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Changes in Demand and in Production Cost

17 April, 2015 - 17:40

The primary application of the model of perfect competition is in predicting how firms will respond to changes in demand and in production costs. To see how firms respond to a particular change, we determine how the change affects demand or cost conditions and then see how the profit-maximizing solution is affected in the short run and in the long run. Having determined how the profit-maximizing firms of the model would respond, we can then predict firms’ responses to similar changes in the real world.

In the examples that follow, we shall assume, for simplicity, that entry or exit do not affect the input prices facing firms in the industry. That is, we assume a constant-cost industry with a horizontal long-run industry supply curve similar to SCC in Figure Figure 9.14. We shall assume that firms are covering their average variable costs, so we can ignore the possibility of shutting down.