Perfect competition in the long run
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Intros
Lessons
- Perfect Competition in the Long Run Overview:
- Long Run: Entry & Exit
- Short-run equilibrium → economic loss, profit, or breaks-even
- Long-run equilibrium → firm always breaks-even
- Firm incentive to enter market when p > ATC
- Firm exits market when p < ATC
- Long-Run: Changes to Demand
- Firm starts by making zero profit
- Increase in Demand → Economic profit
- Firms enter market → increase in supply until firms break-even
- Decrease in Demand → Economic Loss
- Firms exit market → decrease in supply until firms break-even
- Long-Run: Changes to Supply as Technology Advance
- Firms start by making zero profit
- Technology advance decrease MC & ATC → economic profit
- Firms enter market → increase in supply until firms break-even
Examples
Lessons
- Predicting Prices for Exiting & Entering the Market
Suppose the market is perfectly competitive, and you are given the following graph:Output
Total Cost
0
5
1
12
2
17
3
24
4
33
5
44
- Suppose the market is perfectly competitive, and you are given the following information
Output
Total Cost
0
8
1
16
2
22
3
30
4
40
5
52
- Understanding Changes to Demand and Supply in the Long Run
Suppose the equilibrium price and quantity is that the shutdown point. If there is an increase in demand, does that automatically assume there is economic profit? - All the firms are currently breaking even. Suppose a natural disaster destroys all the firm's low-cost plant. All the firms now must switch to a high-cost plant. Describe what happens to the marginal cost, average total cost. Do the firms still breakeven? What happens to the market in the long run? Show this graphically.
Topic Notes
Introduction to Perfect Competition in the Long Run
Welcome to our exploration of perfect competition in the long run! This fascinating economic concept is crucial for understanding market dynamics over extended periods. As your friendly math tutor, I'm excited to guide you through this topic. The introduction video we'll watch shortly is a fantastic starting point, offering clear explanations and visual aids to help you grasp the key principles. In perfect competition long run scenarios, firms have ample time to adjust all aspects of their production, including entering or exiting the market. This leads to some intriguing outcomes, such as economic profits trending towards zero and firms producing at the most efficient scale. The long run perfect competition model helps economists analyze market behavior, predict industry trends, and understand resource allocation. As we delve deeper, you'll see how this concept connects to real-world markets and why it's so important in economic theory. Let's get started on this enlightening journey!
Firm Behavior and Market Equilibrium in the Long Run
In perfectly competitive markets, firms face a unique set of circumstances that shape their behavior over time. To understand how these markets function in the long run, it's essential to first examine the short-run outcomes and then see how they evolve. Let's dive into this fascinating economic concept and explore how firms navigate the path to long-run equilibrium.
In the short run, firms in perfectly competitive markets can experience three possible outcomes: economic loss, economic profit, or break-even. Each of these scenarios plays a crucial role in determining the market's long-term trajectory.
1. Economic Loss: When a firm's average total cost (ATC) exceeds the market price, it incurs an economic loss. In this situation, the firm is not covering all its costs and may consider exiting the market if the loss persists. However, as long as the price is above the average variable cost (AVC), the firm will continue to operate in the short run to minimize its losses.
2. Economic Profit: This occurs when the market price is higher than the firm's ATC. In this favorable scenario, the firm is earning more than just its normal profit, which acts as an incentive for other firms to enter the market.
3. Break-even: At this point, the market price equals the firm's ATC. The firm is covering all its costs, including the opportunity cost of its resources, but isn't earning any economic profit.
Now, let's consider how these short-run outcomes lead to the long-run equilibrium. The key to understanding this process lies in the concept of free entry and exit, a hallmark of perfectly competitive markets.
When firms are earning economic profits in the short run, it attracts new entrants to the market. As more firms join, the market supply increases, putting downward pressure on prices. This continues until the price falls to the point where it equals the minimum of the long-run average total cost (LRATC) curve.
