1. Perfect Competition in the Long-run

2. Entry & Exit Dynamics
Recall, the long-run is the time period in which all inputs can be adjusted and new firms can enter and existing firms can exit the market
There are three key scenarios,
If Profit < 0 (i.e. P < AC) then existing firms exit
This decreases the supply and the market supply curve shifts left
Price (P) increases and quantity (Q) decreases
Price continues to increase and quantity continues to decrease until no firms have incentives to exit (i.e. until existing firms earn zero profits. That is, P = AC)

3. If Profit = 0 (i.e. P = AC) then no firms have an incentive to enter or exit the market
If Profit > 0 (i.e. P > AC) then new firms enter
This increases the supply and the market supply curve shifts right
Price (P) decreases and quantity (Q) increases
Price continues to decrease and quantity continues to increase until no firms have incentives to enter (i.e. until existing firms earn zero profit. That is, P = AC)

4. Long-run Equilibrium
There are several conditions of long-run equilibrium for perfect competition
Economic profit is zero for individual firms and the industry.
There is no tendency for firms to enter or leave the industry
All existing firms are earning normal profit
For a single firm, long-run equilibrium occurs at the point where MR = MC = P = ATC

5. Changes in Demand & Equilibrium
Changes in demand temporarily change the equilibrium quantity and price.
Increase in demand
An Increase in demand temporarily raises price
Higher prices draw in new competitors
Increased supply returns price to equilibrium
Decrease in demand
A decrease in demand temporarily lowers price
Lower prices drive away some competitors
Decreased supply returns price to equilibrium

6. Example; Long-run Equilibrium
Example; Suppose at the initial equilibrium, we have P1 and Q1
Each firm earns zero profit since P = AC
Now, suppose that there is an increase in demand
The market demand curve shifts to the right and price increases
Now, P > AC and existing firms earn positive profit
New firms enter the market
The market supply increases and shifts the supply curve to the right
Price decreases and quantity increases

7. Price will continue to decrease and quantity will continue to increase until P = AC

8. Pure Competition & Efficiency
In purely competitive markets both productive and allocative efficiency are achieved in the long-run
Productive Efficiency: the production of a good in the least costly way
In the long-run, pure competition forces firms to produce at the minimum average total cost of production
Price = Minimum ATC
Allocative Efficiency: the particular mix of goods and services produced is the most highly valued by society
In pure competition, profit-motivated firms produce each good or service to the point where price (marginal benefit) and marginal cost are equal
Price = MC

9. Consumer and Producer Surplus
After long-run adjustments, purely competitive markets maximize the combined amounts of consumer surplus and producer surplus
Consumer Surplus: is the difference between the maximum price a consumer is willing to pay and the market price
Producer Surplus: is the difference between the minimum price that producers are willing to accept and the market price

10. Solution- (10 Marks/20 Minutes)
Example; Efficiency
Question: Using a diagram, explain how allocative and productive efficiency will be achieved in long-run equilibrium in perfect competition.
Solution- (10 Marks/20 Minutes)
Productive Efficiency: is the production of a good or service in the least costly way
In the long-run, a perfectly competitive firm produces at the minimum average total cost of production (i.e. Price = min ATC)
Allocative Efficiency: the goods and service that are produced are those that are most highly valued by society
Price = MC

11. In the long-run, competitive forces drive the price towards equilibrium where P = MC = min ATC
This is illustrated in the diagram below,
There are three different scenarios in the short-run,
If a firm is losing money in the short-run then in the long-run it will exit the industry, thereby driving prices higher as fewer firms will be producing the good.

12. Weaker firms with higher costs can’t compete and exit the industry.
This promotes productive efficiency because firms are forced to try to minimize their costs of production
In contrast, if a firm is earning supernormal profits in the short-run, where explicit and implicit costs are covered and exceeded ,then more firms enter the industry
This drives the price down as more firms begins to compete and produce the good or service
This ensures allocative efficiency because prices are driven down to the point where the marginal benefit is just equal to the marginal cost (i.e. P = MC )
Lastly, if a firm is earning zero economic profit, where implicit and explicit costs are just covered ,then it is in the long-run equilibrium.

13. No firm has any incentive to enter or exit the industry
This occurs where P = MC = min ATC
Perfect competition ensures productive and allocative efficiency in the long run because competitive forces allocate resources where they are most highly-valued.

14. Study Questions
1) Why do individual firms in a perfectly competitive market face horizontal demand curve?
2) Willy’s Diner, a perfectly competitive firm, sells its “breakfast special” for $5. The average variable cost (e.g. waiters, cooks, power and food) is $3.95 per meal and the average fixed cost (e.g. the lease, insurance, and costs of equipment) is $1.25 per meal. What should Willy’s Diner do in the short-run and in the long-run?
3) Merck is a pharmaceutical company in the US. Assume the American drug market is perfectly competitive
Draw a graph and show the equilibrium price and quantity
Suppose the firm is making a positive profit in the short-run. Show this on a graph with the demand curve, MC and AC curve