Perfect Competition and Long Run Equilibrium

Perfect Competition and Long Run Equilibrium

Firm's Break-Even Point

  • Firms break even with no economic profit but positive accounting profit.
  • They earn normal profit.

Side-by-Side Graphs: Market and Firm

  • Key graphs to illustrate:
    • Firm making a profit.
    • Firm making a loss.
    • Firm in long-run equilibrium.
  • Typical questions involve drawing and shifting these graphs to show adjustments in the long run due to profit or loss, or how short-run changes affect long-run equilibrium.

Firm Making a Profit

  • Initial short-run profit attracts new firms.
  • Market supply curve shifts rightward.
  • Market price decreases.
  • Return to long-run equilibrium.

Firm Making a Loss

  • Initial short-run loss leads firms to exit.
  • Market supply curve shifts leftward.
  • Market price increases.
  • Return to long-run equilibrium.

Demand Increase in Long-Run Equilibrium

  • Starting point: long-run equilibrium.
  • Scenario: demand for milk increases.
  • Market demand curve shifts to the right.
  • Market price increases, causing the individual firm to make a profit.
  • In the long run, new firms enter the market, causing the supply curve to shift to the right, returning the market to long-run equilibrium.

Constant Cost Industry

  • Entry of new firms does not increase the prices of inputs (e.g., milking machines, bottles, hay).
  • Costs remain constant; hence, the term "constant cost industry."

Increasing Cost Industry

  • Initial state: long-run equilibrium (no economic profit).
  • Demand for milk increases, raising the market price. Firms now make a profit.
  • New firms enter, increasing demand for inputs and raising their prices.
  • The average total cost (ATC) and marginal cost (MC) for all firms increase.
  • Market supply shifts to the right, but the new long-run equilibrium price is higher than the initial price.
  • Difference from constant cost industry: the long-run price increases.
  • Teachers typically use constant cost industry examples, but understanding increasing cost industries is important.

Long Run Efficiency

  • Firms are extremely efficient in the long run.
    • Two types of efficiency:
      • Allocative Efficiency
      • Productive Efficiency