Conversely, if firms are incurring economic losses, some will exit the market in the long run. This reduces market supply, causing prices to rise until they reach the minimum of the LRATC curve.
The break-even scenario, where price equals ATC, is closest to the long-run equilibrium. However, it's important to note that in the long run, all firms will operate at the minimum point of their LRATC curve.
To illustrate this concept, imagine a market for artisanal bread in a small town. Initially, a few bakeries might earn economic profits due to high demand. This attracts new bakeries to open, increasing the supply of bread and gradually lowering prices. Eventually, the market reaches a point where all bakeries are just breaking even, operating at their most efficient scale.
In the long-run equilibrium of a perfectly competitive market, several key conditions are met:
1. Price (P) equals Marginal Cost (MC): This ensures allocative efficiency, as resources are being used to produce goods that consumers value most.
2. P = Minimum Average Total Cost (ATC): This condition guarantees productive efficiency, as firms are producing at their lowest possible average cost.
3. P = Minimum of Long-Run Average Total Cost (LRATC): This indicates that firms are operating at their optimal scale in the long run.
4. Economic profit = 0: All firms are earning only normal profits, which are just enough to keep them in the industry.
It's fascinating to observe how the invisible hand of the market guides firms towards this equilibrium. The process is dynamic and self-correcting, with prices acting as signals that coordinate the actions of numerous independent firms and consumers.
However, it's important to remember that this model of perfect competition is an idealized concept. In reality, markets often deviate from these conditions due to factors like barriers to entry, product differentiation, and imperfect information. Nonetheless, understanding the principles of long-run equilibrium in perfect competition provides valuable insights into market dynamics and efficiency.
In conclusion, the journey from short-run fluctuations to long-run equilibrium in perfectly competitive markets is a testament to the power
Market Entry and Exit in Perfect Competition
In the world of perfect competition, the process of market entry and exit plays a crucial role in shaping the long-run equilibrium. Let's dive into this fascinating aspect of economics and explore how firms make decisions to enter or leave a market, and how these choices impact supply, demand, and overall market dynamics.
Perfect competition is characterized by many small firms, homogeneous products, perfect information, and free entry and exit. In the long run, firms can adjust all factors of production, including their decision to participate in the market. This flexibility is key to understanding the concept of long-run equilibrium in perfect competition.
When a market is profitable, it attracts new firms. This process is known as market entry. Conversely, when firms are incurring losses, they may choose to exit the market. These decisions are primarily driven by economic profits or losses.
Let's consider a scenario where firms in a perfectly competitive market are earning economic profits. This situation acts as a magnet, drawing new firms into the industry. As new firms enter, the market supply curve shifts to the right. This increase in supply leads to a decrease in the market price, gradually reducing the economic profits for all firms.
To illustrate this, imagine a graph with price on the vertical axis and quantity on the horizontal axis. The initial supply curve (S1) intersects with the demand curve (D) at a price above the average total cost (ATC) of production, indicating economic profits. As new firms enter, the supply curve shifts to the right (S2), causing the equilibrium price to fall.
This process continues until the price equals the minimum of the long-run average cost curve. At this point, firms are earning normal profits (zero economic profits), and there's no incentive for further entry or exit. This state is known as the long-run equilibrium in perfect competition.
On the flip side, if firms are incurring losses, we observe market exit. When the market price falls below the ATC, firms start to exit the industry. As firms leave, the market supply curve shifts to the left, causing the price to rise. This process continues until the remaining firms are no longer incurring losses.
In a graph, this would be represented by a leftward shift of the supply curve from S1 to S2, resulting in a higher equilibrium price. The exit of firms continues until the price rises to meet the minimum of the long-run average cost curve.
It's important to note that in the long run, a perfectly competitive market always tends towards this equilibrium where economic profits are zero. This is a key characteristic of long-run perfect competition. Firms are price takers, meaning they must accept the market price, which is determined by the intersection of market supply and demand.
