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Perfect Competition in Long-Run Equilibrium
Mike FladlienMuscatine High School
Short-RunThe short run is a period in which some of the inputs are fixed. The inputs can be a rent payment, insurance premium, or a fixed amount of capital. The short run assumes that diminishing marginal returns are present.
The short run can also describe a period in which a firm is earning either positive or negative economic profits.
I will begin with a firm making an economic profit then show how the firm moves to the long run.
Let’s look at Barry’s Mud Pies, a firm in the perfectly competitive industry for mud pies.
Side by Side Market and Firm
The market is in equilibrium at $16, so the firm as a price taker sells it’s output at $16. The market produces 42 million units and the firm only supply 4800.
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Starting From an Economic Loss If the price is less than average variable cost, then some firms
will exit the market. The price will rise to the resource allocative price and the productive efficient price.
Long Run
As more competitors enter the market the industry supply curve shifts to the right. The price falls to the resource allocative position where each firm is making zero economic profit.
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Resource Allocative Price
If the price is $16, then the firm will produce 4800 (the quantity is in 100’s). The firm’s average total cost is greater than $12.
In long run the firm produces 3600 and the average total cost is $12. This means that the firm is making the good at the lowest cost (productive efficient) and resources are being employed to the value that society places on them.
I like to say that at point 1, resources are held captive and are employed above their opportunity cost. Since the resources have alternative uses, a lower price would free them to those alternative uses.
