1. Mod 60: LONG-RUN OUTCOMES IN PERFECT COMPETITION
Duffka school of economics

2. Key Economic Concepts For This Module:
The short-run market supply curve is the horizontal summation of each firm’s marginal cost curve at prices above the shut-down price. • When firms are earning short-run economic profits, the entry of new firms in the long run causes the market price to fall until only normal profits are being earned. This occurs when the price is equal to average total cost. This is the long-run equilibrium price in perfect competition. • The long-run supply curve is horizontal if the entry of new firms has no effect on input prices in the industry. This is referred to as a constant cost industry. • The long-run supply curve is upward sloping if the entry of new firms increases input prices in the industry. This is referred to as an increasing cost industry. • The long-run supply curve is downward sloping if the entry of new firms decreases input prices in the industry. This is referred to as a decreasing cost industry. • Long-run equilibrium in perfect competition insures three things: marginal cost is identical for all firms, normal profits are earned where price is equal to minimum average total cost, and the efficient level of output is produced.
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3. Module Presentation
I. The Industry Supply Curve A. The Short-Run Industry Supply Curve B. The Long-Run Industry Supply Curve C. The Cost of Production and Efficiency in Long -Run Equilibrium
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4. I. The Industry Supply Curve
REMINDER: The market price is determined by supply and demand. All of the firms MC=S curves summed create market supply
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5. I. The Industry Supply Curve
A. The Short-Run Industry Supply Curve
Long run market equilibrium occurs when the price has changed from the market to equal the firms minimum atc. There will be economic profit. Normal profit or break even will occur.
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6. the increase in supply caused the market price to decrease.
I. The Industry Supply Curve
A. The Short-Run Industry Supply Curve
the increase in supply caused the market price to decrease.
The market quantity has increased
The firms price will also decrease
The firms quantity(output) will decrease
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7. A market increase in demand leads to a higher P(MR).
I. The Industry Supply Curve
A. The Short-Run Industry Supply Curve
A market increase in demand leads to a higher P(MR).
A higher price entices firms to produce more.
A short run profit encourages new companies to enter
When new firms enter the existing firms will reduce output
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8. I. The Industry Supply Curve
B. The Long-Run Industry Supply Curve
• Profits exist in the short run. • The market sees entry of new firms. • More producers in the market shift the short-run market supply curve to the right. • The price begins to fall in the market. • As the price falls, each firm produces less along the MC curve. • Profits for each firm fall. • When the price reaches the break-even point at the minimum of ATC, entry stops.
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9. C. The Cost of Production and Efficiency in Long -Run Equilibrium
1. Marginal cost is the same for all producers because price is the same for all producers Economic profit is equal to zero for all producers. All firms earn a normal profit in the long run. Because this can only happen at the minimum of ATC, we can say that firms produce this product at the lowest possible average cost The market is efficient. All consumers who are willing to pay the price that is greater than or equal to the sellers’ marginal cost will get to buy the good. In other words, there is no deadweight loss in perfect competition because all mutually beneficial transactions are made.
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10. APE U3 L3 A29
.50= (4k X 1k)=
4,000,000
.75= (5k X 1k)=
5,000,000
1.00= (6k X 1k)=
6,000,000
1.25= (7k X 1k)=
7,000,000
There are 1,000 producers, each with costs like those shown above.
1. Plot on diagram B the current market supply curve for Greebes and label this curve S (Ask how much each producer will supply at various prices, and figure how much the total supply FROM ALL 1,000 PRODUCERS TOGETHER will be at those prices.
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Duffka School of Economics

11. APE U3 L3 A29
There are 1,000 producers, each with costs like those shown above.
1. Plot on diagram B the current market supply curve for Greebes and label this curve S (Ask how much each producer will supply at various prices, and figure how much the total supply FROM ALL 1,000 PRODUCERS TOGETHER will be at those prices.
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Duffka School of Economics

