Pure Competition in Pure Competition in the Long Runthe Long Run

Sam, Greg, Rohit, Matt, Dylan

In the long run...In the long run...Pure competition describes an market where no firms are large enough to have the market power to set the price of a homogeneous product

Firms can expand/contract, enter/exit

The firm is the price taker

Identical costs: all firms in the industry have the same costs

Example: Agricultural products

Short Run vs. Long Short Run vs. Long RunRun

short run: a firm can either earn profits or incur losses

long run: when firms are earning profits, new firms will be attracted to enter the industry

When firms suffer losses, they may be forced to shut down and leave the industry

Entry/exit occurs until the industry has reached a long run equillibrium. Firms then generate normal profits

Entry into the MarketEntry into the Market

An increase in demand raises price and profit.

This encourages other firms to enter into the market.

Entry continuedEntry continuedWhen firms enter the market, demand increases and supply increases.

Supply increases, prices fall

Exit from the MarketExit from the MarketHigher industry output from new entrants drives price and profit back down.

Normal profit

P=MR=MC=ATC

Encourages exit from the market

Exit continuedExit continuedWhen firms exit the market, Supply decreases, demand decreases

Supply decreases, prices fall

EquilibriumEquilibriumEntry or exit will continue until the market price generates normal profits for the industry

With firms earning normal profit, they will have no incentive to enter or exit the industry, which then constitutes an equilibrium in the industry

Entry and exit improves resource allocation: Firms that exit the industry leave their resources to be used in other industries who will use the resources more efficiently

Allocative EfficiencyAllocative EfficiencyDefinition: occurs when there is an optimal distribution of goods and services, taking into account consumer’s preferences

A market will be allocatively efficient if it is producing the right goods for the right people at the right price.

A more precise definition of allocative efficiency is at an output level where the price equals the Marginal Cost (MC) of production

This is because the price that consumer’s are willing to pay is equivalent to the marginal utility that they get. Therefore the optimal distribution is achieved when the marginal utility of the good equals the marginal cost.

Essentially, allocative efficiency will occur when marginal benefit = marginal cost

1.The primary force encouraging the entry of new firms into a purely competitive industry is:A. Normal profits earned by firms already in the industryB. Economic profits earned by firms already in the industryC. Government subsidies for start up firmsD. A desire to provide goods for the betterment of society

2. Suppose a firm in a purely competitive market discovers that the price of its product is above its minimum AVC point but everywhere below ATC. Given this, the firm:A. Minimizes losses by producing at the minimum point of its AVC curve1. Maximizes profits by producing where MR=ATCA. Should close down immediatelyB. Should continue producing in the short run but leave the industry in the long run if the situation

persists

3. Which of the following is true concerning purely competitive industriesA. There will be economic losses in the long run because of cut throat competition• Economic profits will persist in the long run if consumer demand is strong and stable A. In the short run, firms may incurs economic losses or earn economic profits but in the long run,

they earn normal profitB. There are economic profits in the long run but not in the short run

4. Long run competitive equilibrium:A. Is realized only in constant cost industriesB. Will never change once it is realizedC. Is not economically efficient• Results in zero economic profits

5. A constant cost industry is one in which:A. Resource prices fall as output is increased1. Resource prices rise as output is increasedA. Resource prices remain unchanged as output is increasedB. Small and large levels of output entail the same total cost