Perfet Long Run

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Perfect Competition Long Run

Chapter 10-2


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The Long Run

The short run is a timeframe in which atleast one of the resources used inproduction cannot be changed.

Exit and entry are long-run phenomena.

In the long run, all quantities of resources

can be changed.


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An Increase in Demand

An increase in demand leads to higherprices and higher profits.

Existing firms increase output.

New firms enter the market, increasing outputstill more.

Price falls until all profit is competed away.


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If input prices remain constant, the newequilibrium will be at the original price butwith a higher output.


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The original firms return to their originaloutput but since there are more firms inthe market, the total market output

increases.


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In the short run, the price does more of theadjusting.

In the long run, more of the adjustment isdone by quantity.


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Profit$9

10 120

FirmPrice

Quantity

B

A

Market Response to anIncrease in Demand

Market

Quantity

Price

0

B

A

C

MC

AC

SLR

S0SR

D0

7

700

$9

8401,200

D1

S1SR

7

McGraw-Hill/Irwin 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.


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Normal Profit in the Long Run

Entry and exit occur whenever firms are earningmore or less than normal profit (zeroeconomic profit).

If firms are earning more than normal profit, other

firms will have an incentive to enter the market. If firms are earning less than normal profit, firms in the

industry will have an incentive to exit the market.


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Economic Profit in the Long Run


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The Predictions of theModel of Perfect Competition

A zero economic profitis a normal accountingprofit, or just normal profit.

Firms produce where marginal cost equals price.

No one could be made better off without makingsomeone else worse off. Economists refer to this

result as economic efficiency.


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Who is Better Off?

Lower labor costs mean Chinese firms cancharge 30% to 50% less than their U.S.competitors for the same product.

Makers of apparel, electric appliances, andplastics have been shutting U.S. factories fordecades, resulting in the loss of 2.7 millionmanufacturing jobs since 2000.

Meanwhile, America's deficit with China islikely to pass $150 billion this year.


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Long-Run Competitive

Equilibrium

Profits create incentives for new firmsto enter, market supply will increase,and the price will fall until zero profitsare made

At long run equilibrium, economic profits are zero

The existence of losses will cause firms to leave theindustry, market supply will decrease, and the pricewill increase until losses are zero

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Equilibrium

Normal profitis the amount the owners would havereceived in their next best alternative

Zero profit does not mean that the entrepreneur doesnot get anything for his efforts

Economic profits are profits above normal profits

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Equilibrium GraphP

Q

P = D = MR

MC

SRATC

LRATC

At long-run equilibrium,economic profits are zero

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SR Profits

Market Response to an Increase in

Demand GraphP

Q

S0(SR)

P0

D0

P

Q

P0

MC

ATC

Q0,2

Market Firm

S1(SR)

D1

P1

1

P11 1

Q1

2

2 2

Q0 Q1 Q2

1

1 22

S(LR)

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Long-Run Market Supply

If the long-run industry supply curve is

upward sloping, the market is anincreasing-cost industry

If the long-run industry supply curve is perfectlyelastic, the market is a constant-cost industry

If the long-run industry supply curve is downwardsloping, the market is a decreasing-cost industry

In the short run, the price does more of the adjusting,and in the long run, more of the adjustment is doneby quantity

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Application: Kmart

After 2 years of losses, Kmart realizedthat the decrease in demand waspermanent

Although Kmart was making losses, Kmart decidedto keep 300 stores open because P>AVC

They moved from the short run to the long run andclosed the stores because prices had fallen below

their long-run average costs

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Perfet Long Run