Saturday, June 18, 2011

Perfect Competition - Long Run Equilibrium

Before reading this, read: Perfect Competition - Short Run Equilibrium

The long run is a period of time in which the quantities of all inputs are variable. The distinction between short run and long run varies from one industry to another. The plant capacity, which is considered as fixed in the short run, can also be considered as variable in the long run. It is assumed that in the long run all firms have made necessary long-term adjustments. The short run is a period of time in which the quantity of at least one input is fixed and the quantities of the other inputs can be varied.

In the long run it is impossible for a perfectly competitive firm to hold on to its short run economic or supernormal profit. The firm, in the long run, earns just enough profit to cover its economic (opportunity) costs.

As there is supernormal profit in the short run, new firms enter the industry. On the other hand, less efficient firms may be forced to move out of the industry. As new firms enter into the industry, they increase the supply of the product in the market. Competition among all the firms brings down the price of the product. More and more new firms, offering products at lower prices, bring down the market price of the product further.

The market price of the product, and with it the demand, will thus keep coming down until all the firms earn only normal profits. All of the economic or supernormal profit gets wiped out or disappears. Only in perfect competition P = AR = MR. Firms thus have no eagerness to enter or exit the industry. As short run economic profit disappears, there is no incentive for other firms to enter the industry. As the firms do not incur economic loss or earn below-normal profit, there is no urge for the firms to leave the industry.

As there is only 'normal profit', revenue is equal to cost, or average revenue (AR) is equal to average cost (AC). Equilibrium occurs where the AR curve (demand curve) is tangent to the AC curve at the only possible point of tangency, the minimum point. At the equilibrium point D, the equilibrium condition P=AC=AR=MC=MR is satisfied.

Equilibrium output OB is the profit-maximizing output as MC=MR. Equilibrium price is OA. Rectangle OADB represents the total cost, which is equal to total cost.

The firm's long run supply curve is the long run marginal cost curve above the minimum long run average cost curve (AC curve).

Remember that marginal cost rises less sharply in the long run, making the long run marginal cost curve flatter than what it is in the short run.

Also read: Shut down Conditions of a firm


  1. Is the point D, in your diagram, the equilibrium point E?!

    1. I am extremely sorry. The equilibrium point is D. In the narrative it has been referred to by mistake as E. Thanks a lot for pointing out the mistake. Necessary correction has been made.

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