The considered behavior of the firm is typical for a short-term period. However, the entrepreneur is interested not only in the immediate result, but also in the prospects for the development of the enterprise. Obviously, in the long run, the firm also proceeds from the task of maximizing profits.
The long run differs from the short run in that, firstly, the manufacturer can increase production capacity (therefore, all costs become variable) and, secondly, the number of firms in the market can change. In conditions of perfect competition, entry and exit of new firms into the market are absolutely free. Therefore, in the long run, the level of profit becomes a regulator of attracting new capital and new firms to the industry.
If the established market price in the industry is higher than the minimum average cost, then the possibility of obtaining economic profit will serve as an incentive for new firms to enter the industry. As a result, the sectoral supply will increase (S → S1), and the price will decrease (P> P 1), as shown in Fig. 8.11. Conversely, if firms suffer losses (at a price below the minimum average cost), this will lead to the closure of many of them and the outflow of capital from the industry. As a result, the industry supply will decrease (S → S 2), which will lead to an increase in the price (P → P 2 ).
The process of entering and exiting firms will stop only when there is no economic profit. The zero-profit firm has no incentive to get out of the business, and other firms have no incentive to get in. There is no economic profit when the price coincides with the minimum of average costs P = ATC type. In this case, we are talking about long-term average costs LAC.
Long-term average cost of LAC (long average costs) is the cost per unit of production in the long run. Every point LAC corresponds to the minimum of short-term unit costs ATC at any size of the enterprise (volume of output). The nature of the long-run cost curve is related to the concept of economies of scale, which describes the relationship between the scale of production and the magnitude of costs (economies of scale were discussed in the previous chapter). The minimum of long-term costs determines the optimal size of the enterprise. If the price is equal to the minimum of long-term unit costs, the firm's profit in the long run is zero.
Rice. 8.11. Changing industry supply
Thus, the condition for the long-term equilibrium of the firm is the equality of the price to the minimum of long-term unit costs RE = = LAC min (Fig. 8.12).
Rice. 8.12. Long-term equilibrium of the firm
Production at the lowest average cost means production with the most affective combination of resources, i.e. firms use factors of production and technology in the best possible way. This is undoubtedly a positive phenomenon, primarily for the consumer. It means that the consumer receives the maximum volume of products at the lowest price that the unit costs allow.
The firm's long-run supply curve, like the short-run supply curve, is part of the long-run marginal cost curve LMC, located above point E - the minimum of long-term unit costs LAC min. The industry supply curve is obtained by summing the long-term supply volumes of individual firms. However, in contrast to the short term, the number of firms may change in the long term.
So, in the long run in the market of perfect competition, the price of a good tends to a minimum of average costs, which, in turn, means that when the sectoral equilibrium in the long run is achieved, the economic profit of each of the firms will be zero.
At first glance, the correctness of this conclusion can be doubted: after all, individual firms can use unique factors of production, such as soils of increased fertility, highly qualified specialists, modern technology, which makes it possible to produce products with less material and time consumption.
Indeed, the cost of resources per unit of output for competing firms may differ, but their economic costs will be the same. The latter is explained by the fact that in conditions of perfect competition in the market for factors of production, a firm can acquire a factor with increased productivity if it pays for it a price that raises the firm's costs to the general level in the industry. Otherwise, this factor will be outbid by a competitor.
If the firm already has unique resources, then the increased price should be included in the opportunity cost, because the resource could be sold at that price.
What compels firms to enter the industry if economic profits in the long run are reduced to zero? It all depends on the possibility of obtaining high short-term profits. Such an opportunity, by changing the situation of short-term equilibrium, can be provided by the influence of external factors, in particular, a change in demand. Increased demand will bring short-term economic gains. In the future, the action will develop according to the scenario already described above.
Consider the consequences of changes in demand, provided that the prices for resources are unchanged (Fig. 8.13, a), the chains for resources increase (Fig. 8.13, b), the prices for resources are reduced (Fig. 8.13, c).
