Long Run when not constant

Perfect Competition and Long Run Equilibrium

Overview of Perfect Competition

  • Definition of Perfect Competition:
    • A market structure characterized by many firms, identical products (non-differentiated), the same cost structure, and no barriers to entry or exit.

Long Run Equilibrium in Perfect Competition

  • The Long Run Equilibrium or Long Run Steady State occurs when firms have adjusted to market conditions, resulting in no economic profits (zero economic profit).
  • In the context of the market for apples, the following principles apply:
    • Equilibrium Price: Determined by the intersection of the supply and demand curves.
    • For firms, this equilibrium price sets their Marginal Revenue (MR), which is equal across all firms in the market.
Firm Production Decisions
  • Rational Quantity to Produce:
    • The optimal output is where Marginal Revenue (MR) equals Marginal Cost (MC).
    • At this output, a firm achieves zero economic profit, where:
    • extAverageTotalCost(ATC)=extMarginalRevenue(MR)ext{Average Total Cost (ATC)} = ext{Marginal Revenue (MR)}
    • If MR > ATC, firms earn positive economic profit, attracting new entrants.
    • If MR < ATC, firms incur losses, prompting some to exit the market.
  • Any departure from zero economic profits leads to adjustments in the market until a new equilibrium is reached.

Market Shock and Increased Demand

  • Hypothetical Scenario: If a study reveals that apples confer significant health benefits (e.g., longevity, happiness), the demand curve shifts right to D'.
  • New Equilibrium:
    • The equilibrium price becomes P′P', leading to a new equilibrium quantity.
    • This shift raises the firms' Marginal Revenue curve to MR'.
    • The updated rational quantity for firms to produce moves to a higher quantity, Q′Q'.
  • Economic Profit Calculation:
    • At quantity Q′Q', firms profit by the difference between their price per unit and the ATC:
    • Profit per unit = Price - ATC
    • Total Economic Profit = (Profit per unit) × (Quantity produced)

Entry of New Firms

  • Due to the presence of economic profits, new firms enter the market, lured by the prospects of profit.
    • The entry causes demand for resources (like seeds and land) to increase, raising costs.
  • Impact on Cost Structures:
    • The original constant cost structure changes, possibly leading to:
    • An upward shift in the Marginal Cost (MC) curve, denoted as MC'.
    • An upward shift in the Average Total Cost (ATC) curve, denoted as ATC'.
  • New firms keep entering until profits are eroded to zero (equilibrium), marked when:
    • extMR=extMC=extATCext{MR} = ext{MC} = ext{ATC}
    • The equilibrium price ultimately stabilizes at P′P' as the new supply curve expands to S'.

Long Run Supply Curve in Increasing Costs

  • In a scenario with increased costs due to more firms entering the market, the Long Run Supply Curve becomes upward sloping, reflecting increasing costs in production.
    • This contrasts with constant cost markets where the supply curve might be flat.
  • Long Run Adjustments:
    • This includes adjustments related to fixed costs over time as firms respond to market signals (entering or exiting as needed).

Alternative Scenario: Decreasing Costs with Increased Entrants

  • Hypothetical Scenario: If the entry of more firms results in a decrease in input costs due to economies of scale (e.g., cheaper seeds or supplies), the following occurs:
    • The supply curve undergoes a shift downward.
    • The equilibrium price may be lower than prior levels,
    • In this case, firms experience declining costs, leading to a downward-sloping long run supply curve, capturing the opposite result of the increasing cost scenario.