The beauty of this system lies in its self-correcting nature. Profits attract new firms, increasing supply and lowering prices. Losses cause firms to exit, decreasing supply and raising prices. This continuous adjustment ensures that resources are allocated efficiently in the long run.
For students of economics, understanding this process is crucial. It explains why perfectly competitive markets are considered efficient and why they tend towards a state where all firms earn normal profits in the long run. This concept forms the foundation for more complex economic theories and real-world applications.
In conclusion, the process of market entry and exit in perfect competition is a powerful mechanism that drives markets towards long-run equilibrium. It ensures that prices reflect the true cost of production and that resources are allocated efficiently. By understanding this process, we gain valuable insights into how competitive markets function and why they are often held up as a benchmark for economic efficiency.
Long-Run Changes in Demand in Perfectly Competitive Markets
In the long run, perfectly competitive markets are subject to shifts in demand that can significantly impact market equilibrium and firm behavior. Understanding these changes is crucial for both businesses and policymakers. Let's explore how increases and decreases in demand affect perfectly competitive markets over time.
Increases in Demand
When demand increases in a perfectly competitive market, we observe a series of adjustments that occur in the long run:
- Initial Price Increase: As demand shifts rightward, the market price initially rises above the long-run equilibrium.
- Short-term Profits: Existing firms experience economic profits due to the higher price.
- Market Entry: Attracted by these profits, new firms enter the market.
- Supply Increase: The industry supply curve shifts rightward as more firms join.
- Price Adjustment: As supply increases, the price gradually decreases back towards the long-run average cost.
- New Equilibrium: A new long-run equilibrium is established with more firms and higher output, but at the original price level.
Graphically, this process can be illustrated by a rightward shift of the demand curve, followed by a rightward shift of the long-run supply curve. The final equilibrium point shows increased quantity but a return to the original price.
Decreases in Demand
Conversely, when demand decreases in a perfectly competitive market, we see the following long-run adjustments:
- Initial Price Decrease: As demand shifts leftward, the market price initially falls below the long-run equilibrium.
- Short-term Losses: Existing firms incur economic losses due to the lower price.
- Market Exit: Firms unable to cover their average total costs in the long run exit the market.
- Supply Decrease: The industry supply curve shifts leftward as firms leave.
- Price Adjustment: As supply decreases, the price gradually increases back towards the long-run average cost.
- New Equilibrium: A new long-run equilibrium is established with fewer firms and lower output, but at the original price level.
Graphically, this process is represented by a leftward shift of the demand curve, followed by a leftward shift of the long-run supply curve. The final equilibrium point shows decreased quantity but a return to the original price.
Market Adjustment Process
The key to understanding long-run changes in perfectly competitive markets lies in the concept of zero economic profit. In the long run, firms in perfect competition earn zero economic profit, which means they are covering all their costs, including the opportunity cost of their resources.
When demand changes, it creates a temporary situation of either economic profit or loss. This triggers the entry or exit of firms, which is the primary mechanism for market adjustment in the long run. The process continues until the market reaches a new equilibrium where firms are again earning zero economic profit.
Firm Response to Changes
Individual firms in perfectly competitive markets respond to these changes in several ways:
- Output Adjustment: Firms adjust their output levels to maximize profits (or minimize losses) at the new market price.
- Cost Management: In response to changing market conditions, firms may seek to improve efficiency and reduce costs.
- Entry/Exit Decisions: Firms decide whether to enter or exit the market based on their ability to cover long-run average costs.
- Technology Adoption: To remain competitive, firms may invest in new technologies or production methods.
It's important to
Long-Run Changes in Supply in Perfect Competition
In the world of perfectly competitive markets, long-run changes in supply can have significant impacts on market dynamics. Let's explore how technological advancements in perfect competition and other supply-side shifts affect these markets over time, focusing on costs, market equilibrium in perfect competition, and firm behavior.
To begin, it's crucial to understand that in the long run, all factors of production are variable. This means firms have the flexibility to adjust their scale of operations, enter or exit the market, and implement new technologies. These changes can lead to shifts in the long-run supply curve, which represents the relationship between price and quantity supplied when all inputs can be varied.