Rice. 8.13. Industry supply in the long term
If, after reaching equilibrium (point E 1) industry demand will increase ( D 1 → D 2), then at first the price will rise from R 1 before P 2. At such a price, firms will begin to receive economic profits, which will lead to an increase in supply in the industry both due to the expansion of production in individual firms and due to the arrival of new firms (in the figure, this will be reflected by the shift S1 → S2). As a result, the price will again decrease to the level P 1, since the LAC minimum is equal to this value. The balance in the industry will be established at a point E). If the demand decreases (D2> D1). then the price will decrease from R 1 before R 2. At this price, firms will be at a loss, some of them will close and move to other industries. The market supply will decrease (S2 → S 1). The sectoral equilibrium will be restored at the point E 1 (see fig. 8.13, a).
Thus, perfect competition has a kind of self-regulation mechanism. Its essence lies in the fact that the industry is flexible in responding to changes in demand. It attracts a volume of resources that increases or decreases the volume of supply just as much as necessary to compensate for changes in demand, and on this basis ensures the long-term break-even of firms operating in the industry.
If we connect two equilibrium points of the industry in the long run with various combinations of aggregate demand and aggregate supply (in Fig. 8.13, and these are points E 1 and E 2), then the supply line of the industry in the long run is formed - S1. Since we have assumed that input prices are constant, line S1 runs parallel to the abscissa. This is not always the case. There are industries in which resource prices rise or fall.
Most industries use specific resources, the amount of which is limited. Their application determines the upward nature of costs in a given industry. The entry of new firms will lead to an increase in the demand for resources, the emergence of their deficit and, as a consequence, to a rise in prices. For each new firm entering the market, scarce resources will cost more and more. Therefore, the industry will only be able to produce more products at a higher price. This will cause the shift of the S1 curve (Fig. 8.13, b). Market equilibrium will be established at a new point E 2.
Finally, there are industries in which, as the volume of the resource used increases, its price decreases. The minimum average costs in this case are also reduced. In such conditions, the growth of sectoral demand will cause in the long run not only an increase in the volume of supply, but also a decrease in the equilibrium price. Curve S 1 will have a negative slope (Fig. 8.13, c). A new long-term equilibrium will be established at the point E 3.
In any case, in the long run, the industry's supply curve will be flatter than the short-term supply curve. This is explained as follows. First, the ability to use all resources in the long run allows you to more actively influence the price change, therefore, for each individual firm, and therefore for the industry as a whole, the supply curve will be more elastic. Secondly, the possibility of entry into the industry of "new" firms and exit from the industry of "old" allows the industry to respond to changes in market prices to a greater extent than in the short term.
Consequently, output will increase or decrease by more in the long run than in the short run in response to an increase or decrease in price. In addition, the low of the industry's long-term supply price is higher than the low of the short-term supply chain, since all costs are variable and must be recovered.
So, in the long run, in conditions of perfect competition, the following will happen:
a) the equilibrium price will be established at the level of minimum long-term average costs P E = LAC min, what will ensure the long-term break-even of firms;
b) the supply curve of a competitive industry is a line passing through break-even points (minimum average costs) for each level of production;
c) with a change in demand for the products of the industry, the equilibrium chain may remain unchanged, decrease or increase, depending on how prices for factors of production change. The industry supply curve will look like a horizontal straight line (parallel to the abscissa axis), ascending or descending line.
In the long run (LR) the firm can change all factors of production. This determines a number of specific features in her behavior.
At first, the criterion for the continuation of the firm's activities is changed. Since in the long run all costs become variable, variable costs are not distinguished in the structure of production costs, Consequently, the level of costs per unit of production will be characterized only by indicators of average long-term costs (LRAC). This suggests that for any value of the market price below the average long-term costs, the firm will incur a net loss. This means that the economic profit of the firm must be at least zero, and the market price of the product must not be lower than the average long-term costs, the minimum values of which are the closing point of the company. Therefore, in the long run, the company always minimizes losses by stopping production.
Secondly, since the firm has the ability to change all parameters of production, and hence its size, its behavior is reduced to the choice of the optimal volume of production capacity (Fig. 6).
Rice. 6. Optimization of production capacity in the long term
Only by increasing the power to Q3 the firm will be able to optimize the output, since for a given volume of output, the conditions for maximizing profits for the short and long term are met:
P = MC 3 = LRMC
Thirdly, in addition to the ability to change the size of production capacity, the firm has the opportunity to exit the industry in the long run. This circumstance makes it possible to understand why in the long run the company minimizes losses by stopping production. This is because the firm has enough time to avoid losses by transferring its activities to more profitable industry markets.
