Equilibrium with capacity-constrained firms: A classroom experiment

Abstract

The authors develop a two-stage classroom experiment to illustrate convergence to long-run equilibrium in a market where price-taking firms are capacity-constrained. Once equilibrium in the first stage is established, capacity constraints are introduced by imposing discontinuities in the fixed costs of several firms. The experiment demonstrates that this supply shock yields a higher market price and, under assumed parameterization, several higher-cost firms that otherwise are not able to survive in the long-run equilibrium enter the market and earn positive profits.

Keywords:

• capacity constraints
• classroom game
• increasing market supply curve
• profit maximization

JEL CODES:

• A22
• A23
• C92
• D41

Acknowledgments

The authors thank the editors and two anonymous referees for valuable comments and suggestions.

Notes

1 The idea emerged when one of the authors was teaching a principles of microeconomics course using the Mankiw (2011) textbook. The material on pages 293–95 was important but difficult for students to comprehend. The designed game practically demonstrates all those points promoting an active learning of the material. If Mankiw (2011) is not the main textbook or if students are taking an upper-level course, we recommend sharing that part of the textbook with students so they become familiar with the theory (either before or after the experiment).

2 The speed of convergence may depend on the students’ background knowledge.

3 The full package of supporting materials (instruction, record sheets that include the cost structure for each firm, and Excel file) is available upon request from the authors.

4 We conducted the game also with an announcement of a [50,70] price interval, in which case the first stage lasted longer.

5 We thank the students who participated in the related lectures and the game itself. We also thank our colleagues for the opportunity to conduct some of the classroom experiments during their relevant classes.

6 We report results only for the parameterization considered in this article, although we have results also for the parameterization developed in an earlier version. In the current version of the article, we introduce a more sizeable supply shock in the second stage that we think makes the new equilibrium convergence more interesting. We thank one of the referees for this suggestion.

7 In one of the experiments we conducted for an earlier version of the article we did not display the profits: the convergence was smooth, although, as expected, it lasted a bit longer.

8 The integer restrictions on firms’ production levels are neglected in the graph of the long-run supply curve.

9 We do not introduce any change in the market demand.