AP EconomicsMr. Bernstein

Module 60: Long-Run Outcomes in Perfect Competition

November 2015

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AP EconomicsMr. Bernstein

The Industry Supply Curve• In Perfect Competition, there are many small firms

producing identical products• Each has an identical Short-Run cost curve, which

is the MC curve above the shutdown point (AVC)• As P rises, output rises along the MC curve

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AP EconomicsMr. Bernstein

The Industry Supply Curve• The sum of each firm’s output on theirShort-Run supply curveis the Industry Short-Run Supply Curve

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AP EconomicsMr. Bernstein

Long-Run Equilibrium• In Perfect Competition,firms earn a normalprofit• But profits and lossesoccur in the short run…• …those profits and losses do not last, through a process of adjustment

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AP EconomicsMr. Bernstein

The Long-Run Process of Adjustment• When 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 their

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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AP EconomicsMr. Bernstein

The Long-Run Process of Adjustment• When losses exist in the short run• Firms exit • Fewer producers in the market shift the short-run

market supply curve to the left• The price begins to rise in the market• As the price rises, each firm produces more along their

MC curve• Losses for each firm fall• When the price reaches the break-even point at the

minimum of ATC, exit stops

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AP EconomicsMr. Bernstein

The Long-Run Process of Adjustment

At P = $8, P > ATC, profit, firms enter, Supply shifts right, P falls, firm Q falls…(notice we are presenting the market graph and firm graph side-by-side)

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AP EconomicsMr. Bernstein

Long-Run Industry Supply Curves

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AP EconomicsMr. Bernstein

Long-Run Industry Supply Curves• Constant Cost Industry – Supply curve is horizontal• Increasing Cost Industry – more realistic – costs rise

as competitors enter (bidding for resources, increase in advertising, etc.)

• Decreasing Cost Industry – Supply Curve is downward sloping – it is possible for input costs to decrease as an industry grows (ie electric cars)

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AP EconomicsMr. Bernstein

Efficiency in Long-Run Equilibrium in Perfect Competition

• Productive Efficiency: ATC is at minimum• Allocative Efficiency: P = MC• All firms earn normal profit in long run

• Revenues cover costs AND next best alternative• So no existing firms exit and no new firms wish to enter

• No Deadweight Loss, all mutually beneficial transactions are made

• We will compare this to outcomes in other market structures