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Home Price and Output Determination Under Perfect Competition Long Run Equilibrium of the Price Taker Firm

Long Run Equilibrium of the Price Taker Firm:

 

Definition:

 

"All the firms in a competitive industry achieve long run equilibrium when market price or marginal revenue equals marginal cost equals minimum of average total cost."

 

Formula:

 

Price = Marginal Cost = Minimum Average Total Cost

 

Explanation:

 

The long run is a period of time during which the firms are able to adjust their outputs according to the changing conditions. If the demand for a product increases, all the firms have sufficient time to expand their plant capacities, train and engage more labor, use more raw material, replace old machines, purchase new equipments, etc., etc.

 

If the demand for a product declines, the firms reduce the number of workers on the pay roll, use less raw material. In short, all inputs used by a firm are variable in the long run. It is assumed that all the firms in the competitive industry are producing homogeneous product and an individual firm cannot affect the market price. It takes the market price as given. It is also assumed that all the firms in a competitive industry have identical cost' curves. The industry it is assumed is, a constant cost industry. In the long run, it is for further assumed that all the firms in a competitive industry have access to the same technology.

 

When the period is long and profit level of the competitive industry is high, then new firms enter the industry. If the profit level is below the competitive level, the firm then leave the industry. When all the competitive firms earn normal profit, then there is no tendency for the new firms to enter or leave the industry. The firms are then in the long run equilibrium.

 

Diagram:

 

The case of long-run equilibrium of a firm can be easily explained with .the help of a diagram given below:

 

 

In the figure (15.9), the firm is in the long run equilibrium at point K, where price or marginal revenue equals long-run marginal cost equals minimum of long run average cost. The average revenue per unit cost of the firm and its marginal revenue at price OP are the same. The firm at equilibrium point K, produces the best level of output OL and sells at price OP per unit. The total revenue of the firm is equal to the area OPKL.

 

The total cost of producing OL quantity of output is also equal to the area OPKL. The firm is earning only normal profits. At price OP, there is no tendency for the new firms to enter or leave the industry. 

 

This can be proved by taking prices higher or lower price than OP. If the market price in the long run happens to be OR, the firm would be making more than normal profits. The new firms attracted by profit will enter the industry. The supply of the commodity will increase which derives the market price down to the OP level. The firm here makes only normal profits.

 

In case, a firm is faced with a market price OZ, the firm is then covering its full variable cost. As the firm is suffering a net loss at price OZ, it will leave the industry. So in the long run, price must be equal to OP which is the minimum average to cost of the firms.

 

At price OP, all the identical firms to the industry earn only normal profit. There is no tendency for the new firms to enter or leave the industry provided price equals marginal revenue equals marginal cost equals minimum average total cost of the firms.

 

Price = MR = MC = Minimum of LATC

 

 

Long Run Industry Equilibrium:

 

Since all the competitive firms in the long run make normal profits, are of the optimum size and there is no tendency for the new firms to enter or leave the industry, they are, therefore, in equilibrium. When all the identical firms in the industry are in a state of full equilibrium equating price or marginal revenue, equating marginal cost equating minimum of average total cost, the industry itself is then in equilibrium.

 

When the industry is in the long run equilibrium, there is an optimum allocation of resources. The consumers get the. products at the lowest possible price as, the goods are produced at minimum price in the long run.

Relevant Articles:

Market Structure
Perfect Competition
Equilibrium of the Firm
Short Run Equilibrium of the Price Taker Firm
Short Run Supply Curve of a Price Taker Firm
Short Run Supply Curve of the Industry
Long Run Equilibrium of the Price Taker Firm
Long Run Supply Curve For the Industry
Price Determination Under Perfect Competition
Market Price
Determination of Short Run Normal Price
Long Run Normal Price and the Adjustment of Market Price to the Long Run Normal Price
Distinction/Difference Between Market Price and Normal Price
Interdependent Prices
Joint Supply
Fixation of Railway Rates

Composite or Rival Demand

 

Principles and Theories of Micro Economics
Definition and Explanation of Economics
Theory of Consumer Behavior
Indifference Curve Analysis of Consumer's Equilibrium
Theory of Demand
Theory of Supply
Elasticity of Demand
Elasticity of Supply
Equilibrium of Demand and Supply
Economic Resources
Scale of Production
Laws of Returns
Production Function
Cost Analysis
Various Revenue Concepts
Price and output Determination Under Perfect Competition
Price and Output Determination Under Monopoly
Price and Output Determination Under Monopolistic/Imperfect Competition
Theory of Factor Pricing OR Theory of Distribution
Rent
Wages
Interest
Profits
Principles and Theories of Macro Economics
National Income and Its Measurement
Principles of Public Finance
Public Revenue and Taxation
National Debt and Income Determination
Fiscal Policy
Determinants of the Level of National Income and Employment
Determination of National Income
Theories of Employment
Theory of International Trade
Balance of Payments
Commercial Policy
Development and Planning Economics
Introduction to Development Economics
Features of Developing Countries
Economic Development and Economic Growth
Theories of Under Development
Theories of Economic Growth
Agriculture and Economic Development
Monetary Economics and Public Finance
History of Money

 

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