Perfectly Competitive Firms in the Long Run

Introduction

• Presenter: Jacob Reed from revieweecon.com
• Topic: Perfectly competitive firms in the long run
• Resources: Total review booklet at revieweecon.com

Key Concepts

Economic Profits and Losses

• Short Run: Firms can make economic profits or losses
• Long Run: Firms break even (zero economic profit or normal profit)
  • Normal Profit: Accounting profit equals the income from alternative use of resources
• Reason: Low barriers to entry

Drawing Zero Economic Profit

1. Supply and Demand Graph: Mark equilibrium price (P) and quantity (Q)
2. Firm Graph: Equilibrium price from market equals firm’s price (price takers)
3. MR DARP Curve: Marginal Revenue (MR), Demand (D), Average Revenue (AR), and Price (P) are equal
4. Profit Maximizing Quantity: Found where MR = MC
5. Break Even Point: Average Total Cost (ATC) curve tangent to MR = MC intersection

Transition to Long Run Equilibrium

1. Economic Profits: Attract new firms, increasing supply, driving down prices
   • Result: Firm’s MR DARP curve shifts down to ATC minimum point
2. Economic Losses: Firms exit the market, decreasing supply, driving up prices
   • Result: Firm’s MR DARP curve shifts up to ATC minimum point
3. Long Run Equilibrium: Firm’s price and quantity of output remain consistent
4. Market Adjustments: Entry and exit of firms adjust supply and demand to return to equilibrium

Impact of Demand Changes

• Increase in Demand: Short-run profits, new firms enter, increased supply, prices return to original
• Decrease in Demand: Short-run losses, firms exit, decreased supply, prices return to original
• Market Quantity: Changes according to number of firms, not individual firm output

Efficiency in Perfectly Competitive Markets

Allocative Efficiency

• Definition: Maximizes consumer surplus
• Condition: Price equals marginal cost (P = MC)
• Occurs: Always, regardless of firm’s profit situation

Productive Efficiency

• Definition: Producing at minimum ATC
• Condition: Only in the long run
• Occurs: At Q where ATC is minimized

Types of Industries

Constant Cost Industry

• Baseline Assumption: Firms operate in constant cost unless otherwise specified
• Characteristics:
  • High or low output at single price
  • Perfectly elastic long-run supply curve
  • ATC constant with entry/exit of firms

Increasing Cost Industry

• Characteristics:
  • ATC curve shifts up with entry of new firms
  • Upward sloping long-run supply curve
  • Higher long-run prices and costs with more firms

Decreasing Cost Industry

• Characteristics:
  • ATC curve shifts down with entry of new firms
  • Downward sloping long-run supply curve
  • Lower long-run prices and costs with more firms

Conclusion

• Further Practice: Graph drawing practice at revieweecon.com
• Resources: Total review booklet for comprehensive study