Overview
This lecture explains long-run equilibrium in perfectly competitive markets, focusing on how market shocks and input cost changes affect supply, price, and firm profits.
Long-Run Equilibrium in Perfect Competition
- In perfect competition, many firms sell identical products with the same costs and no barriers to entry or exit.
- Market price is determined by the intersection of supply and demand curves; firms are price takers.
- Firms maximize profit where marginal revenue (MR) equals marginal cost (MC).
- In long-run equilibrium, MR also equals average total cost (ATC), resulting in zero economic profit.
- If MR > ATC, firms earn positive economic profit and new firms enter the market.
- If MR < ATC, firms incur losses and exit the market, restoring equilibrium.
Demand Shocks and Short-Run Profits
- An increase in consumer demand (e.g., positive health studies) shifts the demand curve right.
- Higher demand raises equilibrium price and quantity, creating a new MR curve.
- Firms produce more and earn positive economic profit at the new price.
Entry, Exit, and Cost Structure Changes
- Positive economic profit attracts new firms, increasing market supply.
- Increased entry can raise input costs (e.g., seeds, land), shifting firm's MC and ATC curves upward.
- Economic profit disappears when new MR equals new MC and new ATC, restoring zero economic profit in the long run.
Long-Run Supply Curve Scenarios
- In a constant cost industry, the long-run supply curve is flat (horizontal).
- In an increasing cost industry (inputs get more expensive as output rises), the long-run supply curve slopes upward.
- In a decreasing cost industry (inputs get cheaper with scale), the long-run supply curve slopes downward.
Key Terms & Definitions
- Perfect Competition — a market with many firms, identical products, and free entry/exit.
- Marginal Revenue (MR) — the additional revenue from selling one more unit.
- Marginal Cost (MC) — the additional cost of producing one more unit.
- Average Total Cost (ATC) — total cost divided by quantity produced.
- Long-Run Equilibrium — state where MR = MC = ATC and firms earn zero economic profit.
- Long-Run Supply Curve — relationship between market price and quantity supplied after all adjustments.
Action Items / Next Steps
- Review shifts in supply and demand curves under different market cost structures.
- Practice drawing long-run supply curves for constant, increasing, and decreasing cost industries.