Technological advancements in perfect competition are a prime example of a factor that can significantly alter the supply side of a perfectly competitive market. When firms adopt new technologies, they often experience reduced production costs. This cost reduction shifts the individual firm's marginal cost (MC) and average total cost (ATC) curves downward. As a result, each firm can produce the same quantity at a lower cost or increase their output at the same cost.
In the short run, this technological improvement allows firms to earn economic profits in the long run, as their costs are now below the market price. However, in the long run, these profits attract new entrants to the market. As more firms enter, the market supply curve shifts to the right, putting downward pressure on prices. This process continues until the market reaches a new long-run equilibrium where economic profits return to zero.
Let's visualize this process with a graph. Imagine a perfectly competitive market for widgets. Initially, the market is in long-run equilibrium with price P1 and quantity Q1. A technological breakthrough occurs, shifting individual firms' cost curves downward. In the short run, existing firms increase their output, shifting the market supply curve to the right. This leads to a new short-run equilibrium with a lower price P2 and higher quantity Q2.
However, this is not the end of the story. The lower costs and potential for profits attract new firms to the market. As these firms enter, the market supply curve continues to shift right. This process persists until a new long-run equilibrium is established at price P3 and quantity Q3, where economic profits in the long run are once again zero.
It's important to note that while the market price has decreased from P1 to P3, the quantity supplied has increased from Q1 to Q3. This demonstrates how technological advancements in perfect competition can lead to increased market output and lower prices for consumers in the long run, even as individual firms return to normal profit levels.
The behavior of firms during this process is also worth examining. As the market price falls due to increased supply, existing firms must adapt or risk being forced out of the market. They may need to further innovate, reduce costs, or improve efficiency to remain competitive. Some less efficient firms may exit the market if they cannot produce at the new, lower price.
Another interesting aspect of long-run changes in perfectly competitive markets is the concept of the long-run supply curve. This curve shows how the quantity supplied changes as the market price changes when all firms have fully adjusted their production levels and new firms have had time to enter or exit the market. The shape of this curve can vary depending on the industry's cost structure.
In industries with constant costs, where resource prices don't change as the industry expands, the long-run supply curve is horizontal. This means that in the very long run, any quantity can be supplied at the same price. In industries with increasing costs, where resource prices rise as the industry grows, the long-run supply curve slopes upward. Conversely, in industries with decreasing costs due to economies of scale, the long-run supply curve slopes downward.
Understanding these long-run dynamics is crucial for both firms and policymakers. For firms, it highlights the importance of continuous innovation and efficiency improvements to remain competitive. For policymakers, it underscores how policies that encourage technological advancement and reduce barriers to entry can lead to lower prices and increased output in perfectly competitive markets over time.
In conclusion, long-run changes in supply, particularly those driven by technological advancements in perfect competition, have profound effects on perfectly competitive markets. They lead to shifts in cost structures, alterations in market equilibrium in perfect competition, and evolving firm behaviors. While individual firms may experience short-term profits from such changes, the long-run tendency towards zero economic profit ensures that
Long-Run Industry Equilibrium and Efficiency
In the world of economics, understanding long-run industry equilibrium in perfect competition is crucial for grasping how markets function over time. Let's dive into this fascinating concept and explore why firms always break even in the long run, as well as the implications for economic efficiency.
Perfect competition is characterized by many small firms producing identical products, with no barriers to entry or exit. In the long run, firms have the flexibility to adjust all factors of production, including capital and labor. This adaptability plays a significant role in shaping the market's equilibrium.
One of the key features of long-run equilibrium in perfect competition is that price equals average total cost (P = ATC). This condition is crucial because it means firms are earning zero economic profit. But don't worry this doesn't mean businesses are failing! It simply indicates that they're covering all their costs, including the opportunity cost of their resources.