Equilibrium between the firm and the industry... Equilibrium is a state of a subject or phenomenon in which they have no internal tendencies to change this state. Consequently, when it comes to the equilibrium of the firm and the industry, this sets the conditions under which each individual firm has no incentive to change the volume of output, and the number of firms operating in the industry market and, accordingly, the volume of total industry output remain unchanged.
Formation of a long-term equilibrium in a perfectly competitive market is based on the premise that there are no sectoral barriers.
Long-term equilibrium of the firm and the industry- this is the state of the market in which the equilibrium price is equal to the minimum long-term average production costs, and firms carry out output in a volume for which the economic profit is zero.
Why then is there a deviation from the point of long-term equilibrium? This is explained by the fact that the establishment of a long-term equilibrium is the result of unhindered entry and exit of firms, that is, the action of a mechanism that regulates the number of firms in the industry market. However, reality differs precisely in that there are factors in the markets that impede its action.
At first, there are always industry barriers and the only question is how high they are.
Secondly, given the difficulties of capital overflow, this mechanism works better for expansion than contraction. Thus, significant irrecoverable costs will hinder exit from the industry.
Thirdly, firms can enter an industry market with the expectation of generating economic profits in the short run. All this leads to a deviation from the point of long-term equilibrium, and the degree of such deviation will depend on the strength of the influence of these circumstances. Consequently, it is the ability to enter and exit the market that is the factor that determines the establishment of equilibrium at zero economic profit.
The efficiency of a perfectly competitive market.Market efficiency- this is its ability to ensure, firstly, the optimal allocation of resources and, secondly, the use of resources in which the production of goods would be carried out at the lowest cost.
Optimal resource allocation is achieved when their distribution by industry ensures the production of such a set of goods that corresponds to the structure of demand, that is, the needs of consumers.
Efficient use of resources is achieved when the production of goods included in the optimal set is carried out at the lowest production costs for existing technologies.
The efficiency of a perfectly competitive market lies in the fact that the market forces acting on it force firms to produce with minimal long-term average costs and sell the product at prices equal to the marginal costs of its production.
The cost-effectiveness of perfectly competitive markets should not be seen as an absolute to be pursued. It has its own restrictions:
First, the specified efficiency is achievable only under the condition of complete standardization of products, and this leads to a narrowing of the product range, and hence to a decrease in the welfare of consumers, which contradicts the condition of rational distribution of resources;
Secondly, operating at zero economic profit, firms are deprived of a source of development, which becomes an obstacle to scientific and technological progress;
Third, with a high capital intensity of production, which initially determines the large size of the firm, ensuring the atomistic market becomes technically impracticable;
Fourth, in the case of significant positive economies of scale, when the expansion of production capacity leads to To significant reduction in average production costs, perfect competition becomes undesirable by the very criterion of economic efficiency.
Conclusion
Analysis of the behavior of a firm in a perfectly competitive market consists in finding an answer to the question of the principles of the firm's choice of output.
A perfectly competitive firm is a firm that cannot influence the market price and accepts the latter as a given one, and its behavior is reduced to adapting to the prevailing market conditions.
For a long-term period, it is characteristic that firms in the industry have sufficient time to expand or reduce their production capacity and, more importantly, the industry may be replenished with new firms or, conversely, their number may decrease, which depends on the price level and profitability of production. ... If the initial price is above average gross costs, this will lead to the emergence of new firms in the industry. However, this will soon lead to an increase in output, and to such an extent that the price will drop to the level of average gross costs. And then the danger of incurring losses will cause the outflow of firms from the industry. Then there will be a reverse trend in the movement of prices and production volumes.
The reason for the influx or outflow of firms from an industry is that at the moment when prices in a given industry fall and the number of firms decreases, in other industries the owners of firms receive normal or excess profits. Free capital is poured into this area, which leads to the organization of new firms. An increase or decrease in the number of firms is accompanied by an expansion or limitation of the size of the industry, which is associated with changes in the ratio of supply and demand for products manufactured in the industry.