12. APE U3 L3 A29
There are 1,000 producers, each with costs like those shown above.
Shade in the appropriate profit (or loss) rectangle in Diagram A, and calculate the total amount of economic profit or loss each typical Greebe producer will make under these conditions. Fill in the blanks below:
A) Price (P) received by each producer: ____________ per Greebe.
$1.00
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13. APE U3 L3 A29
B) Q produced by each Greebe producer: _____ thousand Greebes per week.
C) ATC for this quantity (approximate):______ per Greebe.
D) Economic profit (loss) for each unit produced (P-ATC): _______ per Greebe.
E) Total economic profit (loss) for each Greebe producer: Profit (loss) per unit X quantity produced = __________ per week.
3. Is the Greebe market in LR equilibrium? Why or why not? 6
$.80
$.20
$1,200
($.20 X 6,000 = $1,200
No. Short run economic profits will attract additional firms. This will shift the market supply curve to the right, thus lowering the price.
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14. APE U3 L3 A29
$.75
What is the LR equilibrium in this market? _________ per Greebe.
A) How many Greebes will each firm produce at this price? _____ thousand Greebes per week.
B) What will be the total market quantity of Greebes produced at this price?
______ million Greebes per week.
C) How many firms will be in the market at this price? _________ 5 8
1,600
8,000,000 / 5,000= 1,600
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15. APE U3 L3 A29
1,000 Firms- New Cost Curve & Changed Market Conditions
Plot on Diagram D the current market supply
Shade in the appropriate profit (loss) in diagram C.
A) P received by each producer: ______ per Greebe
B) Q produced by each Greebe producer :_____th. Greebes per week.
C) ATC for this Q (approximate):________ per Greebe.
D) Economic profit (loss) for each unit produced (P-ATC):_______ per Greebe.
E) Total economic profit (loss) for each Greebe producer: Profit (loss) per unit X quantity produced: _____________ per week.
$.75 5
$1.05
-$.30
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-$1,500
Duffka School of Economics
-$.30 X 5,000 = -$1,500)

16. APE U3 L3 A29
Is the Greebe market in long run equilibrium? Why or why not?
NO. Short-run economic losses will cause some firms to leave the market. This will shift the supply curve to the left, thus raising the price.
What is the LR equilibrium price in this market?_______ per Greebe.
A) How many will each firm produce at this price_______ thousand per week.
B) What will be the total market quantities of Greebes produced at this price?______ million Greebes per week.
C) How many firms will be in the market at this price?_______.
$1.00 6 3
500
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17. Pure Competition and Efficiency
A. Whether the industry is one of constant, increasing, or decreasing costs, the final long‑run equilibrium will have the same basic characteristics (Figure 23-12).
1. Productive efficiency occurs where P = minimum ATC; at this point firms must use the least‑cost technology or they won’t survive.
2. Allocative efficiency occurs where P = MC, because price is society’s measure of relative worth of a product at the margin or its marginal benefit. And the marginal cost of producing product X measures the relative worth of the other goods that the resources used in producing an extra unit of X could otherwise have produced. In short, price measures the benefit that society gets from additional units of good X, and the marginal cost of this unit of X measures the sacrifice or cost to society of other goods given up to produce more of X.

18. Pure Competition and Efficiency
3. If price exceeds marginal cost, then society values more units of good X more highly than alternative products the appropriate resources can otherwise produce. Resources are underallocated to the production of good X.
P>MC—More units desired
4. If price is less than marginal cost, then society values other goods more highly than good X, and resources are overallocated to the production of good X.
P<MC—Other goods valued

19. Pure Competition and Efficiency
5. Efficient allocation occurs when price and marginal cost are equal. Under pure competition this outcome will be achieved.
6. Dynamic adjustments will occur automatically in pure competition when changes in demand or in resource supplies or in technology occur. Disequilibrium will cause expansion or contraction of the industry until the new equilibrium at P = MC occurs.
7. “The invisible hand” works in a competitive market system since no explicit orders are given to the industry to achieve the P = MC result.

20. Practice Question #1
1. In the long run, a perfectly competitive firm will earn a. a negative market return. b. a positive profit. c. a loss. d. a normal profit. e. excess profit.
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21. Practice Question #2
2. With perfect competition, productive efficiency is generally attained in a. the short run but not the long run. b. the long run but not the short run. c. both the short run and the long run. d. neither the short run nor the long run. e. specific firms only.
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22. Practice Question #3
3. Compared to the short-run industry supply curve, the long-run industry supply curve will be more a. elastic. b. inelastic. c. steeply sloped. d. profitable. e. accurate.
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Duffka School of Economics