Why does this happen? Well, in the short run, firms might experience economic profits or losses. However, in the long run, these profits attract new entrants to the market, while losses cause some firms to exit. This process continues until the market reaches a point where no firm has an incentive to enter or leave that's our long-run equilibrium.
Let's visualize this with a graph. Imagine a horizontal line representing the market price, which intersects with a U-shaped average total cost curve at its minimum point. This intersection is where P = ATC, and it's also where the marginal cost (MC) curve crosses the average total cost curve. This graph illustrates why firms produce at the most efficient scale in the long run.
Now, you might be wondering, "If firms always break even in the long run, why bother staying in business?" Great question! Remember, breaking even in economic terms means covering all costs, including a normal return on investment. Firms are still making enough to justify their continued operation they're just not earning excess profits.
This equilibrium has important implications for economic efficiency. When firms produce at the point where P = ATC = MC, they're operating at the lowest possible average cost. This means resources are being used efficiently, and consumers are getting products at the lowest sustainable price. It's a win-win situation!
The long-run supply curve in perfect competition is particularly interesting. Unlike the upward-sloping short-run supply curve, the long-run supply curve is typically horizontal. This is because, in the long run, the industry can expand or contract to meet any level of demand without affecting the price. It's like the industry has an infinite capacity to adjust!
Let's consider an example to bring this to life. Imagine a bustling farmers' market with numerous small vegetable stands. If demand for tomatoes increases, some stands might initially make higher profits. However, word spreads quickly, and soon new tomato sellers enter the market. This continues until profits return to normal, and the price settles back to where it equals the average total cost of production.
It's worth noting that while this model of perfect competition is theoretically elegant, real-world markets often deviate from these ideal conditions. Factors like product differentiation, barriers to entry, and imperfect information can lead to outcomes that don't perfectly match our model. Nevertheless, understanding these principles provides valuable insights into market dynamics and efficiency.
In conclusion, long-run equilibrium in perfect competition is characterized by firms breaking even economically, with price equaling average total cost. This state ensures efficient resource allocation and benefits consumers through competitive pricing. While it might seem counterintuitive that firms don't earn excess profits, this equilibrium drives innovation and efficiency in the market. As you observe various industries, try to spot these principles in action you'll be surprised how often they apply, even in our complex economic landscape!
Conclusion: Key Takeaways on Perfect Competition in the Long Run
In this article, we've explored the fascinating world of perfect competition in the long run. We've seen how firms in this market structure adjust over time, reaching a state of long run equilibrium. The key points we've covered include the concept of zero economic profit, the importance of free entry and exit, and how firms operate at the minimum of their long-run average cost curve. Remember, the introductory video we discussed is crucial in visualizing these concepts, so don't hesitate to revisit it. Perfect competition in the long run is a cornerstone of economic theory, and understanding it will greatly enhance your grasp of market dynamics. To deepen your knowledge, consider exploring related topics like monopolistic competition or oligopolies. Feel free to reach out with any questions or join our online discussion forums. Keep learning and applying these concepts they're invaluable tools for analyzing real-world economic scenarios!
Perfect Competition in the Long Run Overview:
Perfect Competition in the Long Run Overview: Long Run: Entry & Exit
- Short-run equilibrium economic loss, profit, or breaks-even
- Long-run equilibrium firm always breaks-even
- Firm incentive to enter market when p > ATC
- Firm exits market when p < ATC
Step 1: Understanding Short-Run Equilibrium
In the short run, firms in a perfectly competitive market can experience one of three possible outcomes: economic loss, economic profit, or breaking even. Economic loss occurs when the total revenue is less than the total cost, leading to a negative profit. Economic profit happens when the total revenue exceeds the total cost, resulting in a positive profit. Breaking even means that the total revenue equals the total cost, so the firm neither gains nor loses money. These outcomes are determined by the relationship between the price (P) and the average total cost (ATC).
