CHAPTER 11- PURE COMPETITION bought down equal to min.

IN THE LONG RUN average total cost.

If price is initially less than min.
Long run vs short run average total cost resulting loss
will cause firms to leave industry.
As they leave supply will lessen
Entry and exit of firms can only
bringing market price up equal to
happen in the long run
min ave total cost
The industry in short run is
composed of specific firms and
Long run equilibrium
fixed size
Economic profit here is zero,
Short run have no sufficient time
industry is in equilibrium or at
to liquidate and go out of business
rest bec there is no tendency for
Firms in long run have time to
firms to enter or leave. Firms earn
expand or contract capacities
at normal profit
Firms may increase or decrease in
Normal profits earned by these
the long run as new firms enter or
firms are considered an
exit.
opportunity cost and therefore
included in the firms cost curves
Profit maximization in the long run
Entry eliminates economic profit
1.) ENTRY AND EXIT ONLY Exit eliminates losses
2.) IDENTICAL COSTS Competition reflected in entry and
3.)CONSTANT COST INDUSTRY exit of firms eliminates economic
Entrance and exit of firms does profit and lossess by adjusting
not affect resources, prices or price to = minimum long run ave.
consequently the location of ATC total cost. Competition forces
curves of individual firms firms to select output levels at
which ave. total cost is minimized
The long run adjustment process in
pre competition Long run supply curve- effect is the
crucial factor.
After all long run adjustments
product price will exactly be equal Constant cost industry- industry
to and production will occur at expansion or contraction will not affect
each firms min average total cost resource prices and therefore production
costs.
1.) Firms seek profit and shun
lossess Long run supply curve for a constant
2.) Under pure comp. firms are cost industry- increase in demand raises
free to enter and leave the industry output but not price. Similarly a
industry decrease in demand reduces output but
not price. Long run industry supply curve
If market price initially exceed
is Horizontal
min. average total cost, resulting
economic profit will attract new
Increasing cost industries- ATC curves
firms to the industry. This
industry expansion will increase shift upward as industry expands, shift
downward as industry contracts
supply until price until price is
Long run supply curve for increasing The long run equality of price and
cost industries- in increasing cost marginal cost implies that
industries entry of new firms due to an resources will be allocated in
increase in demand will bid up resource accordance with consumer tastes.
prices and thereby increase unit cost. As a Allocative efficiency will occur. In
result an increased industry output will the market the combined amount
be forthcoming only at higher prices. of consumer surplus and and
Long run industry supply curve slopes producer surplus will be at a
upward maximum

Decreasing curve industries- firms Competitive price system will

experience lower cost as industry reallocate resources in response
expands to a change in consumer tastes, in
technology, or in resource
Long run supply curve for decreasing supplies and will thereby
cost industries- in decreasing cost maintain allocative efficiency over
industries entry of new firms in response time.
to an increase in demand will lead to
decreased input prices and consequently
decreased unit costs. As a result increase Productive efficiency- requires goods to
In industry output will be accompanied be produced in the least costly way
by lower prices. The long run industry
supply curve slopes downward. Productive efficiency: p = minimum atc
Allocative efficiency: p = mc
Triple equality- p and MR = MC =
MINIMUM ATC Allocative efficiency- apportionment of
Compeitive firm may realize resources among firms and industries to
economic profit or loss in the obtain the production of the products
short run, it will only earn a most wanted by society, the output of
normal profit by producing in each product at which its marginal costs
accordance with MR= P=MC rule and price or marginal benefit are equal
and at which the sum of consumer
In long run equilib. Profit surplus and producer surplus is
maximizing rule that leads firm to maximized
produce quantity at P=MR implies
that each firm will produce at Maximum consumer and producer
output level assoc. with min. point surplus
on each identical firms ATC curve
Consumer surplus: difference
between maximum prices that
Pure competition and efficiency consumers are willing to pay for a
Long run equality of price and product and the market price of
minimum average total cost the product
means that competitive firms will Producer surplus: difference
use the most efficient known between minimum prices that
technology and charge the lowest producers are willing to accept for
price consistent with their a product and the market price of
production cost. a product
Creative destruction and the profit
incentives for innovation

Creative destruction: creation of

new products and new production
methods destroys the market
position of firms committed to
existing products and old ways of
doing business.

Competition involves never

ending attempts by entrepreneurs
and managers to earn abaove
normal profit by either creating
new products or developing lower
cost production methods for
existing products. These cause
creative destruction

Positive effect: economic growth

Negative effect: workers in

declining industries not flexible
enough to find a new job