It is crucial to determine the meaning of ‘firm and industry’ before analyzing the graph of a purely competitive firm in the long-run equilibrium. A firm is an organization that produces and supplies different types of goods in the respect of public demands. It is done eyeing customer satisfaction and maximizing the profits. It can also buy and hire various resources and sale-related goods and services. To make it simpler, it is a unit that employs aspects of production for producing commodities sold to other firms, government, and households.
Industry, on the other hand, is a group of firms that produce homogenous products in the market. They sell specific products which are not obtainable in other market bases.
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Long-run Equilibrium of the Firm
To define the long-run equilibrium of firm and industry under perfect competition, we need to take a look more precisely. It is possible that a firm’s cost functions may get affected due to the changes in industry output. Long-run equilibrium of the firm under perfect competition may contract or expand based on the changes in the industry’s demands. This also leads to changes in price input. This scenario is common, especially for an input for which the industry is looking to use a significant fraction of the entire amount of that particular input available in the economy.
This is the reason, it is crucial to index the cost functions of the firms based on the industry output. TCY(y) illustrates that the total costs of producing y units in a particular situation when the industry’s output is Y. If the industry output increases in prices of the inputs, then the TC increases with respect to Y: TCY'(y) > TCY(y). To make it simpler, a firm is in the equilibrium model when it does not tends to change the level of output. Therefore, they need no further contraction or expansion. It is for acquiring maximum profits by equating the marginal costs along with the marginal revenue (MC = MR). Understanding the long-run equilibrium of the firm and industry under perfect competition will help you to craft the accounts and business prospects to a higher degree.
Condition for the Long-run Equilibrium of a Firm
An industry is considered to be in equilibrium when there is a completely null chance for the firms to leave or enter the industry. Also, it depends on the factor that if each firm is in equilibrium. The first condition is possible when the average cost coincides with the average revenue shown by all the firms. In this case, they are making normal profits that are to be included in the average cost.
Long-run equilibrium of firm and industry under perfect competition, as per the second case, is possible with the equality of MR and MC, as follows.
AR = MR
MC = MR
AC = AR
MC = AC = AR
These situations indicate the full equilibrium of an industry.
Long-run Equilibrium of the Industry
The factors and characteristics of long-run equilibrium for a perfectly competitive firm are variable and none of them are fixed. The period of the long run is sufficiently long for the firms that allow making changes in terms of production. Therefore, the firms can increase the output as per the changes in capital equipment. They can also wish to expand their old plants or consider replacing lower-capacity plants. Equilibrium of a firm under perfect competition long-run allows new firms to enter the industry and compete with the existing firms. On the other hand, the firms can contract the level of output by minimizing the capital equipment.
Long-run equilibrium of the firm under perfect competition refers to the situations when the capital equipment is allowed for full and free adjustments along with the number of firms. Therefore, the long-run average and marginal cost curve are relevant when it comes to deciding the output of equilibrium in the long run.
FAQs on Competitive Firm and Industry: Long-Run Equilibrium
1. What is meant by the long-run equilibrium of a firm and industry under perfect competition?
In a perfectly competitive market, the long-run equilibrium is a state where a firm has no incentive to change its output level, and there is no tendency for firms to enter or leave the industry. This occurs when the firm is maximising its profit by producing at a level where the market price equals both its marginal cost and the minimum of its long-run average cost. Consequently, all firms in the industry earn only normal profit (zero economic profit), and the industry's output is stable.
2. What are the key conditions for a firm to achieve long-run equilibrium in a perfectly competitive market?
A firm in a perfectly competitive market is in long-run equilibrium when it satisfies the following three conditions simultaneously:
- The firm must be maximising its profits, which means its Marginal Cost (MC) must be equal to its Marginal Revenue (MR). In perfect competition, Price (P) is equal to MR. So, P = MC.
- There should be no incentive for new firms to enter or existing firms to exit the industry. This happens when all firms are earning zero economic profit, meaning Price (P) equals Average Cost (AC). So, P = AC.
- Combining these, the ultimate condition is that the firm produces at the minimum point of its Long-Run Average Cost (LRAC) curve, where P = MR = MC = minimum LRAC.
3. Why do firms in a perfectly competitive industry earn only normal profit in the long run?
Firms in a perfectly competitive industry earn only normal profit (or zero economic profit) in the long run due to the core characteristic of free entry and exit. If existing firms start making super-normal profits (economic profits), new firms are attracted to the industry. This increases the market supply, which in turn drives down the market price. The price continues to fall until it equals the minimum average cost, eliminating the super-normal profits. Conversely, if firms are making losses, some will exit the industry, reducing supply, raising the price, and eliminating losses until only normal profit remains.
4. How does the long-run equilibrium of a competitive firm differ from its short-run equilibrium?
The main difference lies in the level of profit and the flexibility of production. In the short run, a firm can earn super-normal profits, normal profits, or even incur losses, as the number of firms in the industry is fixed. The equilibrium condition is simply P = MC. In the long run, however, all factors of production are variable, and firms can freely enter or exit. This process forces profits down to zero, so the firm can only earn normal profit. The long-run equilibrium condition is more stringent: P = MC = minimum AC.
5. What is the relationship between a single firm's equilibrium and the entire industry's equilibrium in the long run?
The equilibrium of a single firm and the industry are interdependent in the long run. The industry is considered in equilibrium only when two conditions are met: first, every single firm within it is in equilibrium (producing where P = MC = minimum AC), and second, the number of firms is stable, with no tendency for entry or exit. Therefore, the industry's long-run equilibrium is the sum of all individual firms operating at their own profit-maximising and zero-economic-profit output levels.
6. Can you explain with an example how an industry adjusts to long-run equilibrium?
Consider the market for street food vendors, which approximates perfect competition. If a new food trend makes a particular dish highly profitable, existing vendors will start making super-normal profits. Seeing this, new vendors will enter the market, increasing the number of stalls (increasing supply). This heightened competition will force prices down. New vendors will continue to enter until the price drops to a level where it just covers the average cost of making the food, at which point vendors only earn a normal profit. The market has now reached a new long-run equilibrium with more vendors but zero economic profit for each.
7. What are the efficiency implications for an economy when an industry is in long-run competitive equilibrium?
The long-run equilibrium under perfect competition leads to optimal efficiency for the economy. It achieves both:
- Productive Efficiency: Since every firm produces at the minimum point of its Long-Run Average Cost (LRAC) curve, goods are being produced in the most cost-effective way possible.
- Allocative Efficiency: The condition P = MC ensures that the price consumers are willing to pay for the last unit of a good is exactly equal to the marginal cost of producing it. This means resources are allocated perfectly to match consumer preferences, maximising social welfare.
