Perfect Competition in the Long-Run 1 You are a wheat farmer. You learn that there is a more profit in making corn. What do you do in the long run? Copyright ACDC Leadership 2015

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. 2 Copyright ACDC Leadership 2015

P Q P Q 5000 D S Industry Firm (price taker) $15 Side-by-side graph for perfectly completive industry and firm in the LONG RUN 3 MR=D ATC MC 8 Is the firm making a profit or a loss? Why? Copyright ACDC Leadership 2015

Firm in Long-Run Equilibrium 4 P Q $15 4 MR=D ATC MC 8 There is no incentive to enter or leave the industry TC = TR Copyright ACDC Leadership 2015

Going from Short-Run to Long-Run 5 Copyright ACDC Leadership 2015

P Q P Q 5000 D S IndustryFirm $15 6 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 Copyright ACDC Leadership 2015

P Q P Q 5000 D S IndustryFirm $15 7 MR=D ATC MC 8 S1S1 $10 Firms enter to earn profit so supply increases in the industry Price decreases and quantity increases 6000 Copyright ACDC Leadership 2015

P Q P Q 5000 D S IndustryFirm $15 8 MR=D ATC MC 8 Price falls for the firm because they are price takers. Price decreases and quantity decreases S1S1 $10 MR 1 =D Copyright ACDC Leadership 2015

P Q P Q 5000 D IndustryFirm 9 ATC MC New Long Run Equilibrium at $10 Price Zero Economic Profit S1S1 $10 MR 1 =D Copyright ACDC Leadership 2015

P Q P Q 5000 D S IndustryFirm $15 10 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 Copyright ACDC Leadership 2015

P Q P Q 5000 D S IndustryFirm $15 11 MR=D MC 8 S1S1 $20 Firms leave to avoid losses so supply decreases in the industry Price increases and quantity decreases ATC 4000 Copyright ACDC Leadership 2015

P Q P Q 5000 D S IndustryFirm $15 12 MR=D MC 8 S1S1 $20 Price increase for the firm because they are price takers. Price increases and quantity increases ATC 4000 MR 1 =D 1 9 $20 Copyright ACDC Leadership 2015

P Q P Q D IndustryFirm 13 MC S1S1 $20 New Long Run Equilibrium at $20 Price Zero Economic Profit ATC 4000 MR 1 =D 1 9 $20 Copyright ACDC Leadership 2015

Going from Long-Run to Long-Run Constant Cost Industry- New firms entering the market does not increase the costs for the firms already in the market. 14 Copyright ACDC Leadership 2015

P Q P Q 5000 D S IndustryFirm $15 15 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 Copyright ACDC Leadership 2015

P Q P Q 5000 D S IndustryFirm $15 16 MR=D MC 8 D1D1 $20 Demand Increases The price increases and quantity increases Profit is made in the short-run ATC MR 1 =D 1 9 $20 Copyright ACDC Leadership 2015

P Q P Q 5000 D S IndustryFirm $15 17 MR=D MC 8 D1D1 $20 Firms enter to earn profit so supply increases in the industry Price Returns to $15 ATC MR 1 =D 1 9 $ S1S1 Copyright ACDC Leadership 2015

P Q P Q D IndustryFirm $15 18 MR=D MC 8 D1D1 Back to Long-Run Equilibrium The only thing that changed from long-run to long-run is quantity in the industry ATC 7000 S1S1 Copyright ACDC Leadership 2015

P Q P Q 5000 D S IndustryFirm $15 19 MR=D MC 8 What if demand falls? If demand decreases, what happens in the short- run and how does it return to the long run? ATC Copyright ACDC Leadership 2015

P Q P Q 5000 D S IndustryFirm $15 20 MR=D MC 8 D1D1 $10 Demand Decreases The price decreases and quantity decreases Loss is taken in the short-run ATC MR 1 =D 1 7 $10 Copyright ACDC Leadership 2015

P Q P Q 5000 D S IndustryFirm $15 21 MR=D MC 8 D1D1 $10 Firms exit to avoid losses so supply decreases in the industry Price Returns to $15 ATC MR 1 =D 1 7 $10 S1S Copyright ACDC Leadership 2015

P Q P Q IndustryFirm $15 22 MR=D MC 8 D1D1 Back to Long-Run Equilibrium The only thing that changed from long-run to long-run is quantity in the industry ATC S1S Copyright ACDC Leadership 2015

Practice 23

Multiple Choice #23

Multiple Choice #38

FRQ #1

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Going from Long-Run to Long-Run Increasing Cost Industry- New firms entering the market increase the costs for the firms already in the market. (Only asked once on a FRQ Form B) 29 Copyright ACDC Leadership 2015

P Q P Q D S IndustryFirm $15 30 MR=D Currently in Long-Run Equilibrium If demand increases, what happens in the short-run and how does it return to the long run? Copyright ACDC Leadership 2015 ATC MC

P Q P Q D S IndustryFirm $15 31 MR=D D1D1 $25 INCREASING COST Industry The price increases and quantity increases Profit is made in the short-run ATC $25 Copyright ACDC Leadership 2015 MC

P Q P Q D S IndustryFirm $15 32 MR=D D1D1 $25 Copyright ACDC Leadership 2015 Firms enter to earn profit but fight for resources causing costs to increase Price Falls to $20 S1S1 ATC MC $20 ATC1 MC1

P Q P Q IndustryFirm 33 MR1 D1D1 Copyright ACDC Leadership 2015 Firms enter to earn profit but fight for resources causing costs to increase Price Falls to $20 S1S1 $20 ATC1 MC1

2008 Audit Exam

Efficiency 35 Copyright ACDC Leadership 2015

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 : 36 Copyright ACDC Leadership 2015

Productive Efficiency- Producing at the lowest possible cost (minimum amount of resources are being used) Graphically it is where price equals the minimum ATC Allocative Efficiency- Producing at the amount most desired by society (allocating resources towards the products society wants) Graphically it is where price equals marginal cost 37 Copyright ACDC Leadership 2015

Single FirmMarket Price Quantity 0 0 Long-Run Equilibrium P MR D S QeQe QfQf ATC Productive Efficiency: Price = minimum ATC Allocative Efficiency: Price = MC Pure competition has both in its long-run equilibrium What about in the short run? MC P=MC=Minimum ATC (Normal Profit) P 9-38

Summary Perfectly competitive firms are allocatively and productively efficient in the long-run In the short-run, they are always allocatively efficient, but they are not productively efficient. 40 Copyright ACDC Leadership 2015