Step 2: Long-Run Equilibrium
In the long run, firms in a perfectly competitive market always break even. This is because the entry and exit of firms in the market adjust the supply until the price equals the average total cost (P = ATC). When firms are making an economic profit, new firms are incentivized to enter the market, increasing the supply and driving the price down. Conversely, when firms are experiencing economic losses, some firms will exit the market, decreasing the supply and driving the price up. This process continues until firms are breaking even, meaning there is no economic profit or loss.
Step 3: Firm Incentive to Enter the Market
Firms are incentivized to enter the market when the price (P) is greater than the average total cost (ATC). This situation indicates that existing firms are making an economic profit. For example, if a firm sees that other firms are selling products at a price higher than their production costs, it will be motivated to enter the market to take advantage of the profit opportunity. As more firms enter the market, the supply increases, which eventually drives the price down to the point where P equals ATC, and firms break even.
Step 4: Firm Exits the Market
Firms will exit the market when the price (P) is less than the average total cost (ATC). This situation indicates that firms are experiencing economic losses. For instance, if a firm is selling products at a price lower than their production costs, it will incur losses and may decide to exit the market. As firms exit, the supply decreases, which drives the price up until it reaches the point where P equals ATC, and the remaining firms break even.
Step 5: Entry and Exit Dynamics
The dynamics of entry and exit in a perfectly competitive market ensure that in the long run, firms will always break even. When firms enter the market due to economic profit, the increased supply drives prices down. When firms exit the market due to economic losses, the decreased supply drives prices up. This self-regulating mechanism ensures that the market price always adjusts to the point where firms break even, meaning there is no incentive for new firms to enter or existing firms to exit.
Step 6: Graphical Representation
Graphically, the entry and exit of firms can be represented by shifts in the supply curve. When firms enter the market, the supply curve shifts to the right, leading to a lower equilibrium price. When firms exit the market, the supply curve shifts to the left, leading to a higher equilibrium price. The equilibrium price will continue to adjust until it equals the average total cost, ensuring that firms break even in the long run.
Step 7: Conclusion
In conclusion, the long-run equilibrium in a perfectly competitive market is characterized by firms breaking even. This outcome is achieved through the entry and exit of firms in response to economic profits and losses. When firms make an economic profit, new firms enter the market, increasing supply and driving prices down. When firms experience economic losses, some firms exit the market, decreasing supply and driving prices up. This process continues until the price equals the average total cost, ensuring that firms break even in the long run.
FAQs
Here are some frequently asked questions about perfect competition in the long run:
1. What happens to perfect competition in the long run?
In the long run, perfectly competitive markets tend towards equilibrium where economic profits are zero. Firms produce at the most efficient scale, and the price equals both the marginal cost and the minimum point of the long-run average total cost curve. If there are short-term profits, new firms enter the market, increasing supply and driving prices down. If there are losses, some firms exit, decreasing supply and allowing prices to rise.
2. What does a perfect competition earn in the long run?
In the long run, firms in perfect competition earn zero economic profit. This doesn't mean they're not making money; rather, they're earning just enough to cover all their costs, including the opportunity cost of their resources. This state is also known as normal profit.
3. What is true about perfect competition in the long run?
In the long run, perfect competition is characterized by free entry and exit of firms, production at the most efficient scale, price equal to marginal cost and minimum average total cost, and zero economic profits. The long-run supply curve tends to be horizontal, indicating that the industry can expand or contract to meet demand without affecting the price.
4. What is the long-run equilibrium condition for perfect competition?
The long-run equilibrium condition for perfect competition is P = MC = min ATC, where P is price, MC is marginal cost, and ATC is average total cost. This condition ensures that firms are producing efficiently and earning zero economic profit.
5. Why is the long-run supply curve horizontal in perfect competition?
The long-run supply curve in perfect competition is typically horizontal because, in the long run, the industry can expand or contract to meet any level of demand without affecting the price. This is due to the free entry and exit of firms and the assumption of constant costs as the industry expands. However, in some cases, the long-run supply curve may slope upward if there are increasing costs in the industry.
