Question

1. Why does pure competition provide consumers with the largest consumer and producer surpluses?
2. Describe the graph for a long-run supply curve in a decreasing-cost industry.

Answer 1

Pure competition provides maximum social surplus as quantity is produced where marginal cost = Price (or average revenue). In other words, Price is the least minimum possible. If the price is lowered any further firms will not cover the cost of production. So, consumers get the maximum possible benefit out of this situation. Highest possible quantity is available for minimum cost. Output in competitive firms is allocatively efficient. Therefore the social surplus (consumer or producer surplus) is largest possible.

b)

  

Long run supply curve is shown in the graph above. In the industry graph (right side), it is sloping downward because it has expanded its output from OQ to OQ1. Perhaps to meet the increased demand.The industry becomes larger, and can take advantage of economies of scale to procure some inputs cheaply. So, the individual firm's AC curve will shift downward (left graph), and the market price falls. Decreased price and costs attract more firms, and price decreases further as output is now larger. There is a new long run equilibrium now, and the long run supply curve slopes downward.