Unit 4: Perfect Competition
Lecture #3: Long-Run Supply
and Equilibrium
McGraw-Hill/Irwin
Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
The Long Run in Pure Competition
• In the long run
• Firms can expand or contract
capacity
• Firms enter and exit the industry
LO1
9-2
Three Assumptions for the Long Run
• Easy entry and exit
• The only long-run adjustment we consider
• Identical costs
• All firms in the industry have identical costs
• Constant-cost industry
• Entry and exit do not affect resource prices
LO2
9-3
Long-Run Equilibrium
• Entry eliminates profits
• Firms enter when P rises above ATC
• Ex. Consumer tastes increase demand
• Supply increases in the short-run
• Price falls back to long-run equilibrium
• Exit eliminates losses
• Firms exit when P falls below ATC
• Ex. Consumer tastes decrease demand
• Supply decreases in the short-run
• Price falls back to long-run equilibrium
LO3
9-4
Entry Eliminates Economic Profits
P
P
S1
MC
ATC
$60
50
MR
40
S2
$60
50
D2
40
D1
0
100
(a)
Single Firm
LO3
q
0
80,000 90,000 100,000
Q
(b)
Industry
9-5
Exit Eliminates Losses
P
P
S3
MC
ATC
$60
S1
$60
50
50
MR
D1
40
40
D3
0
100
(a)
Single Firm
LO3
q
0
80,000
90,000
100,000 Q
(b)
Industry
9-6
How do costs impact long-run supply?
• Constant cost industry
• Entry/exit does not affect LR ATC
• Constant resource price
• Supply curve is perfectly elastic
• Industry has ability to adjust to demand
shifts
LO4
9-7
LR Supply: Constant-Cost Industry
P
P1
P2 $50
Z3
Z1
Z2
S
P3
D1
D3
0
LO4
Q3
90,000
Q1
100,000
D2
Q2
110,000
Q
9-8
How do costs impact long-run supply?
• Increasing cost industry
• More firms = higher costs
• LR ATC increases with expansion &
causes new equilibrium price
• Supply curve is upward sloping
LO4
9-9
LR Supply: Increasing-Cost Industry
P
S
P2 $55
Y2
P1 $50
Y1
P3 $40
Y3
D2
D1
D3
0
LO4
Q3
90,000
Q1
100,000
Q2
110,000
Q
9-10
How do costs impact long-run supply?
• Decreasing-cost industry
• More firms = lower costs
• LR ATC increases and changes
equilibrium
• Long-run supply curve is downsloping
LO4
9-11
LR Supply: Decreasing-Cost Industry
P
P3 $55
X3
X1
P1 $50
X2
P2 $40
D3
S
D2
D1
0
LO4
Q3
90,000
Q1
100,000
Q2
110,000
Q
9-12
Pure Competition and Efficiency
• In the long run, efficiency is achieved
• P/MR = min ATC
• MC intersects ATC at minimum,
• therefore MR = MC = min. ATC
• Only normal profits in the long-run
LO5
9-13
Pure Competition and Efficiency
• Productive efficiency
• Producing where P = min. ATC
• Benefits consumers/society
• Only firms who use the best production
methods survive
LO5
9-14
Pure Competition and Efficiency
• Allocative efficiency
• Producing where P = MC
• Each item produced to the point at which the
•
LO5
value of the last unit is equal to the value of
the alternative good being sacrificed
Best mix of products and use of resources
9-15
Pure Competition Results
• Consumer and producer surplus
•
•
•
LO5
maximized
P = MC = lowest ATC
MC = MB
Maximum willingness to pay = minimum
acceptable price
9-16
Pure Competition and Efficiency
Single Firm
Market
P=MC=Minimum
ATC (Normal Profit) MC
Consumer
Surplus
S
Price
Price
ATC
P
MR P
Producer
Surplus
D
0
LO5
Qf
Quantity
0
Qe
Quantity
9-17
Dynamic Adjustments
• Purely competitive markets always
adjust to
• Changes in consumer tastes
• Resource supplies
• Technology
• Recall the “Invisible Hand”
LO6
9-18
Technological Advance: Competition
• Entrepreneurs seek economic profit
(beyond normal profit)
• Decrease costs by innovating
• New product development
LO6
9-19
Creative Destruction
• Competition and innovation may lead
to “creative destruction”
• Creation of new products and methods
destroys the old products and methods
LO6
9-20
Efficiency Gains from Entry
• Patent protected prescription drugs earn
substantial economic profits for the
pharmaceutical company
• Generic drugs become available as the
patent expires on the existing drug
• Results in a 30-40% reduction price
• Greater consumer surplus and efficiency
9-21
Efficiency Gains from Entry
a
S
P1
b
c
d
f
P2
D
Q1
Q2
9-22