Perfect Competition in
the Long-Run
You are a wheat farmer. You learn that
there is a more profit in making corn.
What do you do in the long run?
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ACDC Leadership 2015
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In the Long-run…
•Firms will enter if there is profit
•Firms will leave if there is loss
•So, ALL firms break even, they make
NO economic profit
(No Economic Profit = Normal Profit)
•In long run equilibrium a perfectly
competitive firm is EXTREMELY
efficient.
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ACDC Leadership 2015
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Side-by-side graph for perfectly completive
industry and firm in the LONG RUN
Is the firm making a profit or a loss? Why?
P
S
P
MC
ATC
$15
MR=D
$15
D
5000
Industry
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ACDC Leadership 2015
Q
8
Q
Firm
(price taker)
3
Firm in Long-Run Equilibrium
***Price = MC = Minimum ATC***
Firm is making NO economic profit
Firm is making positive accounting profit
P
MC
ATC
$15
MR=D
There is no incentive to
enter or leave the
industry
TC = TR
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ACDC Leadership 2015
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Q
4
4
Going from Short-Run
to Long-Run
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ACDC Leadership 2015
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1.
2.
3.
4.
Is this the short or the long run? Why?
What will firms do in the long run?
What happens to P and Q in the industry?
What happens to P and Q in the firm?
P
S
P
MC
ATC
$15
MR=D
$15
D
5000 6000 Q
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ACDC Leadership 2015
Industry
8
Firm
Q
6
Firms enter to earn profit so supply
increases in the industry
Price decreases and quantity increases
P
S
P
MC
S1
ATC
$15
MR=D
$15
$10
D
5000 6000 Q
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ACDC Leadership 2015
Industry
8
Firm
Q
7
Price falls for the firm because they are
price takers.
Price decreases and quantity decreases
P
S
P
MC
S1
ATC
$15
$15
MR=D
$10
$10
MR1=D1
D
5000 6000 Q
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ACDC Leadership 2015
Industry
5 8
Firm
Q
8
New Long Run Equilibrium at $10 Price
Zero Economic Profit
P
P
MC
S1
ATC
$10
MR1=D1
$10
D
5000 6000 Q
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ACDC Leadership 2015
Industry
5
Firm
Q
9
1.
2.
3.
4.
Is this the short or the long run? Why?
What will firms do in the long run?
What happens to P and Q in the industry?
What happens to P and Q in the firm?
P
S
P
$15
MC
ATC
MR=D
$15
D
4000 5000
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ACDC Leadership 2015
Industry
Q
8
Firm
Q
10
Firms leave to avoid losses so supply
decreases in the industry
Price increases and quantity decreases
S1
P
S
P
MC
ATC
$20
$15
MR=D
$15
D
4000 5000
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ACDC Leadership 2015
Industry
Q
8
Firm
Q
11
Price increase for the firm because they
are price takers.
Price increases and quantity increases
S1
P
S
P
$20
MC
$20
$15
$15
ATC
MR1=D1
MR=D
D
4000 5000
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ACDC Leadership 2015
Industry
Q
89
Firm
Q
12
New Long Run Equilibrium at $20 Price
Zero Economic Profit
S1
P
P
$20
MC
$20
ATC
MR1=D1
D
4000
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ACDC Leadership 2015
Industry
Q
9
Firm
Q
13
Going from Long-Run to
Long-Run
Constant Cost Industry- New firms entering the
market does not increase the costs for the firms
already in the market.
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Currently in Long-Run Equilibrium
If demand increases, what happens in the short-run
and how does it return to the long run?
P
S
P
MC
ATC
$15
MR=D
$15
D
5000
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ACDC Leadership 2015
Industry
Q
8
Firm
Q
15
Demand Increases
The price increases and quantity increases
Profit is made in the short-run
P
S
P
MC
ATC
$20
$20
$15
$15
MR1=D1
MR=D
D1
D
5000
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ACDC Leadership 2015
Industry
Q
8 9
Firm
Q
16
Firms enter to earn profit so supply
increases in the industry
Price Returns to $15
P
S S1
P
MC
ATC
$20
$20
$15
$15
MR1=D1
MR=D
D1
D
5000 7000 Q
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ACDC Leadership 2015
Industry
8 9
Firm
Q
17
Back to Long-Run Equilibrium
The only thing that changed from long-run to
long-run is quantity in the industry
S1
P
P
MC
ATC
$15
MR=D
$15
D1
D
7000 Q
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ACDC Leadership 2015
Industry
8
Firm
Q
18
What if demand falls?
