The Structure of Costs and the Competitive Equilibrium

There are three cases that we wish to study. Each involves the equilibrium adjustment in a competitive market to changes in exogenous constraints. Number one is the effect of a change in an input price; two is the effect of an input restriction; and three is the effect of an output quota. An example of the first case is the minimum wage. When the government increases the minimum wage, we want to be able to describe its effect on the Average Cost functions of the firms using this resource, unskilled labor. If the minimum wage affects AC, it must also have an effect on the price of output. An increase in the minimum wage must increase AC and hence increase the price of output. Thus, the level of market output must fall. The question becomes one of how the optimal firm size changes and how the optimal number of firms adjusts. That is, do firms enter or leave the market? A collateral question is, How is the use of other inputs affected by the change in the price of the one? We will attempt to answer all of these questions as we develop the theory. But, you have to crawl before you walk, as they say. So, we will first take up the simplest question first: the market equilibrium effect of output quotas.