23. Practice Question #4
4. Which of the following is generally true for perfect competition?    I. There is free entry and exit.    II. Long-run market equilibrium is efficient.    III. Firms maximize profits at the output level where P = MC. a. I only b. II only c. III only d. I and II only e. I, II, and III
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24. Practice Question #5
5. Which of the following will happen in response if perfectly competitive firms are earning positive economic profit? a. Firms will exit the industry. b. The short-run industry supply curve will shift right. c. The short-run industry supply curve will shift left. d. Firm output will increase. e. Market price will increase.
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25. APE U3 L3 A31 Figure 31.1: Short Run Economic Profit Industry Firm SMC
ATC
PRICE
PRICE
MR=D
AVC D
QUANTITY
QUANTITY
The firm will maximize profits where MR=MC and will achieve profitability because P is above its ATC curve.
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26. Figure 31.2 Short Run Economic Loss Industry Firm MC S ATC PRICE PRICE
MR=D D
AVC
QUANTITY
QUANTITY
The firm will minimize losses where MR=MC. At this level of output, the firm is covering all of its variable costs and a portion of its fixed costs. In this example, the firm will minimize its losses in the SR by continuing to produce b/c price is above it AVC curve.
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27. Figure 31.3 Classic Shutdown Position Industry FirmMC S
ATC
PRICE
PRICE
AVC
MR=D
P<AVC D
QUANTITY
QUANTITY
Price is below the AVC curve, and the firm will minimize its losses by closing down. However, it will still experience fixed costs.
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28. Figure 31.4 Long Run Equilibrium Industry FirmMC S
Long Run=P=MC=MR=D=AR
Allocative & Productive
ATC
PRICE
PRICE
MR=D D
AVC
QUANTITY
QUANTITY
The firm will be in long run equilibrium where MC=minimum ATC=MR. The firm is breaking even; there is no incentive for other firms to enter the market.
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29. Figure 31.5 From SR Profit to LR Equilibrium: Industry Firm S MC S2
ATC
PRICE
PRICE
MR=D
MR2
AVC D
QUANTITY
QUANTITY
Reports of firms making an economic profit will cause other firms to enter the market. This will shift the supply curve to the right, causing prices to drop and eliminating profits. The firm will then be in LR equilibrium at the break-even point.
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30. Figure 31.6
From Short-Run Losses to Long Run Equilibrium
Industry Firm MC S2
PRICE
PRICE
ATC S1
MR1=P1
MR=P=D
AVC D
QUANTITY
QUANTITY
Firms within an industry cannot continue to operate at a loss in the LR. Therefore, the least efficient firms will exit the industry first, thus shifting the industry supply curve to the left and raising price. Firms that survive will move to their break-even long-run equilibrium.
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31. 2008 Free Response #1
… In answering the questions, you should emphasize the line of reasoning that generated your results; it is not enough to list the results of your analysis. Include correctly labeled diagrams, if useful or required, in explaining your answers. A correctly labeled diagram must have all axes and curves clearly labeled and must show directional changes. Use a pen with black or dark blue ink.
1. Callahan’s Orchard grows apples and operates in a constant-cost, perfectly competitive apple industry. Callahan’s Orchard is currently in long-run equilibrium.
(a) Draw correctly labeled side-by-side graphs for the apple market and Callahan’s Orchard, and show each of the following.
(i) Market output and price, labeled as “QM” and “PM”, respectively
(ii) Callahan’s output and price, labeled as “QF” and “PF”, respectively
(b) Now assume that the government provides farm support to apple growers by granting an annual lump-sum subsidy to all apple growers. Indicate the effect the subsidy would have on each of the following in the short run.
(i) Callahan’s quantity of output. Explain.
(ii) Callahan’s profit
(iii) The number of firms in the industry
(c) Indicate how each of the following will change in the long run as a result of the lump-sum subsidy.
(i) The number of firms in the industry. Explain.
(ii) Price
(iii) Industry output

32. 2008 Free Response #1
(a) 4 points: • One point is earned for a correctly labeled graph of the apple market, with PM and QM properly indicated.
• One point is earned for showing that the firm’s price equals the market price.
• One point is earned for the tangency of flat firm demand (PF) and ATC.
• One point is earned for QF where MR (P) = MC.
1. Callahan’s Orchard grows apples and operates in a constant-cost, perfectly competitive apple industry. Callahan’s Orchard is currently in long-run equilibrium.
(a) Draw correctly labeled side-by-side graphs for the apple market and Callahan’s Orchard, and show each of the following.
(i) Market output and price, labeled as “QM” and “PM”, respectively
(ii) Callahan’s output and price, labeled as “QF” and “PF”, respectively
correctly labeled
apple market
Callahan’s Orchard

33. 2008 Free Response #1
(b) Now assume that the government provides farm support to apple growers by granting an annual lump-sum subsidy to all apple growers. Indicate the effect the subsidy would have on each of the following in the short run.
(i) Callahan’s quantity of output. Explain.
(ii) Callahan’s profit
(iii) The number of firms in the industry
ANSWER:
(b) 4 points:
• One point is earned for concluding that the lump-sum subsidy will have no impact on Callahan’s output.
• One point is earned for explaining that the lump-sum subsidy will not affect MC (or MR).
• One point is earned for concluding that Callahan’s profit will increase.
• One point is earned for concluding that the number of firms in the industry will not change.

34. 2008 Free Response #1
(c) Indicate how each of the following will change in the long run as a result of the lump-sum subsidy.
(i) The number of firms in the industry. Explain.
(ii) Price
(iii) Industry output
ANSWER:
(c) 4 points:
• One point is earned for concluding that the number of firms in the industry will increase.
• One point is earned for explaining that the existence of profits attracts new firms.
• One point is earned for concluding that the price will fall.
• One point is earned for concluding that industry output will increase.

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