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How Does A Perfectly Competitive Market Reach Long Run Equilibrium?
P
Q
P
Q 5000
D
S
Industry Firm (price taker)
$15 $15
Side-by-side graph for perfectly completive
industry and firm.
2
AVC
MR=D ATC
MC
8
Is the firm making a profit or a loss? Why?
Total Revenue
$25
20
15
10
0
Co
st
an
d R
even
ue
1 2 3 4 5 6 7 8 9 10
MC
AVC
ATC
Where is the profit maximization point? How do you know?
MR=P
Total Cost
Profit
How much is the profit or loss?
What is TR? What is TC?
Where is the Shutdown Point?
What output should be produced?
3
I. Supply
Revisited
4
$50
45 40 35 30 25 20 15 10
5 0
Co
st a
nd
Rev
en
ue
1 2 3 4 5 6 7 9
AVC
ATC
5
MR1
Marginal Cost and Supply
MR2
MR3
MR4
MR5
MC
Q
As price increases, the quantity increases
When price increases, quantity increases When price decrease, quantity decreases
$50
45 40 35 30 25 20 15 10
5 0
Co
st a
nd
Rev
en
ue
1 2 3 4 5 6 7 9
AVC
ATC
6
Marginal Cost and Supply
MC
Q
= Supply
MC above AVC is the supply curve
What if variable costs increase (ex: tax)?
$50
45 40 35 30 25 20 15 10
5 0
Co
st a
nd
Rev
en
ue
1 2 3 4 5 6 7 9
AVC
7
Marginal Cost and Supply
Q
MC1=Supply1
AVC
MC2=Supply2
When MC increases, SUPPLY decrease
What if variable costs decrease (ex: subsidy)?
$50
45 40 35 30 25 20 15 10
5 0
Co
st a
nd
Rev
en
ue
1 2 3 4 5 6 7 9
AVC
8
Marginal Cost and Supply
Q
MC1=Supply1
AVC
MC2=Supply2
When MC decreases, SUPPLY increases
II. Perfect Competition
in the Long-Run
9
You are a wheat farmer. You learn that there is a more profit in making corn.
What do you do in the long run?
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.
10
P
Q
P
Q 5000
D
S
Industry Firm (price taker)
$15 $15
Side-by-side graph for perfectly completive
industry and firm in the LONG RUN
11
MR=D
ATC
MC
8
Is the firm making a profit or a loss? Why?
Price = MC = Minimum ATC
Firm making a normal profit
Firm in Long-Run Equilibrium
12
P
Q
$15
12
MR=D
ATC
MC
8
There is no incentive
to enter or leave the
industry TC = TR
III. Going from Long-
Run to Short-Run
13
P
Q
P
Q 5000
D
S
Industry Firm
$15 $15
14
MR=D ATC
MC
8
1. Is this the short or the long run? Why?
2. What will firms do in the long run?
3. What happens to P and Q in the industry?
4. What happens to P and Q in the firm?
6000
P
Q
P
Q 5000
D
S
Industry Firm
$15 $15
15
MR=D ATC
MC
8
S1
$10
Firms enter to earn profit so supply increases in the industry
Price decreases and quantity increases
6000
P
Q
P
Q 5000
D
S
Industry Firm
$15 $15
16
MR=D ATC
MC
8
Price falls for the firm because they are
price takers. Price decreases and quantity decreases
S1
$10 $10 MR1=D1
5 6000
P
Q
P
Q 5000
D
Industry Firm 17
ATC
MC
New Long Run Equilibrium at $10 Price Zero Economic Profit
S1
$10 $10 MR1=D1
5 6000
P
Q
P
Q 5000
D
S
Industry Firm
$15 $15
18
MR=D
ATC MC
8
1. Is this the short or the long run? Why?
2. What will firms do in the long run?
3. What happens to P and Q in the industry?
4. What happens to P and Q in the firm?
4000
P
Q
P
Q 5000
D
S
Industry Firm
$15 $15
19
MR=D
MC
8
S1
$20
Firms leave to avoid losses so supply decreases in the industry
Price increases and quantity decreases
ATC
4000
P
Q
P
Q 5000
D
S
Industry Firm
$15 $15
20
MR=D
MC
8
S1
$20
Price increase for the firm because they are price takers.
