44:39,940
And price would be
$0.71 per kilogram.

1009
00:44:39,940 --> 00:44:42,720
Now let's say, however,
demand for cotton

1010
00:44:42,720 --> 00:44:45,710
is 5 billion kilograms per year.

1011
00:44:45,710 --> 00:44:48,700
Well, now, that intersects
this supply curve.

1012
00:44:48,700 --> 00:44:50,030
This is the world supply curve.

1013
00:44:50,030 --> 00:44:54,570
There's the supply
curve at $1.71.

1014
00:44:54,570 --> 00:44:59,160
So now, US producers
are making zero profits

1015
00:44:59,160 --> 00:45:00,690
because their
marginal cost's $1.71.

1016
00:45:00,690 --> 00:45:02,250
The price is $1.71.

1017
00:45:02,250 --> 00:45:05,230
But what about
producers in Pakistan?

1018
00:45:05,230 --> 00:45:07,190
They still make cotton.

1019
00:45:07,190 --> 00:45:10,410
They make the first
almost 2 billion kilos.

1020
00:45:10,410 --> 00:45:15,420
But they're selling at $1.71,
and it's costing them $0.71.

1021
00:45:15,420 --> 00:45:18,400
So they just made profits.

1022
00:45:18,400 --> 00:45:23,830
The point is that if there are
firms which have rising costs

1023
00:45:23,830 --> 00:45:26,150
and demand is high enough
that the high-cost firms are

1024
00:45:26,150 --> 00:45:28,090
actually producing,
that higher price means

1025
00:45:28,090 --> 00:45:30,010
profits for the low-cost firm.

1026
00:45:30,010 --> 00:45:30,610
Yeah?

1027
00:45:30,610 --> 00:45:34,503
AUDIENCE: Would this increase
the price variable in Pakistan?

1028
00:45:34,503 --> 00:45:35,920
JONATHAN GRUBER:
You could imagine

1029
00:45:35,920 --> 00:45:38,410
those profits could
then have a feedback

1030
00:45:38,410 --> 00:45:40,300
effect in asset markets.

1031
00:45:40,300 --> 00:45:42,850
And you could imagine the long
run, in the very, very, very

1032
00:45:42,850 --> 00:45:45,373
long run, as people
buy land, that

1033
00:45:45,373 --> 00:45:46,540
could dissipate the profits.

1034
00:45:46,540 --> 00:45:47,373
That's a good point.

1035
00:45:47,373 --> 00:45:48,730
We'll come back to that.

1036
00:45:48,730 --> 00:45:51,400
But no, that's
very long run, OK?

1037
00:45:51,400 --> 00:45:54,298
But for now, people have
their land in Pakistan,

1038
00:45:54,298 --> 00:45:55,840
and they're making
their money on it.

1039
00:45:55,840 --> 00:45:58,120
And so that becomes
long-run profits.

1040
00:45:58,120 --> 00:46:02,380
So long-run profits can come
from heterogeneous costs.

1041
00:46:02,380 --> 00:46:05,230
If some firms are
particularly efficient

1042
00:46:05,230 --> 00:46:09,870
in a multimarket firm,
those firms can make money.

1043
00:46:09,870 --> 00:46:14,250
That's a second feature.

1044
00:46:14,250 --> 00:46:17,800
Now, the third feature
is, in some sense,

1045
00:46:17,800 --> 00:46:23,840
the most interesting, which is
input prices may not be fixed.

1046
00:46:23,840 --> 00:46:29,230
And in fact, input
prices, input prices--

1047
00:46:29,230 --> 00:46:29,730
ah.

1048
00:46:34,230 --> 00:46:42,410
Input may have an
upward-sloping supply.

1049
00:46:42,410 --> 00:46:45,277
There could be an upward-sloping
supply for inputs.

1050
00:46:45,277 --> 00:46:47,360
We've assumed input prices
are, everywhere, fixed,

1051
00:46:47,360 --> 00:46:48,780
but that's not true.

1052
00:46:48,780 --> 00:46:51,540
And in a few lectures, we'll
come and teach you about that.

1053
00:46:51,540 --> 00:46:53,900
But for now, let's
recognize that inputs may

1054
00:46:53,900 --> 00:46:55,770
have an upward-sloping supply.

1055
00:46:55,770 --> 00:46:58,963
So let's go through that for a
couple minutes before we stop.

1056
00:46:58,963 --> 00:47:00,380
Let's take a market
in figure 8-5.

1057
00:47:03,730 --> 00:47:06,847
This is the market for labor.

1058
00:47:06,847 --> 00:47:08,680
Now, we've only been
doing markets for goods

1059
00:47:08,680 --> 00:47:10,805
so far in this course, and
I'm sort of shortcutting

1060
00:47:10,805 --> 00:47:11,680
by jumping to here.

1061
00:47:11,680 --> 00:47:13,540
We'll spend a lot more
time on this graph.

1062
00:47:13,540 --> 00:47:17,770
But the bottom line is this is
a graph of the amount of labor

1063
00:47:17,770 --> 00:47:19,300
supply to the market.

1064
00:47:19,300 --> 00:47:22,227
In this graph, people
are now the suppliers

1065
00:47:22,227 --> 00:47:23,560
because they're supplying labor.

1066
00:47:23,560 --> 00:47:25,300
Firms are the demanders.

1067
00:47:25,300 --> 00:47:27,190
They're demanding labor.

