LONG RUN EQUILIBRIUM
Equilibrium of firm in the long run under perfect competition
Assumptions of Perfect Competition:
1. Many firms and many buyers: No single firm or buyer has market power; they are all
price takers.
2. Homogeneous products: The products offered by different firms are identical.
3. Free entry and exit: Firms can freely enter or exit the market based on economic
conditions.
4. Perfect information: All firms and consumers have complete knowledge about prices
and technology.
5. Profit Maximization: Firms aim to maximize their profit by choosing the quantity of
output that equates marginal cost (MC) with marginal revenue (MR).
Short-Run vs. Long-Run Equilibrium:
In the short run, firms may experience either economic profits, normal profits, or losses.
However, the long-run equilibrium in a perfectly competitive market ensures that all firms earn
only normal profit (zero economic profit). Here’s why:
1. Entry and Exit of Firms:
Economic profits: If firms are earning economic profits in the short run, new firms are
attracted to the market because of the high profits. The entry of new firms increases the
market supply, causing the price to fall. As the price falls, the economic profits of the
existing firms decrease until they are zero in the long run.
Economic losses: If firms are incurring economic losses, some firms will exit the market
because they cannot cover their costs. As firms leave, the market supply decreases,
causing the price to rise. The price will continue to rise until the remaining firms are no
longer experiencing losses and are earning zero economic profit.
2. Zero Economic Profit in the Long Run:
In the long-run equilibrium, firms adjust their production such that the price equals the
minimum average total cost (ATC). When price equals the minimum ATC, the firm
earns just enough revenue to cover all of its costs, including a normal return on the
entrepreneur's investment (i.e., zero economic profit).
At this point, firms operate efficiently, producing at the level where marginal cost (MC)
= marginal revenue (MR) = price and price = minimum average total cost (ATC).
1. Short Run: The firm may be producing where price (P) is above or below average total
cost (ATC), leading to either economic profits or losses.
, 2. Long Run: The price adjusts to the point where it equals the minimum point of the ATC
curve, ensuring firms make zero economic profit.
Key Features of Long-Run Equilibrium:
1. Price equals Marginal Cost (MC) = Average Total Cost (ATC): The firm produces at
the most efficient scale where costs are minimized, and no firm has an incentive to
change its level of output or enter/exit the market.
2. Normal Profit: Firms earn just enough to cover their costs, with no incentive for firms to
enter or exit the market.
3. Efficient Allocation of Resources: The market operates at the most efficient output level
where resources are allocated optimally, and there is no deadweight loss.
Key Points to Include:
1. Marginal Cost (MC): The curve that represents the additional cost of producing one
more unit of output.
2. Average Total Cost (ATC): The curve that represents the average cost per unit of
output.
3. Price (P): In the long-run equilibrium, the price is determined by the intersection of the
market supply and demand curves. The firm is a price taker, so it faces a perfectly elastic
demand curve at price PPP.
4. Long-Run Equilibrium Condition: In the long run, the firm will produce at the output
level where P=MC=ATCP = MC = ATCP=MC=ATC.
Key Features of the Diagram:
The demand curve (D) is horizontal at the market price because the firm is a price taker.
The MC curve intersects the ATC curve at its lowest point, indicating that the firm is
producing at the most efficient scale.
The price equals both the marginal cost (MC) and the average total cost (ATC), which
means the firm is earning zero economic profit in the long run.
Diagram:
Below is a simplified outline of the diagram:
Equilibrium of firm in the long run under perfect competition
Assumptions of Perfect Competition:
1. Many firms and many buyers: No single firm or buyer has market power; they are all
price takers.
2. Homogeneous products: The products offered by different firms are identical.
3. Free entry and exit: Firms can freely enter or exit the market based on economic
conditions.
4. Perfect information: All firms and consumers have complete knowledge about prices
and technology.
5. Profit Maximization: Firms aim to maximize their profit by choosing the quantity of
output that equates marginal cost (MC) with marginal revenue (MR).
Short-Run vs. Long-Run Equilibrium:
In the short run, firms may experience either economic profits, normal profits, or losses.
However, the long-run equilibrium in a perfectly competitive market ensures that all firms earn
only normal profit (zero economic profit). Here’s why:
1. Entry and Exit of Firms:
Economic profits: If firms are earning economic profits in the short run, new firms are
attracted to the market because of the high profits. The entry of new firms increases the
market supply, causing the price to fall. As the price falls, the economic profits of the
existing firms decrease until they are zero in the long run.
Economic losses: If firms are incurring economic losses, some firms will exit the market
because they cannot cover their costs. As firms leave, the market supply decreases,
causing the price to rise. The price will continue to rise until the remaining firms are no
longer experiencing losses and are earning zero economic profit.
2. Zero Economic Profit in the Long Run:
In the long-run equilibrium, firms adjust their production such that the price equals the
minimum average total cost (ATC). When price equals the minimum ATC, the firm
earns just enough revenue to cover all of its costs, including a normal return on the
entrepreneur's investment (i.e., zero economic profit).
At this point, firms operate efficiently, producing at the level where marginal cost (MC)
= marginal revenue (MR) = price and price = minimum average total cost (ATC).
1. Short Run: The firm may be producing where price (P) is above or below average total
cost (ATC), leading to either economic profits or losses.
, 2. Long Run: The price adjusts to the point where it equals the minimum point of the ATC
curve, ensuring firms make zero economic profit.
Key Features of Long-Run Equilibrium:
1. Price equals Marginal Cost (MC) = Average Total Cost (ATC): The firm produces at
the most efficient scale where costs are minimized, and no firm has an incentive to
change its level of output or enter/exit the market.
2. Normal Profit: Firms earn just enough to cover their costs, with no incentive for firms to
enter or exit the market.
3. Efficient Allocation of Resources: The market operates at the most efficient output level
where resources are allocated optimally, and there is no deadweight loss.
Key Points to Include:
1. Marginal Cost (MC): The curve that represents the additional cost of producing one
more unit of output.
2. Average Total Cost (ATC): The curve that represents the average cost per unit of
output.
3. Price (P): In the long-run equilibrium, the price is determined by the intersection of the
market supply and demand curves. The firm is a price taker, so it faces a perfectly elastic
demand curve at price PPP.
4. Long-Run Equilibrium Condition: In the long run, the firm will produce at the output
level where P=MC=ATCP = MC = ATCP=MC=ATC.
Key Features of the Diagram:
The demand curve (D) is horizontal at the market price because the firm is a price taker.
The MC curve intersects the ATC curve at its lowest point, indicating that the firm is
producing at the most efficient scale.
The price equals both the marginal cost (MC) and the average total cost (ATC), which
means the firm is earning zero economic profit in the long run.
Diagram:
Below is a simplified outline of the diagram:
