Question

Explain how the long run differs from the short run in pure competition. [Use the Price & Output determination, Profits in the short & Long run, & Efficiency test]

Please use all tests

Answer 1

Long run in pure or perfect competition:

In long run all factors of production are variable means all factors of productiom can be increased or decreased, i.e. Labour, Land, Machinery, Capital equipment, etc. In long run firm and industry will earn only normal profit since there will be no bar on entry and exit on the firm's and if firms are earning super normal profit then new firms will enter the market and this will increase the cost of factors of production and due to competition price will also come down and firms and industry as a whole will earn only normal profit and on the other hand if firms and industry is incurring loss then some firms will leave the industry and this will decrease the demand for the factors of production and due to decreased competition price will also come down and firm and industry will again earn only normal profit.

Short run- in short run firm and Industry will earn super normal profit because in short run no new firm can enter the industry and no existing firm can leave the industry. In short run firms can only increase or decrease their level of production by increasing or decreasing their variable factors of production , i.e. labour and raw material.

Price & Output determination.

In short run under pure or perfect competition price is always given and firms has to sell their products on the given price, firm is price taken in perfectly competitive market and that's why demand or average revenue curve of the firm is a horizontal line(i.e. perfectly elastic).

Output is determined where short run marginal cost curve is equal to marginal revenue curve and price and marginal cost curve cuts the marginal revenue curve from below and rising.

Profit in the short run- Firm and industry will earn super normal profit in the short run because in short run it is not possible for new firms to enter and old/existing firms to leave and firms can maximize their production in the given price and they can only increase or decrease their variable factors of production only. In short run price is higher than average variable cost as well as average fixed cost and firms earn super normal profit only.

Profit in Long run- in long run firms and industry will earn only normal profit because in long run all factors of production are variable and also if firms are earning super normal profit then new firms will enter the industry and will increase competition and it will increase cost for the factors of production and also due to competition price will also come down and due to this firm and Industry will earn only normal profit whereas when firm and industry is earning loss then some firms will leave the industry and due to this competition will get decreased and price will also get increased and again firm and industry will earn only normal profit.

Efficiency test.

When profit maximizing firms in perfectly competitive markets combines with utility maximizing consumers then in result quantity of output produced shows both productive and allocative efficiency.

Productive efficiency - when production is done without waste and price equals long run average cost curve.

Allocative efficiency- in this price equals tht marginal cost and this is the price which consumer is willing to pay and in perfectly competitive market profit is maxized at a price which is equal to Marginal cost of the production and this ensures that social benefit received from producing the good is equal to social cost of the production.