1

Perfect Competition in the

LONG RUN

2

Useful diagramP

D1 S1 ATC1 MC1

P=MR1P1

Q1 q1Q q

Market Firm

3

Produce the q where MR = MC and see what type of profit exists by looking at (P - ATC) times Q or TR-TC at the q mentioned.

Profit = TR - TC but this is hidden by the laws of algebra.

PQ = TRATC times Q = (TC/Q) times Q = TC

(P-ATC) times Q = PQ - (ATC times Q) = TR - TC

4

Notes about diagramMarketIn the market the price is determined by the interaction of supply and demand.When you think about the supply curve, there are a certain number of firms involved. You can think of this as being the short run where the amount of capital is fixed for each seller. In the short run, then, no new firms can enter either because they can’t get more capital either.

5

Notes about diagramFirmThe firm will produce where MR = MC and have profit = (P - ATC)Q = 0.

6

increase demandOn the next screen you will see demand increase in the market. Imagine consumers demand more. Then,1) The price in the market will increase to P2,2) The MR(price) for the firm will rise to MR2, 3) The output of the firm will expand to q2,4) The firm will have profit given by the shaded rectangle.

7

increase demandP

D1 S1 ATC1 MC1

P1=MR1P1

Q1 q1 q2

Q q

Market Firm

D2

P2P2 = MR2

8

demand increaseIn the short run when the demand increases, existing firms find it worthwhile to produce more, but they can not expand the production facility, by definition, and other firms can not enter the industry.The profit that exists in the short run are enjoyed by the firms in the industry. But in the long run other firms can enter the industry, as well as have existing firms expand their production facility. In the long run we want to note1) what impact profit has on firms and2) what happens to input prices.

9

profit impactIn the long run positive economic profit attracts firms to the industry. Firms will enter the industry until profit is driven to zero.The presence of economic losses(negative profits) forces some firms to leave the market. Firms will exit until the profit is zero.

10

input pricesBy definition in economics, resources are scarce. In the context of increasing demand for output we want to think about what might happen to the price of inputs. We consider three cases.1) Inputs are relatively abundant and thus there is no increase in input prices as the demand for inputs increases. This is called a constant cost industry.2) Inputs are in relative short supply and thus there is an increase in input prices as the demand for inputs increases. This is called an increasing cost industry.3) Inputs can be used in new ways and thus there is a decrease in input prices. This is called a decreasing cost industry.

11

ideas to comeNow, if a firm has positive economic profit we will see1) firms enter the market and thus market price falls, and2) the firms cost curves may shift if input prices change. This will have an impact on how much the supply curve shifts.

12

no change in input pricesP

D1 S1 ATC1 MC1

P1=MR1P1

Q1 q1 q2

Q q

Market Firm

D2

P2P2 = MR2

S2

Q2

13

no change in input pricesSince there is no change in input prices in this example profit will again be zero when the supply shifts out as far as the new demand to return the price to P1.

Supply S1 had a certain amount of firms involved and then some more firms entered(when profit was positive) to give us a certain amount of firms involved with S2. So there really is a separate supply curve for each specific number of firms in the industry. So in the long run we have variation in the number of firms in the industry, depending on the level of demand.

14

Long run supply curveThe long run supply curve in the market shows us the price and quantity combinations where1) the number of firms adjusts, and2) profit is zero.On the slide two screens ago we see the same price, P1, but two levels of output, Q1 and Q2. Since input prices didn’t change, P1 will always be the price that results in zero profit. On the following screen you will see the long run supply curve in the market in this constant cost case.

15

no change in input pricesP

D1 S1 ATC1 MC1

P1=MR1P1

Q1 q1 q2

Q q

Market long run supply Firm

D2

P2P2 = MR2

S2

Q2

16

input prices riseP

D1 S1 S2 ATC1 MC1

P1=MR1P1

Q1 q1 q2

Q q

Market Firm

D2

P2P2 = MR2

MC2 ATC2

P3

17

input prices increaseSince input prices increase in this example profit will again be zero when the supply shifts out, but not as far as the demand. Since the cost curves shift up the price to have zero profit will be higher than P1. Here you see the price is P3. Thus supply must shift out to have price P3.

18

input prices riseP

D1 S1 S2 ATC1 MC1

P1=MR1P1

Q1 q1 q2

Q q

Market Firm

D2

P2P2 = MR2

MC2 ATC2

P3

long runsupply

19

input prices fallP

D1 S1 ATC1 MC1

P1=MR1P1

Q1 q1 q2

Q q

Market Firm

D2

P2P2 = MR2

MC2

ATC2

S2

20

input prices fallSince input prices decrease in this example profit will again be zero when the supply shifts out, but farther than the demand. Since the cost curves shift down the price to have zero profit will be lower than P1. Here you see the price is P4. Thus supply must shift out to have price P4.

21

input prices fallP

D1 S1 ATC1 MC1

P1=MR1P1

Q1 q1 q2

Q q

Market long run Firm

D2

P2P2 = MR2

MC2

ATC2

S2

supply

22

long run supplyWe see the market supply curve is flatter in the long run that in the short run because in the long run firms can enter or exit the industry in response to positive or negative profit.