Pure Competition in the Long Run 11 Pure Competition in the Long Run The long‑run equilibrium position for a competitive industry is shown by reviewing the process of entry and exit in response to relative profit levels in the industry. Long‑run supply curves and the conditions of constant, increasing, and decreasing costs are explored. McGraw-Hill/Irwin Copyright © 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 Constant cost industry Recall, in the short run the industry is fixed in both the number of sellers and the plant size of existing sellers. In the long run all of these restrictions are relaxed. LO1

Entry eliminates profits Firms enter Supply increases Price falls Long-Run Equilibrium Entry eliminates profits Firms enter Supply increases Price falls Exit eliminates losses Firms exit Supply decreases Price rises Profits attract firms from less profitable industries and losses cause them to leave the unprofitable industry to find another more profitable one. This reflects the supply determinant, a change in the number of sellers. LO3

Pure Competition and Efficiency In long run efficiency is achieved Productive efficiency Producing where P = min. ATC Allocative efficiency Producing where P = MC Productive efficiency is producing goods in the least costly way. Allocative efficiency is producing the mix of goods most desired by society. Another bonus is consumer surplus and producer surplus are maximized in the long run in pure competition. Note: P=min ATC=MC does not occur in decreasing cost industries. LO5

Purely competitive markets will automatically adjust to: Dynamic Adjustments Purely competitive markets will automatically adjust to: Changes in consumer tastes Resource supplies Technology The “Invisible Hand” Dynamic adjustments will occur automatically in pure competition when changes in demand, or resource supplies, or technology occur. Disequilibrium will cause expansion or contraction of the industry until the new equilibrium at P = MC occurs. “The invisible hand” works in a competitive market system since no explicit orders are given to the industry to achieve the P = MC result. The profit motivation brings about highly desirable economic outcomes. LO6

Technological Advance: Competition Entrepreneurs would like to increase profits beyond just a normal profit Decrease costs by innovating New product development Innovation means using better technology or improved business organization. New product development means the firm may be first to market with a new product but others will soon follow and may destroy the innovating firm’s position. LO6

Competition and innovation may lead to “creative destruction” Creation of new products and methods Destroys the old products and methods Positive, but can increase unemployment Creative destruction refers to the idea that the creation of new products and new production methods destroys the market positions of firms committed to existing products and old ways of doing business. Examples of creative destruction are CDs (compact discs) being replaced with music downloads. Faxes and emails have affected traditional postal service. Online retailers like Amazon have taken business away from traditional bricks-and-mortar retailers. LO6