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PDF Market Structure and Equilibrium

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When the supply curve shifts to the right, given the same demand curve, the equilibrium will price fall.

Perfect Competition - Short Run Price and Output Equilibrium

In the long run, all firms will operate at a point where marginal cost MC intersects at the lowest level on the average total cost ATC curve. In the long run, perfectly competitive markets operate at practically zero economic profit. Also note that the demand curve at this point is perfectly elastic, which is represented by a horizontal line. As firms under this market structure start reporting higher profits, more firms will take advantage of entering into the market. Since entrant costs are low, customers will shift to buying the products from these new firms. This will reduce the demand for firms that produce similar goods.

As a result, the economic profits realized by monopolistically competitive firms will fall and there will be advertising costs for product differentiation. This can be seen from consumer goods products such as clothing in which advertising costs are quite high. Take for examples large sporting brands that pay lucrative contracts to professional sports players to differentiate themselves from the competition.

In the long run, there is a possibility for economic profits in oligopoly markets.

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However, the market share of a dominant firm will decline in the long run. As is always the case, profits attract more firms to enter the oligopoly market.


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Marginal costs incurred by entrant firms fall and the profitability of the dominant firm declines. The reactions of entrant firms are included in the optimal pricing strategy. Some firms may decide to incorporate innovation as a way of maintaining market leadership.

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However, these innovations are usually not very effective at maintaining the market share of the dominant firm. Monopolies can make economic profits even in the long-run since the long-run equilibrium creates room for every input to change. A monopoly must be protected by barriers to entry. For monopolies that are regulated, there exist a number of solutions to long-run equilibrium, such as:. Indeed, the condition that marginal revenue equals marginal cost is used to determine the profit-maximizing level of output of every firm, regardless of the market structure in which the firm is operating.

Market Structure and Equilibrium | History of Political Economy | Duke University Press

The two sets of diagrams below will help to show that in the long run, all firms in a perfectly competitive market earn only normal profit. In the diagrams above, the initial price is P 1 , due to the fact that the initial demand and supply curves, D 1 and S 1 , cross at point C. This given price means that each firm's demand curve is D 1.

mahournyidmit.tk But what will happen as we move towards the long run? Remember that there are no barriers to entry or exit in a perfectly competitive market. This means that new firms will be attracted, in quite large numbers, into the market. This will increase market supply, shifting the supply curve to the right.

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This will keep happening until the given price is such that all firms in the market earn only normal profit. All of the super normal profit will have been competed away. Once the supply curve has shifted all the way to S 2 , with a given price of P 2 , then every firm in the industry will be earning normal profit and there will be no incentive for any firm to enter or leave the industry.

This is, therefore, the long run equilibrium. In the second set of diagrams above, each firm is making a loss at the initial price P 1.

Perfect Competition in the Short Run- Microeconomics Topic 3.7 (1 of 2)

As we said earlier, firms can take a reasonable sized loss in the short run, but this is not sustainable as we move into the long run. Again, there are no barriers to exit, so some firms will leave the industry, causing the market supply curve to shift to the left.

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Once the supply curve has shifted all the way to S 3 , with a given price of P 3 , then every firm in the industry will be earning normal profit and there will be no incentive for any firm to enter or leave the industry. Notice that I haven't drawn a set of 'long run' diagrams for the situation where firms earn normal profit in the short run. This is because nothing happens.


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If firms are earning normal profit in the short run, there is no incentive for any firms to leave or enter the industry. The diagram stays the same so that the long run equilibrium looks the same as the short run equilibrium. In the topic on 'Market failure', the fact that a market has not failed if it is efficient in both these ways was discussed.

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