ENTRY AND EXIT OF FIRMS

ENTRY AND EXIT OF FIRMS

Firms entering the market will shift the supply curve to the right, thereby 

lowering the equilibrium price and increasing the equilibrium quantity. Firms 

leaving the market will shift the supply curve to the left, causing the 

equilibrium price to rise and the equilibrium quantity to fall.

SHORTRUN AND LONGRUN

In the shortrun producers are faced with a problem if they wish to increase 

their output. They can increase the number of hours their employees work 

and buy more raw materials, in other words labour and land (raw materials) 

are variable in the shortrun. The amount of factory space and machinery 

(capital) are fixed as they can't simply be added. In the shortrun land and 

labour are variable and capital is fixed.

In the longrun all economic resources are variable as land, labour and capital 

can all be changed. The only variable that is fixed is the level of technology, 

but this can be introduced in the very long run, e.g., new IT or production 

techniques are introduced.

There is no standard measure for these time periods as they vary greatly from 

industry to industry, e.g., a market trader can increase its capital (the market 

stall) a lot quicker than ICI (a new chemical plant). 

CONSUMER SURPLUS

Consumer surplus measures the welfare that consumers derive from their 

consumption of goods and services, or the benefits they derive from the 

exchange of goods.  Consumer surplus is the difference between what 

consumers are willing to pay for a good or service (indicated by the position of 

the demand curve) and what they actually pay (the market price).  The level of 

consumer surplus is shown by the area under the demand curve and above 

the ruling market price

Consider the demand for public transport shown in the diagram. The initial 

fare is price P1 for all passengers and at this price, Q1 journeys are demanded 

by local users.  At price P1the level of consumer surplus is shown by the area 

AP1B. If the bus company cuts price to P2 the demand for bus journeys 

expands to Q2 and the new level of consumer surplus rises to AP2C. This 

means that the level of consumer welfare has increased by the area P1P2CB. 

Consumer surplus = total willingness to pay for a good or service - the total 

amount consumers actually do pay.  ]

If a zero fare is charged, consumers will demand bus journeys up to the point 

where the demand curve cuts the x-axis. When demand for a product is 

perfectly elastic, the level of consumer surplus is zero since the price that 

people pay matches the price they are willing to pay. There must be perfect 

substitutes in the market for this to be the case.  When demand is perfectly 

inelastic the amount of consumer surplus is infinite. Demand is invariant to a 

price change.

DYNAMIC PRICING AND CONSUMER SURPLUS

Dynamic pricing is becoming more common place with the diffusion of 

information technology in the economy. Dynamic pricing is when the price the 

firm charges to customers is sensitive to very short run changes in demand. 

For example, Coca Cola is experimenting in raising the price of cans from 

vending machines when the average temperature increases. Hotel bookings 

systems can change room rates on offer in response to fluctuations in 

occupancy rates. Changes in price to reflect certain market conditions can 

take advantage of variations in consumers' willingness to pay for certain 

items. 

PRODUCER SURPLUS

Producer surplus is used as a measure of producer welfare. It is defined as 

being the difference between what producers are willing and able to supply a 

good for (indicated by the position of the supply curve) and the price they 

actually receive.

The level of producer surplus is shown by the area above the supply curve 

and below the market price.