Perfect competition – the firm in the long run Outline Outline 1. Features of the long run 1. Features of the long run 2. Long-run equilibrium of the firm 2. Long-run equilibrium of the firm 3. Derivation of the long run supply curve 3. Derivation of the long run supply curve 4. Advantages & disadvantages of perfect competition 4. Advantages & disadvantages of perfect competition Outline Outline 1. Features of the long run 1. Features of the long run 2. Long-run equilibrium of the firm 2. Long-run equilibrium of the firm 3. Derivation of the long run supply curve 3. Derivation of the long run supply curve 4. Advantages & disadvantages of perfect competition 4. Advantages & disadvantages of perfect competition

1. Features of the long run A) Existing firms are making supernormal profits A) Existing firms are making supernormal profits B) All factors of production are variable B) All factors of production are variable existing firms expand existing firms expand C) Perfect factor mobility & perfect information C) Perfect factor mobility & perfect information new firms enter the industry (market) new firms enter the industry (market) new start-ups new start-ups switching switching Long-run equilibrium of the firm Long-run equilibrium of the firm price, output & profit price, output & profit A) Existing firms are making supernormal profits A) Existing firms are making supernormal profits B) All factors of production are variable B) All factors of production are variable existing firms expand existing firms expand C) Perfect factor mobility & perfect information C) Perfect factor mobility & perfect information new firms enter the industry (market) new firms enter the industry (market) new start-ups new start-ups switching switching Long-run equilibrium of the firm Long-run equilibrium of the firm price, output & profit price, output & profit

Fig 1a Long-run equilibrium under perfect competition OO D (a) Industry P£ Q (millions) P1P1 (b) Firm Q (thousands) LRAC AR 1 S1S1 D1D1 LRAC Supernormal profit

2. Long run equilibrium all supernormal profits competed away all supernormal profits competed away A) price is high (e.g. P 1 on Figure 1a) A) price is high (e.g. P 1 on Figure 1a) B) AR > LRAC: supernormal profit B) AR > LRAC: supernormal profit C) industry supply expands; supply shifts right C) industry supply expands; supply shifts right D) price falls (e.g. P L on Figure 1b) D) price falls (e.g. P L on Figure 1b) process continues until supernormal profits are competed away process continues until supernormal profits are competed away At P L, Q L we have long run equilibrium At P L, Q L we have long run equilibrium LRAC=AC=MC=MR=AR (see Fig 2) LRAC=AC=MC=MR=AR (see Fig 2) all supernormal profits competed away all supernormal profits competed away A) price is high (e.g. P 1 on Figure 1a) A) price is high (e.g. P 1 on Figure 1a) B) AR > LRAC: supernormal profit B) AR > LRAC: supernormal profit C) industry supply expands; supply shifts right C) industry supply expands; supply shifts right D) price falls (e.g. P L on Figure 1b) D) price falls (e.g. P L on Figure 1b) process continues until supernormal profits are competed away process continues until supernormal profits are competed away At P L, Q L we have long run equilibrium At P L, Q L we have long run equilibrium LRAC=AC=MC=MR=AR (see Fig 2) LRAC=AC=MC=MR=AR (see Fig 2)

OO S1S1 D (a) Industry P£ Q (millions) P1P1 (b) Firm AR 1 LRAC PLPL AR L QLQL SeSe D1D1 DLDL Q (thousands) Fig 1b Long-run equilibrium under perfect competition

Long-run equilibrium of the firm under perfect competition £ Q O AR = MR (SR)AC LRAC (SR)MC DLDL

3. Derivation of the long run supply curve Industry demand increases: what happens to P and Q? Industry demand increases: what happens to P and Q? initial rise in price, supernormal profits attracts new firms initial rise in price, supernormal profits attracts new firms supply increases supply increases If If A) price falls back to original level, the long run supply curve (LRS) is horizontal – constant costs A) price falls back to original level, the long run supply curve (LRS) is horizontal – constant costs B) price is higher than originally, the LRS is upward sloping – increasing costs – external diseconomies B) price is higher than originally, the LRS is upward sloping – increasing costs – external diseconomies C) price is lower than originally, LRS is downward sloping – decreasing costs – external economies C) price is lower than originally, LRS is downward sloping – decreasing costs – external economies

4. Advantages & disadvantages Advantages of perfect competition Advantages of perfect competition i) optimal allocation of resources i) optimal allocation of resources P = MC, P=MU thus MU = MC P = MC, P=MU thus MU = MC (ii) competition encourages efficiency (ii) competition encourages efficiency (iii) consumers charged a lower price (iii) consumers charged a lower price (iv) responsive to consumer wishes: change in demand, leads extra supply (iv) responsive to consumer wishes: change in demand, leads extra supply Advantages of perfect competition Advantages of perfect competition i) optimal allocation of resources i) optimal allocation of resources P = MC, P=MU thus MU = MC P = MC, P=MU thus MU = MC (ii) competition encourages efficiency (ii) competition encourages efficiency (iii) consumers charged a lower price (iii) consumers charged a lower price (iv) responsive to consumer wishes: change in demand, leads extra supply (iv) responsive to consumer wishes: change in demand, leads extra supply

4. Advantages & disadvantages Disadvantages Disadvantages (i) insufficient profits for investment (i) insufficient profits for investment (ii) lack of product variety (ii) lack of product variety (iii) lack of competition over product design and specification (iii) lack of competition over product design and specification (iv) unequal distribution of goods & income (iv) unequal distribution of goods & income (v) externalities e.g. pollution (v) externalities e.g. pollution Disadvantages Disadvantages (i) insufficient profits for investment (i) insufficient profits for investment (ii) lack of product variety (ii) lack of product variety (iii) lack of competition over product design and specification (iii) lack of competition over product design and specification (iv) unequal distribution of goods & income (iv) unequal distribution of goods & income (v) externalities e.g. pollution (v) externalities e.g. pollution