1068
00:47:27,190 --> 00:47:29,320
So what happens is you
have supply curve of labor,

1069
00:47:29,320 --> 00:47:30,862
and let's assume
it's upward sloping.

1070
00:47:30,862 --> 00:47:33,400
What I mean by that is
as the wage goes up,

1071
00:47:33,400 --> 00:47:35,557
people want to work harder.

1072
00:47:35,557 --> 00:47:37,390
You want to work harder
as the wage goes up.

1073
00:47:37,390 --> 00:47:38,770
So it's an
upward-sloping supply.

1074
00:47:38,770 --> 00:47:41,260
It makes sense, right?

1075
00:47:41,260 --> 00:47:43,240
Upward-sloping supply of labor.

1076
00:47:43,240 --> 00:47:47,560
Now let's imagine a firm
suddenly wants to produce more.

1077
00:47:47,560 --> 00:47:49,960
They used to produce little q1.

1078
00:47:49,960 --> 00:47:52,430
Now they want to
produce little q2.

1079
00:47:52,430 --> 00:47:55,280
To do so, they
need more workers.

1080
00:47:55,280 --> 00:47:59,460
That represents a shift out
in the demand for workers.

1081
00:47:59,460 --> 00:48:02,680
With upward-sloping
supply, what does that do?

1082
00:48:02,680 --> 00:48:04,720
Raises the wage.

1083
00:48:04,720 --> 00:48:07,428
If you want more workers,
you've got to pay them more.

1084
00:48:07,428 --> 00:48:08,470
We didn't do that before.

1085
00:48:08,470 --> 00:48:10,940
We assumed W was a constant.

1086
00:48:10,940 --> 00:48:13,940
But imagine if, to produce
more, you have to pay more.

1087
00:48:13,940 --> 00:48:15,080
What does that do?

1088
00:48:15,080 --> 00:48:17,900
Well, you see that
in figure 8-6.

1089
00:48:17,900 --> 00:48:21,560
Now, I used to produce--
the market equilibrium used

1090
00:48:21,560 --> 00:48:28,240
to be at point E1 with n1
firms producing little q1.

1091
00:48:28,240 --> 00:48:30,110
So that point big E1--

1092
00:48:30,110 --> 00:48:33,020
biggie, big comma E1--

1093
00:48:33,020 --> 00:48:35,090
is little n1.

1094
00:48:35,090 --> 00:48:40,220
There was n firms producing
little q1 units per firm.

1095
00:48:40,220 --> 00:48:43,120
And they were making
these profits.

1096
00:48:43,120 --> 00:48:47,780
Their profits were where
price equaled marginal cost 1,

1097
00:48:47,780 --> 00:48:49,520
now shifting to the left.

1098
00:48:49,520 --> 00:48:52,310
p equals marginal
cost one at little e1.

1099
00:48:52,310 --> 00:48:55,110
So they were producing
where marginal cost equaled

1100
00:48:55,110 --> 00:48:56,730
average cost.

1101
00:48:56,730 --> 00:49:00,620
So little q1 at price
p1 meant that firms

1102
00:49:00,620 --> 00:49:05,090
producing at little e1, which
was the zero-profit point, OK?

1103
00:49:05,090 --> 00:49:07,220
Now what happens?

1104
00:49:07,220 --> 00:49:08,840
Now the firm wants
to produce more.

1105
00:49:08,840 --> 00:49:09,500
Demand goes up.

1106
00:49:09,500 --> 00:49:10,790
Firm wants to produce more.

1107
00:49:10,790 --> 00:49:12,772
It wants to produce q2.

1108
00:49:12,772 --> 00:49:15,560
You have a new long-run
equilibrium with n2 firms

1109
00:49:15,560 --> 00:49:16,960
producing q2.

1110
00:49:16,960 --> 00:49:21,520
Well, in that case, now
if you want to produce q2,

1111
00:49:21,520 --> 00:49:23,830
you're going to have
to pay a higher wage.

1112
00:49:23,830 --> 00:49:28,540
A higher wage means a higher
marginal average cost.

1113
00:49:28,540 --> 00:49:30,370
Higher marginal
average cost means

1114
00:49:30,370 --> 00:49:34,410
that you're now producing
at a higher price

1115
00:49:34,410 --> 00:49:36,450
and, therefore, the supply
curve slopes upward.

1116
00:49:39,210 --> 00:49:40,607
Now, this is very different.

1117
00:49:40,607 --> 00:49:41,690
One thing to think about--

1118
00:49:41,690 --> 00:49:42,357
I'll let you go.

1119
00:49:42,357 --> 00:49:44,600
One last thing to think,
think about the difference

1120
00:49:44,600 --> 00:49:47,160
between this third case
and the other two cases.

1121
00:49:47,160 --> 00:49:50,720
In the other two cases,
firms made profits.

1122
00:49:50,720 --> 00:49:54,310
In this case, firms
still don't make profits.

1123
00:49:54,310 --> 00:49:55,860
So notice that
profit's still zero,

1124
00:49:55,860 --> 00:49:58,225
but the supply curve's
upward sloping.

1125
00:49:58,225 --> 00:49:59,850
So you don't need
positive profits have

1126
00:49:59,850 --> 00:50:01,630
an upward-sloping supply curve.

1127
00:50:01,630 --> 00:50:02,580
So let's stop there.

1128
00:50:02,580 --> 00:50:04,530
I've given you a
lot to think about.

1129
00:50:04,530 --> 00:50:06,330
And we will come
back and talk more

1130
00:50:06,330 --> 00:50:09,230
about this stuff on Wednesday.