Perfect Competition Output, Price,

and Profit in the Short Run and Long

Run
Competition
Output, Price, and Profit in the Short Run
Output, Price, and Profit in the Long Run
Changing Tastes and Advancing Technology
Output, Price, and Profit in the
Short Run

In short-run equilibrium:
The number of firms is fixed
Each firm has a fixed amount of capital
The quantity supplied equals the quantity demanded
Short-Run Equilibrium

In short-run equilibrium, firms might:

earn an economic profit
earn normal profit (break even)
incur an economic loss.
Fig. 11.7 shows three possible short-run
equilibrium outcomes.
 Short-Run Equilibrium
The industry supply
curve is S.
First, suppose the
demand curve is
D1.
The equilibrium
price is $25.
 Short-Run Equilibrium
At this price, the
firm produces 9
sweaters a day and
earns an economic
profit.
 Short-Run Equilibrium
Next, suppose the
demand curve is
D2.
The equilibrium
price is $20.
 Short-Run Equilibrium
At this price, the
firm produces 8
sweaters a day and
breaks even. It
earns a zero
economic profit.
 Short-Run Equilibrium
Finally, suppose the
demand curve is
D3.
The equilibrium
price is $17.
 Short-Run Equilibrium
At this price, the
firm produces 7
sweaters a day and
incurs an economic
loss.
Output, Price, and Profit in the
Long Run
Long-run equilibrium occurs in a competitive
industry when economic profits are zero
Long-run equilibrium comes about because of
entry and exit and because firms choose their least
cost plant size
Long-Run Equilibrium
Profits and losses are signals for entry and exit.
Entry affects profits and losses.
Long-Run Equilibrium
As new firms enter a competitive industry, the
industry supply shifts rightward, price falls and
quantity increases.
 Long-Run Equilibrium
Fig. 11.8 shows
the effects of
entry.
Initially, the
industry supply
curve is SA.
 Long-Run Equilibrium
The price is $23
and firms are
earning economic
profits.
New firms enter
the industry.
 Long-Run Equilibrium
As entry takes
place, industry
supply increases.
The supply curve
shifts rightward
toward S0.
 Long-Run Equilibrium
As supply
increases, the
quantity increases
and the price falls.
When the price
has fallen to $20,
firms break even.
 Long-Run Equilibrium
At this point,
entry ceases
and the
industry is in
long-run
equilibrium.
 Long-Run Equilibrium
Fig. 11.8 also
shows the effects
of exit.
Initially, the
industry supply
curve is SB.
 Long-Run Equilibrium
The price is $17
and firms are
incurring
economic losses.
Firms begin to exit
the industry.
 Long-Run Equilibrium
As exit takes
place, industry
supply decreases.
The supply curve
shifts leftward
toward S0.
 Long-Run Equilibrium
As supply
decreases, the
quantity decreases
and the price rises.
When the price
has risen to $20,
firms break even.
 Long-Run Equilibrium
At this point,
exit ceases and
the industry is
in long-run
equilibrium.
Long-Run Equilibrium
Changes in plant size.
Firms change plant size if they are not producing at
least-cost.
In long-run equilibrium, each firm has chosen the
plant size that minimizes cost.
Fig. 11.9 shows the situation when the firm has
made the plant changes necessary to minimize
cost.
Long-Run Equilibrium
Long-Run Equilibrium

When firms use their minimum cost

plant, there is no further incentive
either to expand or contract.
Changing Tastes and Advancing
Technology

When there is a permanent decrease in demand

(e.g. as for typewriters and TV repairs), the following
events take place:
The industry demand curve shifts leftward
The price falls
Firms begin to incur economic losses
Some firms exit the industry
Permanent Decrease in Demand
As exit takes place the supply shifts leftward and
the price begins to increase
Losses decline and the exit process slows down
After a large enough number of firms have exited,
the remaining ones make zero profit
Permanent Decrease in Demand
Fig. 11.10 shows
the effect of a
permanent
decrease in
demand.
Demand decreases
from D0 to D1
Permanent Decrease in Demand
The price falls
from P0 to P1
And the quantity
decreases from Q0
to Q1
Permanent Decrease in Demand
Each firm now
incurs an
economic loss.
Permanent Decrease in Demand
So some firms
exit the industry.
Permanent Decrease in Demand
As they exit,
supply
decreases and
the supply curve
begins to shift
leftward.
Permanent Decrease in Demand
With a decrease
in supply, the
price begins to
rise.
And the quantity
keeps on
decreasing.
Permanent Decrease in Demand
But with a rising
price, each
remaining firm
in the industry
increases
production.
Permanent Decrease in Demand
When the
process ends in
a new long-run
equilibrium, the
price is back at
P0.
 Permanent Decrease in Demand
The quantity
produced has
decreased to Q2
And each
remaining firm is
producing q0, its
initial quantity.
External Economies and
Diseconomies
External economies are factors beyond the
control of an individual firm that lower a firms
costs as industry output expands.
Examples:
growth of specialist support services in agriculture
during the 19th century
growth of technology support services today.
External Economies and
Diseconomies
External diseconomies are factors beyond the
control of an individual firm that increase a firms
costs as industry output expands.
Examples:
highway congestion in trucking
air traffic control congestion in air transportation
services.
 External Economies and
Diseconomies
In the absence of
external economies
and diseconomies,
when industry
output increases,
price remains
constant.
 External Economies and
Diseconomies
In the face of
external
diseconomies,
when industry
output increases,
price rises.
 External Economies and
Diseconomies
In the presence of
external
economies, when
industry output
increases, price
falls.
Technological Change

Technological change is constantly decreasing

costs and increasing supply in competitive
industries.
Increases in supply lower prices.
Firms that do not switch to the new technology
incur losses and eventually exit.
THE END