Long-term equilibrium is considered to be achieved when three conditions are met:
The firm has no incentive to change the volume of production, i.e. short-term equilibrium is observed MR = MC;
The firm is satisfied with the scale of production, since any change in them will cause an increase in average total costs, i.e. the minimum short-term costs are equal to the minimum long-term costs;
There is no incentive for firms to leave or enter the industry. This condition is fulfilled only when firms receive normal profits, i.e. when the price is equal to the long-term minimum average total costs.
Generalizing all three conditions, we obtain the equation for the long-term equilibrium of a competitive firm:
P = MR = MC = minATC
Long-term equilibrium is graphically illustrated in Fig. 4.6.
Fig 4.6. Equilibrium of a competitive firm in the long run.
The graph shows that at point E, all three conditions of long-term equilibrium are met. If the price exceeds the minimum average total cost, firms in the industry will generate economic profits that will attract competitors to the market. As a result, the supply will rise and the price will fall to the equilibrium level. Conversely, if prices fall below equilibrium, firms will receive less than normal profits, which will cause their outflow from the industry. The supply will decrease and the price will rise to the equilibrium level.
Therefore, we can conclude that in conditions of perfect competition, economic profit is a temporary phenomenon.
Economists consider markets with perfect competition to be highly efficient, since, first, production efficiency is achieved here at a price equal to the minimum average total cost, which means manufacturing the goods in the least expensive way (the best technology, minimum resources, low prices); secondly, there is an efficient allocation of resources, i.e. creation of goods necessary for consumers at P = MS; and thirdly, due to the free overflow of resources, competitive markets have the ability to quickly restore the efficiency of resource use in case of possible imbalances.
The short-term supply curve discussed above describes the prompt response of a profit-maximizing or loss-minimizing firm to short-term, current fluctuations in the price of a commodity. However, the entrepreneur is interested not only in the immediate result, but also in the prospects for the development of the enterprise. The main strategic criterion is obtaining a stable stream of profits due to active output, the most efficient production volumes in accordance with the forecast of the market condition in the long term.
The long run differs from the short run in that, first, the producer can increase production capabilities (so all costs become variable) and, second, the number of firms in the market can change. In other words, a firm can curtail production (go out of business) or continue to produce new types of products (go into business), and in conditions of perfect competition, entry and exit to the market of new firms is absolutely free. There are no legal or economic barriers.
Free entry into the industry and equally free exit from it is one of the main features of the market of perfect competition. Freedom of entry, of course, does not mean that a firm can enter an industry without incurring any costs. This means that it has made all the necessary investments to enter the industry and is competing with existing enterprises. In such a situation, new firms do not stand in the way of new restrictions associated with the validity of patents and licenses, with the presence of explicit or implicit collusion. Likewise, freedom of exit means that a firm that wishes to leave the industry will not encounter any barriers in its path that prevent the enterprise from closing or relocating its activities to another region. Moreover, when a firm leaves the industry, it either finds new uses for its permanent assets, or sells them without prejudice to itself.
If a firm has an economic profit in the short run (type 4), then its production becomes more attractive to other producers. New firms enter the market for a specific product, diverting part of the effective demand to themselves. In order to sell successfully, this enterprise is forced to reduce prices or incur additional costs to support sales. Profits are falling, and the influx of competitors is decreasing.
In the case of unprofitable production, the picture is the opposite: individual firms will be forced to leave the industry, which will lead to an increase in the demand price for other firms. This process will continue until the price at least covers the average costs of the remaining firms in the industry, i.e. R= ATC. If the process of exit of firms from the industry continues, then an increase in price will lead to its excess over the average costs for firms remaining in the industry and, therefore, to the receipt of economic profits by these firms, which in turn will serve as a signal for entry into the industry of new firms.
The process of entering and exiting will only stop when there is no economic profit. The zero-profit firm has no incentive to get out of the business, and other firms have no incentive to get in. There is no economic profit when the price coincides with the minimum of average costs, i.e. the firm is of the "marginal" type. In this case, we are talking about long-term average costs LAC.
