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Short Run and Long Run Equilibrium

Profit maximization depends on producing a given quantity of output at the lowest possible cost, and the long-run equilibrium in perfect competition requires zero economic profit. Therefore, firms ultimately produce the output level associated with minimum long-run average total cost. Marginal cost must pass through the minimum point of average total cost.

The illustration shows the long-run equilibrium in perfect competition. The left diagram illustrates the equilibrium price, P E , being determined by the intersection of demand and supply in the market. This price also corresponds to minimum long-run average total cost to ensure zero economic profit in the long run. Thus, new firms have no incentive to enter the market, and existing firms have no incentive to leave the market.

Price or marginal revenue equals marginal cost at q 0 , ensuring that profit is maximized. Assume the short-run average-total-cost function associated with minimum long-run average total cost is. The long-run equilibrium requires that both average total cost is minimized and price equals average total cost zero economic profit is earned.

Remember that zero economic profit means price equals average total cost, so substituting for q in the average-total-cost equation equals price. Firms have no difficulty moving into or out of a perfectly competitive market. If economic profit is greater than zero, your business is earning something greater than a normal return.

Long run and short run - Wikipedia

This profit attracts other firms to enter the market. This situation is illustrated below. At the initial price P A , your firm maximizes profits at q A based on marginal revenue equals marginal cost. This lowers the supply, which raises the price and increases profits for the remaining firms.

In the long run, a monopolistically competitive firm earns a normal average accounting, or zero economic profits.

Long Run Equilibrium of Competitive Firm and Industry

A firm looks at its cost of production and then marks up its price to obtain a reasonable profit. If firm A marks up its price too much, competing firm B will take advantage of it by charging a lower price. This will cause firm A to lose market share, and it will have to respond by lowering its price.

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Because of the relative ease of entry into the industry, it is rare for a firm in a competitive market to charge excessively high prices and experience above-normal profits in the long run. The firm makes zero economic profits, so the average total cost curve just touches the demand curve.

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  5. This is where price P lr equals average total cost. The profit-maximizing price and average cost are to the left of the minimum average total cost. This means that in terms of average costs the monopolistically competitive firm is not producing at its most efficient point.

    Long-Run Equilibrium: Normal Profits

    Monopolistically competitive industries are more common than purely competitive ones. It is rare that two competitive firms sell identical products.

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    5. Just about all firms, small or large, differentiate. They may include slightly different ingredients or parts in their products, or they differentiate in the way that they package, name, distribute, or provide service to the customer. In order to accentuate these differences, monopolistically competitive firms frequently advertise.

      Perfect Competition Long Run Factor Mobility

      Advertising usually occurs on a local scale, because monopolistically competitive firms are small. Advertising benefits the firm by emphasizing the unique aspect of its product. This allows the firm to control its price and reap higher profits in the short run. The Internet has been an effective advertising tool for many businesses, and has helped consumers in comparing product quality and prices.

      Video Explanation For a video explanation of profit-maximization for a firm in monopolistic competition, please watch:.