11

Pure Competition in the Long Run

McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
 The Long Run in Pure Competition

• In the long run

• Firms can expand or contract
capacity
• Firms enter and exit the industry

LO1 11-2
 Profit Maximization in the Long Run
• Easy entry and exit
• The only long-run adjustment we
consider
• Identical costs
• All firms in the industry have identical
costs
• Constant-cost industry
• Entry and exit do not affect resource
prices
LO2 11-3
 Long-Run Equilibrium
• Entry eliminates profits
• Firms enter
• Supply increases
• Price falls
• Exit eliminates losses
• Firms exit
• Supply decreases
• Price rises
LO3 11-4
 Entry Eliminates Economic Profits

S1
MC

ATC S2
$60 $60

50 50
MR
D2
40 40
D1

LO3 11-5
 Exit Eliminates Losses

S3
MC

ATC S1
$60 $60

50 50
MR
D1
40 40
D3

LO3 11-6
 Long Run Supply
• Constant cost industry
• Entry/exit does not affect LR ATC
• Constant resource price
• Special case
• Increasing cost industry
• Most industries
• LR ATC increases with expansion
• Specialized resources
• Decreasing cost industry
LO4 11-7
 LR Supply: Constant-Cost Industry

$50 S
Z3 Z1 Z2

D3 D1 D2

Q3 Q1 Q2
90,000 100,000 110,000

LO4 11-8
 LR Supply: Increasing-Cost Industry

S
P2 $55
Y2
P1 $50
Y1
P3 $40
Y3
D2
D1
D3
Q3 Q1 Q2
90,000 100,000 110,000

LO4 11-9
 LR Supply: Decreasing-Cost Industry

X3
P3 $55
P1 $50 X1

P2 $40 X2
S
D3 D2
D1

Q3 Q1 Q2
90,000 100,000 110,000

LO4 11-10
 Pure Competition and Efficiency

• In the long run, efficiency is achieved

• Productive efficiency
• Producing where P = min. ATC
• Allocative efficiency
• Producing where P = MC

LO5 11-11
 Pure Competition and Efficiency

P=MC=Minimum
ATC (Normal Profit) MC Consumer S
Surplus
ATC

P MR P Producer
Surplus
D

Qf Qe

LO5 11-12
 Dynamic Adjustments

• Purely competitive markets will

automatically adjust to
• Changes in consumer tastes
• Resource supplies
• Technology
• Recall the “Invisible Hand”

LO6 11-13
 Technological Advance: Competition

• Entrepreneurs would like to increase

profits beyond just a normal profit
• Decrease costs by innovating
• New product development

LO6 11-14
 Creative Destruction

• Competition and innovation may lead

to “creative destruction”
• Creation of new products and
methods destroys the old products
and methods

LO6 11-15
 Efficiency Gains from Entry

• Patent protected prescription drugs earn

substantial economic profits for the
pharmaceutical company
• Generic drugs become available as the
patent expires on the existing drug
• Results in a 30-40% reduction price
• Greater consumer surplus and efficiency

11-16
Efficiency Gains from Entry

a
S
P1 b c

d
P2 f

Q1 Q2

11-17