Long-term average cost of LAC or LRAC (long run average costs)- is the cost of production of a unit of production ^ Long-term period. Every point LAC corresponds to the minimum of short-term unit costs ATC at any size of the enterprise (volume of output). The nature of the long-run cost curve is associated with the concept of economies of scale, which describes the relationship between the scale of production and the magnitude of costs (economies of scale were discussed earlier). The minimum of long-term costs determines the optimal size of the enterprise. If the price is equal to the minimum of long-term unit costs, then the firm's profit in the long run is zero. Thus, the condition for the long-term equilibrium of the firm is the equality of the price to the minimum of long-term unit costs: P e = min LAC(fig. 7.10).
Production at the lowest average cost means producing with the most efficient combination of resources, i.e. firms use factors of production and technology in the best possible way. This is undoubtedly a positive phenomenon, primarily for the consumer. It means that the consumer receives the maximum volume of products at the lowest price that the unit costs allow.
Rice. 7.10. Long-term balance
The firm's long-run supply curve, like the short-run supply curve, is part of the long-run marginal cost curve LMC, located above the point E- the minimum of long-term unit costs. If the price falls below this point, then the firm does not cover all costs, and it should leave the industry (see Fig. 7.76; the following situation provokes the exit from the industry: at first, in a short-term period, the firm is able to pay only permanent, or fixed, costs with or without interruption of production, and over a longer time interval, it does not receive the expected increase in prices for its products).
The market supply curve is obtained by summing the volumes of long-term supply of individual firms. However, in contrast to the short term, the number of firms may change in the long term.
What compels firms to enter into business if economic profit in the long run is reduced to zero? It all depends on the possibility of obtaining high short-term profits. Such an opportunity, by changing the situation of short-term equilibrium, can be provided by the influence of external factors, in particular, a change in demand. Increased demand will bring short-term economic gains. In the future, the action will develop according to the scenario already described above. In this case, there are three options for changing the industry supply:
1) the offer price is unchanged;
2) the offer price increases;
3) the offer price decreases.
The implementation of this or that option is determined by the degree of dependence between the change in the volume of output and the change in the supply price. The level of the supply price, in turn, is determined by the value of costs and, consequently, the cost of resources. Here you can define three options (Fig.7.11 a, b, c)
Equilibrium of a perfectly competitive firm in the short run.
An equilibrium output that maximizes the profit of a perfectly competitive firm is output where the market price equals marginal cost and marginal revenue. Any output below this level means that the firm can increase output to increase profits, and vice versa.
When the price is greater than the average cost of production (AC), then a perfectly competitive firm makes an economic profit. Obtaining an economic profit means that its income exceeds all its costs.
If the market price is equal to the minimum average cost, then it allows a perfectly competitive firm to only cover its costs; as a result, the firm receives an economic profit equal to zero, i.e. normal profit. A perfectly competitive firm in this case is in self-sufficiency.
When the market price falls below the minimum possible average cost, but exceeds the minimum average variable cost, then a perfectly competitive firm incurs a loss.
Finally, when the price falls to the lowest possible average variable cost, the firm is at the point of no operation. For any price that falls below the lowest possible average variable cost, the firm’s losses exceed the fixed cost, and the perfectly competitive firm is closed.
The supply curve of a perfectly competitive firm shows the relationship between price and quantity on offer. The short-term supply curve of a perfectly competitive firm coincides with its marginal cost curve, but only in that part of it, which is located above the minimum possible average variable costs.
The market short-term supply curve reflects the total volume of output supplied by all firms offering a standardized product to the market at any possible price.
A long-term time interval assumes the mobility of all production resources, as well as a change in the number of firms in the industry. New firms will enter an industry if the industry's profits exceed what they can get from other industries. If the economic profit in the industry is negative and firms make profits below normal profit, then they leave the industry. When an industry has zero economic profits, firms are not incentivized to enter or leave the industry. A perfectly competitive firm produces products in the long run only if the price does not fall below the long run average cost. Accordingly, when the price is initially lower than the long-term average costs, there are losses and outflow of firms from the industry. When the equality of the price of goods and the minimum possible average costs in the long-term period is achieved, then there is no incentive for new firms to enter the industry, and for functioning firms - to increase the volume of production, and it is achieved long term competitive equilibrium, the condition of which is the equality of prices to marginal costs at the point of minimum average costs: P = LMC = min LAC.
The long-run supply curve of a perfectly competitive firm is that portion of the long-run marginal cost curve that is above the minimum possible long-run average cost.