If demand decreases, what happens in the shortrun and how does it return to the long run?
P
S
P
MC
ATC
$15
MR=D
$15
D
5000
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ACDC Leadership 2015
Industry
Q
8
Firm
Q
19
Demand Decreases
The price decreases and quantity decreases
Loss is taken in the short-run
P
S
P
MC
ATC
$15
$10
5000
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ACDC Leadership 2015
MR=D
$15
$10
D1 D
Q
Industry
MR1=D1
7 8
Firm
Q
20
Firms exit to avoid losses so supply
decreases in the industry
Price Returns to $15
S1
P
S
P
MC
ATC
$15
$10
MR=D
$15
$10
3000 5000
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ACDC Leadership 2015
D1 D
Q
Industry
MR1=D1
7 8
Firm
Q
21
Back to Long-Run Equilibrium
The only thing that changed from long-run to
long-run is quantity in the industry
S1
P
P
MC
ATC
$15
MR=D
$15
D1
3000
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ACDC Leadership 2015
Industry
Q
8
Firm
Q
22
Practice
23
2012 Multiple Choice #23
24
2012 Multiple Choice #38
25
2010 FRQ #1
27
28
Going from Long-Run to
Long-Run
Increasing Cost Industry- New firms entering the
market increase the costs for the firms already in
the market.
(Only asked once on a FRQ- 2011 Form B)
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Currently in Long-Run Equilibrium
If demand increases, what happens in the short-run
and how does it return to the long run?
P
S
P
MC
ATC
$15
MR=D
$15
D
Q
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ACDC Leadership 2015
Industry
Q
Firm
30
INCREASING COST Industry
The price increases and quantity increases
Profit is made in the short-run
P
S
P
MC
$25
$25
ATC
$15
$15
MR=D
D1
D
Q
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ACDC Leadership 2015
Industry
Q
Firm
31
Firms enter to earn profit but fight for
resources causing costs to increase
Price Falls to $20
$25
$25
MC1
MC ATC1
ATC
$20
$15
$15
MR=D
P
S
P
S1
D1
D
Q
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ACDC Leadership 2015
Industry
Q
Firm
32
Firms enter to earn profit but fight for
resources causing costs to increase
Price Falls to $20
P
S1
MC1
P
ATC1
MR1
$20
D1
Q
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ACDC Leadership 2015
Industry
Q
Firm
33
2008 Audit Exam
Efficiency
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ACDC Leadership 2015
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In general, efficiency is the optimal use
of societies scarce resources
•Perfect Competition forces producers to use
limited resources to their fullest.
•Inefficient firms have higher costs and are the
first to leave the industry.
•Perfectly competitive industries are extremely
efficient
There are two kinds of efficiency:
1. Productive Efficiency
2. Allocative Efficiency
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Productive Efficiency- Producing at the
lowest possible cost (minimum amount
of resources are being used)
Graphically it is where price equals the
minimum ATC
Allocative Efficiency- Producing at the
amount most desired by society
(allocating resources towards the
products society wants)
Graphically it is where price equals
marginal cost
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ACDC Leadership 2015
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Long-Run Equilibrium
Single Firm
P=MC=Minimum
ATC (Normal Profit)
Market
MC
S
Price
Price
ATC
MR
P
P
D
0
Qf
Quantity
0
Qe
Quantity
Productive Efficiency: Price = minimum ATC
Allocative Efficiency: Price = MC
Pure competition has both in
its long-run equilibrium
What about in the short run?
9-38
Summary
Perfectly competitive firms are
allocatively and productively
efficient in the long-run
In the short-run, they are always
allocatively efficient, but they are
not productively efficient.
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