Pure Competition in the Long Run

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McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

The Long Run in Pure Competition

• In the long run

• Firms can expand or contract capacity

• Firms enter and exit the industry

LO1

Profit Maximization in the Long Run

• Easy entry and exit

• The only long-run adjustment we consider

• Identical costs

• All firms in the industry have identical costs

• Constant-cost industry

• Entry and exit do not affect resource prices

LO2

Long-Run Equilibrium

• Entry eliminates profits

• Firms enter

• Supply increases

• Price falls

• Exit eliminates losses

• Firms exit

• Supply decreases

• Price rises

LO3

Entry Eliminates Economic Profits

LO3

ATC

MR

MC

$60

50

40D1

S1

D2

$60

50

40

S2

Exit Eliminates Losses

LO3

ATC

MR

MC

$60

50

40D3

S3

D1

$60

50

40

S1

Long Run Supply

• Constant cost industry

• Entry/exit does not affect LR ATC

• Constant resource price

• Special case

• Increasing cost industry

• Most industries

• LR ATC increases with expansion

• Specialized resources

• Decreasing cost industryLO4

LR Supply: Constant-Cost Industry

LO4

90,000 100,000 110,000Q3 Q1 Q2

$50 SZ1 Z2Z3

D3 D1 D2

LR Supply: Increasing-Cost Industry

LO4

90,000 100,000 110,000Q3 Q1 Q2

$50P1

S

Y1

Y2

Y3

D3

D1

D2

$40

$55P2

P3

LR Supply: Decreasing-Cost Industry

LO4

90,000 100,000 110,000Q3 Q1 Q2

$50P1

S

X1

X2

X3

D3

D1

D2

$40

$55P3

P2

Pure Competition and Efficiency

• In the long run, efficiency is achieved

• Productive efficiency

• Producing where P = min. ATC

• Allocative efficiency

• Producing where P = MC

LO5

Pure Competition and Efficiency

LO5

P MR

D

S

QeQf

ATC

MCP=MC=MinimumATC (Normal Profit)

P

Consumer Surplus

Producer Surplus

Dynamic Adjustments

• Purely competitive markets will automatically adjust to

• Changes in consumer tastes

• Resource supplies

• Technology

• Recall the “Invisible Hand”

LO6

Technological Advance: Competition

• Entrepreneurs would like to increase profits beyond just a normal profit

• Decrease costs by innovating

• New product development

LO6

Creative Destruction

• Competition and innovation may lead to “creative destruction”

• Creation of new products and methods destroys the old products and methods

LO6

Efficiency Gains from Entry

• Patent protected prescription drugs earn substantial economic profits for the pharmaceutical company

• Generic drugs become available as the patent expires on the existing drug

• Results in a 30-40% reduction price

• Greater consumer surplus and efficiency

Efficiency Gains from Entry

Q1 Q2

P1

S

D

P2

a

b c

df