Prerequisite Topics
Understanding perfect competition in the long run requires a solid foundation in several key economic concepts. While there are no specific prerequisite topics provided for this subject, it's crucial to recognize that economics is a field built on interconnected ideas. A strong grasp of fundamental economic principles is essential for comprehending the complexities of perfect competition in the long run.
To fully appreciate the dynamics of perfect competition in the long run, students should be familiar with basic microeconomic concepts such as supply and demand, market structures, and firm behavior. These foundational elements provide the necessary context for exploring how firms operate in a perfectly competitive environment over an extended period.
Additionally, an understanding of short-run market behavior is vital for contrasting and comparing with long-run outcomes. Concepts like marginal cost, average cost, and profit maximization play crucial roles in analyzing firm decisions and market equilibrium in both the short and long run.
The concept of economic efficiency is also closely tied to perfect competition in the long run. Students should be comfortable with ideas such as allocative efficiency and productive efficiency to fully grasp the implications of perfect competition on resource allocation and societal welfare.
Furthermore, knowledge of market entry and exit barriers is essential for comprehending how firms behave in a perfectly competitive market over time. This understanding helps explain the process of market adjustment and the tendency towards zero economic profit in the long run.
While specific prerequisite topics are not listed, it's important to note that a solid foundation in these general economic principles will significantly enhance a student's ability to analyze and interpret perfect competition in the long run. Each of these concepts contributes to a more comprehensive understanding of how markets function and evolve over time.
As students delve into the study of perfect competition in the long run, they'll find that their prior knowledge of these economic fundamentals serves as a valuable toolkit. This background allows for a deeper exploration of how firms adapt to market conditions, how industry-wide changes occur, and why perfect competition leads to specific long-term outcomes.
In conclusion, while there may not be a definitive list of prerequisites, a well-rounded understanding of basic economic principles is indispensable. This foundation enables students to navigate the complexities of perfect competition in the long run with greater ease and insight, fostering a more comprehensive grasp of this important economic concept.
Recall in the short-run, firms can either have economic loss, economic profit, or break-even.
In the long run, firms will always end up breaking even.
Entry: Firms will only enter the market if firms in the market are making economic profit (p > ATC).
When firms enter the market, they increase the supply, shifting the supply curve rightward. This causes the equilibrium price to decrease, which also causes the MR curve (p) to shift down.
The supply curve keeps shifting rightward until p = ATC In this case, the firms break even.
Exit: Firms will only exit the market if they are incurring economic loss (p < ATC).
When firms exit the market, the decrease the supply, shifting the supply curve leftward. This causes the equilibrium price to increase, which also causes the MR curve (p) to shift up.
The supply curve keeps shifting leftward until p = ATC. In this case, the firms again break even.
Long Run: Changes to Demand
Increase in Demand: Suppose the firm’s profit is breaking even.
The increase in demand shifts the demand curve rightward, causing an increase to equilibrium price. This causes the MR curve (p) to shift up.
Firms will see that p > ATC, so there is an economic profit. This causes firms to enter the market, which will shift the supply curve rightward and decrease equilibrium price. Thus, the MR curve (p) shifts back down.
The MR curve shifts down until p > ATC. Hence, the firms will break-even.
Decrease in Demand: Suppose the firm’s profit is breaking even.
The decrease in demand shifts the demand curve leftward, causing a decrease to equilibrium price. This causes the MR curve (p) to shift down.
Firms will see that p < ATC, so they will incur economic loss. This causes firms to exit the market, which shifts the supply curve leftward and increase equilibrium price. Thus, the MR curve (p) shifts back up.
The MR curve shifts up until p = ATC. Hence, the firms will break-even.
Long Run: Changes to Supply as Technology Advance
Decrease in Cost: Suppose the firm’s profit is breaking even.
Technology advances will shift the ATC curve and MC curve downward, causing firms to have economic profit.
This causes firms to enter the market, which will shift the supply curve rightward and decrease equilibrium price. This causes the MR curve (p) to shift down.
The MR curve will shift down until p = ATC. In this case, the firms will break-even.
