Long-run equilibrium

Definition

Long-run equilibrium refers to a state in a perfectly competitive market where firms have adjusted their output to the point where economic profits are zero. In this situation, all firms in the market earn just enough revenue to cover their costs, including a normal return on investment. The long-run equilibrium is characterized by firms entering and exiting the market freely, which leads to the price of the product equaling the minimum point of the average total cost curve.

5 Must Know Facts For Your Next Test

1. In long-run equilibrium, firms produce at an output level where price equals marginal cost (P = MC) and also equals average total cost (P = ATC).
2. Long-run equilibrium leads to a stable market price, as any economic profits will attract new firms, increasing supply and driving prices down.
3. When firms are making losses, some will exit the market in the long run, reducing supply until the remaining firms can break even.
4. Long-run equilibrium does not imply that all firms are identical; instead, they can have different efficiencies as they converge on zero economic profit.
5. In the long run, resources are allocated efficiently in perfectly competitive markets because firms produce at minimum average total costs.

Review Questions

• How does the concept of long-run equilibrium differ from short-run equilibrium in a competitive market?
  • Long-run equilibrium occurs when all firms in a perfectly competitive market adjust their production levels such that they earn zero economic profit, while short-run equilibrium can involve firms making positive or negative profits. In short-run equilibrium, firms may not have fully adjusted their output due to fixed costs or market conditions. Over time, as firms enter or exit the market based on profitability, the market moves toward long-run equilibrium where supply equals demand and price stabilizes.
• What role do new entrants play in achieving long-run equilibrium in a perfectly competitive market?
  • New entrants are crucial for achieving long-run equilibrium as they respond to economic profits being earned by existing firms. When some firms in the market earn positive economic profits, this signals potential profitability to other businesses. Consequently, new firms enter the market, increasing supply and driving down prices. This process continues until economic profits are eliminated, and the remaining firms earn zero economic profit at long-run equilibrium.
• Evaluate how long-run equilibrium contributes to resource allocation efficiency in perfectly competitive markets.
  • Long-run equilibrium promotes resource allocation efficiency because it ensures that firms produce at an output level where price equals marginal cost (P = MC) and also equals average total cost (P = ATC). This means that resources are used in a way that maximizes total welfare in the economy. Since no firm can earn an economic profit in the long run, it discourages inefficient practices and encourages firms to innovate and minimize costs. As a result, consumer needs are met at the lowest possible prices while maintaining optimal production levels.

Related terms

perfect competition: A market structure characterized by a large number of small firms, homogeneous products, and easy entry and exit from the market.

economic profit: The difference between total revenue and total costs, including both explicit and implicit costs; when positive, it indicates that a firm is earning more than its opportunity costs.

short-run equilibrium: A situation in a competitive market where firms maximize their profits given existing market conditions, potentially earning positive or negative economic profits.