Perfect competition

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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

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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

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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
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2. Long run equilibrium

• all supernormal profits competed away
• A) price is high (e.g. P1 on Figure 1a)
• B) AR gt 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
• LRACACMCMRAR (see Fig 2)

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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
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Long-run equilibrium of the firm under perfect
competition

(SR)MC
(SR)AC
LRAC
DL
AR MR
O
Q
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3. Derivation of the long 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

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4. Advantages disadvantages

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

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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