Question

Draw graphs showing a perfectly competitive firm and industry in the long-run equilibrium.

a. How do you know that the industry is in long-run equilibrium?

Long-run when quantity demanded=quantity supplied, no entry and not exit as firms are breaking even. (Which holds true when the P=ATC)

b. Suppose that there is an increase in demand for this product. Show and explain the short-run adjustment process for both the firm and the industry.

Market demand curve shifts to the right. Equilibrium price increases. P>ATC and firms are making a positive economic profits.

c. Show and explain the long-run adjustment process for both the firm and the industry. What will happen to the number of firms in the new long-run equilibrium? More firms enter the market, which increases market supply and causes equilibrium price to decrease (back to original levels). Firms break even and no additional firms will enter the industry. More firms are now each producing the same quantity at the same price (for an overall increased market quantity). See also: the section titled Long Run Adjustment in Perfect Competition: Entry and Exit on p. 179-180 of your textbook.  Show and explain the long-run adjustment process for both the firm and the industry. What will happen to the number of firms in the new long-run equilibrium?

Answer 1

1) A perfectly competitive firm in a long run equilibrium will be only breaking even i.e. no profit and no loss. In a long run equilibrium, the firm produces at the point where its Long-run average cost is at its lowest and they try to match their Long run Marginal cost with Average revenue and price.

As the firms, in the long run, are only breaking even there is no more firm looking to enter the market and no firms exit the market.

2) As the demand increases in the short run, the firm can't make many changes, to increase their production they will increase the price of their product earning more profit and supplying higher amount of goods.

As the firms in the industry are earning more than normal profit this will attract other firms in the industry and this will continue as long as the profit comes down to the normal level.

3) I the transition from the short run to the long run the firm will again be making a normal profit. As new firms have entered the market, this will increase the supply and bring the price down. entry of the new firms will continue to the point where there is no more supernormal profit to earn and the frim are only making breaking even i.e. no profit and no loss.