Long-Run Equilibrium

Definition

Long-run equilibrium refers to the state in which a firm or market has achieved a balance between supply and demand, where all adjustments have been made and no further changes are expected. This concept is particularly relevant in the context of perfect competition, monopolistic competition, and the aggregate demand-aggregate supply model.

5 Must Know Facts For Your Next Test

1. In long-run equilibrium, firms in a perfectly competitive market earn only normal profits, as any supernormal profits will attract new entrants until the market price is driven down to the minimum of the long-run average cost curve.
2. For a monopolistically competitive firm, long-run equilibrium occurs where the firm's marginal revenue equals its marginal cost and its price equals its long-run average cost, resulting in zero economic profits.
3. In the aggregate demand-aggregate supply model, the long-run aggregate supply curve is vertical, indicating that the economy will always return to its potential output level in the long run, regardless of changes in aggregate demand.
4. The long-run equilibrium price and quantity in a perfectly competitive market are determined by the intersection of the market demand curve and the long-run supply curve, which reflects the minimum of the long-run average cost curve.
5. The long-run equilibrium in monopolistic competition is characterized by firms producing at a point where price is greater than marginal cost, leading to a less efficient allocation of resources compared to perfect competition.

Review Questions

• Explain how the concept of long-run equilibrium applies to a perfectly competitive market.
  • In a perfectly competitive market, the long-run equilibrium is achieved when firms are producing at the minimum of their long-run average cost curve. At this point, firms are earning only normal profits, as any supernormal profits will attract new entrants until the market price is driven down to the level of the minimum long-run average cost. This ensures that resources are allocated efficiently, and no firm has an incentive to enter or exit the market.
• Describe how the long-run equilibrium in a monopolistically competitive market differs from that of a perfectly competitive market.
  • Unlike in perfect competition, the long-run equilibrium in a monopolistically competitive market is characterized by firms producing at a point where price is greater than marginal cost. This leads to a less efficient allocation of resources compared to perfect competition, as firms have some control over their own prices due to product differentiation. In long-run equilibrium, monopolistically competitive firms earn only normal profits, but they produce at a point where average cost is not minimized.
• Analyze the role of the long-run aggregate supply curve in the aggregate demand-aggregate supply model and explain how it relates to the economy's potential output level.
  • In the aggregate demand-aggregate supply model, the long-run aggregate supply curve is vertical, indicating that the economy will always return to its potential output level in the long run, regardless of changes in aggregate demand. This is because in the long run, wages, prices, and other factors of production can fully adjust to restore the economy to its potential output, which is determined by factors such as the size and quality of the labor force, the capital stock, and the state of technology. The long-run equilibrium in this model is where aggregate demand intersects the vertical long-run aggregate supply curve, representing the economy's full employment level of output.

Related terms

Perfect Competition: A market structure characterized by many small firms, homogeneous products, and free entry and exit, where firms are price takers and must accept the market price.

Monopolistic Competition: A market structure with many firms selling differentiated products, where each firm has some control over its own price but faces competition from other firms.

Aggregate Demand: The total demand for all goods and services in an economy at a given price level and time.