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Perfect competition – the firm in the long run

Perfect competition – the firm in the long run. Outline 1. Features of the long run 2. Long-run equilibrium of the firm 3. Derivation of the long run supply curve 4. Advantages & disadvantages of perfect competition. 1. Features of the long run.

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Perfect competition – the firm in the long run

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  1. Perfect competition – the firm in the long run • Outline • 1. Features of the long run • 2. Long-run equilibrium of the firm • 3. Derivation of the long run supply curve • 4. Advantages & disadvantages of perfect competition

  2. 1.Features of the long run • A) Existing firms are making supernormal profits • B) All factors of production are variable • existing firms expand • C) Perfect factor mobility & perfect information • new firms enter the industry (market) • new start-ups • switching • Long-run equilibrium of the firm • price, output & profit

  3. Fig 1a Long-run equilibrium under perfect competition P £ S1 Supernormal profit LRAC P1 AR1 D1 LRAC D O O Q (thousands) Q (millions) (a) Industry (b) Firm

  4. 2. Long run equilibrium • all supernormal profits competed away • A) price is high (e.g. P1 on Figure 1a) • B) AR > LRAC: supernormal profit • C) industry supply expands; supply shifts right • D) price falls (e.g. PL on Figure 1b) • process continues until supernormal profits are competed away • At PL, QL we have long run equilibrium • LRAC=AC=MC=MR=AR (see Fig 2)

  5. Fig 1b Long-run equilibrium under perfect competition P £ S1 Se LRAC P1 AR1 D1 PL ARL DL D O O QL Q (thousands) Q (millions) (a) Industry (b) Firm

  6. Long-run equilibrium of the firm under perfect competition £ (SR)MC (SR)AC LRAC DL AR = MR O Q

  7. 3.Derivation of thelong run supply curve • Industry demand increases: what happens to P and Q? • initial rise in price, supernormal profits attracts new firms • supply increases • If • A) price falls back to original level, the long run supply curve (LRS) is horizontal – constant costs • B) price is higher than originally, the LRS is upward sloping – increasing costs – external diseconomies • C) price is lower than originally, LRS is downward sloping – decreasing costs – external economies

  8. 4. Advantages & disadvantages • Advantages of perfect competition • i) optimal allocation of resources • P = MC, P=MU thus MU = MC • (ii) competition encourages efficiency • (iii) consumers charged a lower price • (iv) responsive to consumer wishes: change in demand, leads extra supply

  9. 4. Advantages & disadvantages • Disadvantages • (i) insufficient profits for investment • (ii) lack of product variety • (iii) lack of competition over product design and specification • (iv) unequal distribution of goods & income • (v) externalities e.g. pollution

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