Pure Competition in the Long Run 12 McGraw-Hill/IrwinCopyright © 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

Profit Maximization in 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

Long-Run Equilibrium Entry eliminates profits Firms enter Supply increases Price falls Exit eliminates losses Firms exit Supply decreases Price rises LO3

Entry Eliminates Economic Profits LO3 (a) Single Firm (b) Industry P P q Q ,00080,000100,000 ATC MR MC $ D1D1 S1S1 D2D2 $ S2S2

Exit Eliminates Losses LO3 (a) Single Firm (b) Industry P P q Q ,00080, ,000 ATC MR MC $ D3D3 S3S3 D1D1 $ S1S1

Long Run Supply Constant cost industry Entry/exit does not affect LR ATC Constant resource price Special case Increasing cost industry Most industries LR ATC increases with expansion Specialized resources Decreasing cost industry LO4

LR Supply: Constant-Cost Industry LO4 P 0 Q 90,000100,000110,000 Q3Q3 Q1Q1 Q2Q2 $50 P1P2P3P1P2P3 S Z1Z1 Z2Z2 Z3Z3 D3D3 D1D1 D2D2

LR Supply: Increasing-Cost Industry LO4 P 0 Q 90,000100,000110,000 Q3Q3 Q1Q1 Q2Q2 $50 P1P1 S Y1Y1 Y2Y2 Y3Y3 D3D3 D1D1 D2D2 $40 $55 P2P2 P3P3

LR Supply: Decreasing-Cost Industry LO4 P 0 Q 90,000100,000110,000 Q3Q3 Q1Q1 Q2Q2 $50 P1P1 S X1X1 X2X2 X3X3 D3D3 D1D1 D2D2 $40 $55 P3P3 P2P2

Pure Competition and Efficiency In the long run, efficiency is achieved Productive efficiency Producing where P = min. ATC Allocative efficiency Producing where P = MC LO5

Pure Competition and Efficiency LO5 Single FirmMarket Price Quantity 0 0 P MR D S QeQe QfQf ATC MC P=MC=Minimum ATC (Normal Profit) P Consumer Surplus Producer Surplus

Dynamic Adjustments Purely competitive markets will automatically adjust to Changes in consumer tastes Resource supplies Technology Recall the “Invisible Hand” LO6

Technological Advance: Competition Entrepreneurs would like to increase profits beyond just a normal profit Decrease costs by innovating New product development LO6

Creative Destruction Competition and innovation may lead to “creative destruction” Creation of new products and methods destroys the old products and methods LO6

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

Efficiency Gains from Entry Q1Q1 Q2Q2 P1P1 S D P2P2 a b c d f