Short-run equilibrium

Definition

Short-run equilibrium is a market condition where the quantity supplied equals the quantity demanded at a specific price level, with firms unable to fully adjust their resources and production levels due to fixed factors. In this scenario, firms may earn economic profits or losses, but they will typically not change their number of firms in the market until long-run adjustments take place. This concept is crucial in understanding how different market structures operate in the short run, particularly in contexts of monopolistic competition and perfect competition.

5 Must Know Facts For Your Next Test

1. In short-run equilibrium, firms may operate at a loss or make economic profits due to fixed inputs and existing competition.
2. Short-run equilibrium occurs at the intersection of the short-run supply curve and the demand curve, determining the market price.
3. Unlike in the long run, firms cannot enter or exit the market freely during short-run equilibrium because of fixed costs or barriers.
4. In monopolistic competition, firms can differentiate their products, allowing them to set prices above marginal cost in short-run equilibrium.
5. In perfect competition, firms are price takers, meaning they accept the market price determined in short-run equilibrium without influencing it.

Review Questions

• How does short-run equilibrium differ between monopolistic competition and perfect competition?
  • In monopolistic competition, short-run equilibrium allows firms to set prices above marginal cost due to product differentiation, leading to potential economic profits. Conversely, in perfect competition, firms are price takers and must sell at the market-determined price, which is equal to marginal cost, often resulting in zero economic profit in the long run. This distinction highlights how firm behavior and pricing strategies differ across these two market structures despite both reaching an equilibrium point where supply equals demand.
• Explain how changes in demand affect short-run equilibrium in a perfectly competitive market.
  • When demand increases in a perfectly competitive market, the demand curve shifts rightward. This causes an upward pressure on prices and leads to a higher quantity produced in the short run as firms respond by increasing output. However, since firms cannot change their fixed resources immediately, this results in economic profits in the short run. Over time, new firms may enter the market attracted by these profits, leading to adjustments that restore long-run equilibrium at zero economic profit.
• Evaluate the impact of short-run equilibrium on long-term market dynamics and firm behavior.
  • Short-run equilibrium significantly impacts long-term market dynamics by influencing firm entry and exit based on observed economic profits or losses. In markets with positive economic profits during short-run equilibrium, new firms are incentivized to enter the market, leading to increased competition and ultimately driving prices down. Conversely, if firms face losses, some will exit the market, reducing supply until the remaining firms can achieve normal profits. This cyclical process between short-run conditions and long-term adjustments shapes overall market structure and firm strategies over time.

Related terms

Economic profits: The difference between total revenue and total costs, including both explicit and implicit costs, which can influence firms' decisions to enter or exit a market.

Marginal cost: The additional cost incurred by producing one more unit of a good or service, important for firms when determining their production levels in short-run equilibrium.

Supply and demand: The fundamental economic model that describes how the price and quantity of goods are determined in a market based on consumers' willingness to buy and producers' willingness to sell.