Price increases and quantity increases
ATC
4000
MR1=D1
9
$20
P
Q
P
Q
D
Industry Firm 21
MC
S1
$20
New Long Run Equilibrium at $20 Price Zero Economic Profit
ATC
4000
MR1=D1
9
$20
IV. Going from Long-
Run to Long-Run
22
P
Q
P
Q 5000
D
S
Industry Firm
$15 $15
23
MR=D
MC
8
Currently in Long-Run Equilibrium If demand increases, what happens in the short-run
and how does it return to the long run?
ATC
MR1=D1
P
Q
P
Q 5000
D
S
Industry Firm
$15 $15
24
MR=D
MC
8
D1
$20
Demand Increases The price increases and quantity increases
Profit is made in the short-run
ATC
MR1=D1
9
$20
P
Q
P
Q 5000
D
S
Industry Firm
$15 $15
25
MR=D
MC
8
D1
$20
Firms enter to earn profit so supply increases in the industry
Price Returns to $15
ATC
MR1=D1
9
$20
7000
S1
P
Q
P
Q
D
Industry Firm
$15 $15
26
MR=D
MC
8
D1
Back to Long-Run Equilibrium The only thing that changed from long-run to
long-run is quantity in the industry
ATC
7000
S1
V. Efficiency
27
PURE COMPETITION AND EFFICIENCY
•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
In general, efficiency is the optimal use of societies scarce resources
1. Productive Efficiency
2. Allocative Efficiency
There are two kinds of efficiency:
28
Efficiency Revisited B
ike
s
Computers
14
12
10
8
6
4
2
0
0 2 4 6 8 10
A
B
C
D
F
E
Which points are productively efficient?
Which are allocatively efficient?
G
29
Productive Efficient combinations are A through D
(they are produced at the lowest cost)
Allocative Efficient combinations depend on
the wants of society
Productive Efficiency
Price = Minimum ATC
The production of a good in a least costly way. (Minimum amount of resources are being used)
Graphically it is where…
30
P
Q
MC ATC
Quantity
Pri
ce
Notice that the product is NOT being made at the lowest possible cost
(ATC not at lowest point).
Short-Run
Profit
31
D=MR
P
Q
MC
ATC
Quantity
Pri
ce
Notice that the product is NOT being made at the lowest possible cost (ATC not at lowest point).
Short-Run
Loss
32
D=MR
P D=MR
Q
MC ATC
Quantity
Pri
ce
Notice that the product is being made at the lowest possible cost (Minimum ATC)
Long-Run Equilibrium
33
Allocative Efficiency
Price = MC
Producers are allocating resources to make the products most wanted by society.
Graphically it is where…
34
Why? Price represents the benefit people get from a product.
P MR
Q
MC
Quantity
Pri
ce
The marginal benefit to society (as measured by the price) equals the marginal cost.
Long-Run Equilibrium
Optimal amount being produced
35
$5 MR
15
MC
Quantity
Pri
ce
The marginal benefit to society is greater the
marginal cost. Not enough produced.
Society wants more
What if the firm makes 15 units?
20 Underallocation of resources
$3
36
$5 MR
22
MC
Quantity
Pri
ce
The marginal benefit to society is
less than the marginal cost.
Too much Produced.
Society wants less
20 Overallocation of resources
$7
37
What if the firm makes 22 units?
P D=MR
Q
MC ATC
Quantity
Pri
ce
P = Minimum ATC = MC EXTREMELY EFFICIENT!!!!
Long-Run Equilibrium
38
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