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Economics - Perfect Competition

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    Study Guide Economics – Perfect Competition 1. Long - Run Supply 1 .1 What Does “Long Run” Mean? In the long run , firms can change all of their inputs. This includes things like factory size, machines, and technology. Because firms are flexible in the long run: • New firms can enter the market • Existing firms can leave the market In a perfectly competitive market , there are no barriers to entry or exit. This means firms are free to join or leave whenever they want. 1.2 Entry and Exit of Firms • If firms are making economic profits , new firms are attracted to the market. • If firms are making losses , some firms will leave the market. As a result, the number of firms does not stay fixed in the long run. 1.3 Zero Economic Profits in the Long Run Because of free entry and exit: • Profits do not last forever • Losses also do not continue forever Why does this happen? • Profits → new firms enter → more supply → price falls • Losses → firms exit → less supply → price rises

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    Study Guide Eventually: • Every firm earns zero economic profit • Firms earn normal profit (just enough to stay in business) • The market reaches long - run equilibrium Long - run equilibrium occurs when: • All firms earn zero economic profit • No firms want to enter or leave the market 1.4 Minimization of Long - Run Average Total Cost In the long run, firms aim to produce at the lowest possible cost per unit . Since all inputs are adjustable: • Firms can change factory size • Firms can adopt better production methods Minimum Efficient Scale (MES) • MES is the level of output where average cost is lowest Two possible situations: 1. If output is too low 2. → Firm experiences economies of scale 3. → Firm increases output to reach MES 4. If output is too high 5. → Firm experiences diseconomies of scale 6. → Firm reduces output to reach MES In the long run, firms always operate at MES , where long - run average total cost (LRATC) is minimum .

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    Study Guide 1.5 Long - Run Profit Maximization by a Firm Figure 1 The firm’s long - run profit - maximizing decision Explanation of the Diagram • The firm maximizes profit where: • Marginal Cost (MC) = Marginal Revenue (MR) • This determines the equilibrium output level Q • At this point: o Price = Average Total Cost o Economic profit = zero o Firm produces at the minimum point of LRATC This confirms long - run equilibrium for an individual firm .

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    Study Guide 1.6 Long - Run Market Supply Curve • Short - run market supply = horizontal sum of all firms’ supply curves • Long - run market supply depends on how costs change as industry output changes To understand this, we look at two types of industries . 1.7 Constant - Cost Industry Figure 2 Long - run market supply curves What Happens Here? • Firms’ production costs do not change as industry output increases Step - by - step: 1. Market is initially in equilibrium at P ₁ 2. Demand increases from D ₁ to D ₂ 3. Price rises to P ₂ (short run) 4. Firms earn economic profits 5. New firms enter the market 6. Supply shifts from S ₁ to S ₂ 7. Price falls back to P ₁

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    Study Guide Key Result • Long - run market supply curve is horizontal • Price stays the same even when output increases 1.8 Increasing - Cost Industry What Happens Here? • Firms’ costs increase as industry output increases • (due to higher wages, land prices, raw material costs, etc.) Step - by - step: 1. Market starts at price P ₁ 2. Demand increases from D ₁ to D ₂ 3. Price rises to P ₂ (short run) 4. Firms earn economic profits 5. New firms enter the market 6. Supply shifts from S ₁ to S ₂ 7. Final price settles at P ₃ Key Result • P ₃ > P ₁ • Long - run market supply curve is upward sloping Summary • In the long run , all inputs are variable • Firms enter with profits and exit with losses • Long - run equilibrium means zero economic profit • Firms produce at minimum LRATC • Constant - cost industry → horizontal long - run supply • Increasing - cost industry → upward - sloping long - run supply

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    Study Guide 2. Conditions for Perfect Competition When economists study how a firm makes production decisions, they first look at the type of market the firm operates in. This is called the market structure . Market structure helps us understand how firms set prices, decide output levels, and compete with each other. The structure of a market depends on four main characteristics . Let’s look at them step by step. 1. Number and Size of Firms In some markets, there are only a few big firms. In others, there are many small firms. In a perfectly competitive market , there are many firms , and each firm is very small compared to the entire market. Because no single firm is large, no firm has power over the market price . Key idea: Each firm’s individual decisions have almost no effect on the whole market. 2. Ease of Entry and Exit Another important feature of a market is how easy it is for firms to enter or leave . In perfect competition: • New firms can enter easily if they see a chance to earn profits. • Existing firms can exit easily if they are facing losses. There are no major barriers , such as high startup costs, government restrictions, or control by existing firms. Key idea: Firms are free to come and go based on profit or loss.

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