Welcome back. In this session, we'll look at what determines long-run equilibrium in a perfectly competitive marketplace. Remember one of our four assumptions about perfect competition, was no barriers to entry that exit or entry is costless. Firms are producing a homogeneous product. Whether consumers or suppliers. Both sides of the market are perfectly informed. And that assumption of costless entry and exit is what'll drive the long run result. In the short run, firms can make profits or losses. In the long run, it's long enough so that firms can make adjustments in their scale of operations the, they can adjust all the inputs they're using. And they were, can, can respond to profit or loss signals, by entering the market, expanding production or exiting the market. So what we'll see in the long run competitive equilibrium and again these [UNKNOWN] are prefaced with the letter l to indicate long run. Is that where price equals the long run marginal cost. The individual firm's output decision rule. It's also where long run marginal cost equals long run average cost, that we're at the bottom of the average cost, the long run average cost curve view and we're just covering overall costs. And what that translates into is zero economic profit. Now characteristics. There are three important characteristics to keep in mind of long-run competitive equilibrium. Each firm is still striving to maximize profit, so it's still looking to produce along its marginal cost-curve. Out to where price hits long-run marginal cost. And we have to be above all costs or variable in the long-run, so we have to be above the long-run average cost curve. Second characteristic, there can't be any incentive for entry or exit. So profit equals zero. If profit doesn't equal zero, then there's still opportunity, there's still a signal that there are either too many players or not enough players in this industry. So, so long as there's a positive or negative, negative signal, there's still opportunity to adjust, and we haven't reached long-run equilibrium. And last thing. Total quantity supplied across all firms has to equal total quantity demanded. So same as what we saw initially in the first few weeks of the course. Equilibrium occurs when total quantity supplied equals total quantity demanded. Those three conditions characterize long-run competitive equilibrium. Let's look at Figure 9.8 of what we mean by applying in better understanding there by the three conditions. Let's say, we're in short-run situation. In particular, operating with shorter than average cost-curve one, and short and marginal cost-curve one. And that the prevailing price is p. Which in a competitive market, is the same as a competitive firm's marginal revenue and average revenue. Your price taker, you're stuck, because it's, it's atomistic setting, homogeneous products, perfect information. In the short run, this particular firm by looking out to where price hits short on marginal cost makes a prot, positive profit. The amount of the profit remembers comparing the heights of average curves. Average revenue at quantity small q1, so height of g above height of H. H is the height of average cost, we'll compare average revenue to average cost. That's the average profit margin, multiplied by q1, small q1, that gives the total profit this firm is making. And that profit is indicated by the hatched area, EGHI. Now, this firm is, it has the opportunity to adjust its scale of plant. Well, think about, well if I'm free to adjust all inputs, I've gotta think about my long-run marginal cost and long-run average cost. So, if I truly have that flexibility over the long-run, what I'm concerned about is LMC and LAC. And if the price tool stayed at the height of p equals mr equals ar, then I'd want to increase the scale of my plant, increase output to small q3. To where that price hits the long run marginal cost curve and I make even more money. I'd make the entire blue area of EFAC. However, this isn't a long-run setting. Why not? Because there is still a positive profit signal. And if entry is costless that profit signal is like a flower attracting a bee. It's going to attract greater entry into the market. Where the market will eventually settle, in the long run, is where the price gets reduced in this case to P prime. And, where that reduced price hits the long run marginal cost curve, at the same height as the long run average cost curve at small Q2. At that point, the profit signal has been extinguished and will be able to come to rest in this perfectly competitive setting. Now how does that happen? Positive profits attract entry. And so when we look at the summation of all the short-run marginal cost curves above average variable cost. Entry means more short-run marginal cost curves, means that the short run supply curve for the industry keeps shifting to the right, so long as there is positive profit signal. That entry will keep occurring until the profit signal gets wiped out. Until we get down to a price, P prime, where there's no more opportunity to make money. So that's the process that occurs. And what we'll turn to next is that there's a subtlety involved here. Because input cost so far we've assumed remained constant as an industry expands. That needn't be the case, and we'll turn to dealing with how that complication affects the analysis. Fundamentally, the adjustment will keep occurring so long as profits are positive. Or exit will keep occurring so long as there's a negative profit signal for, for exit. But for now we've assumed that that isn't the case, and that entry will keep occurring until the profits are eliminated. Two final points on this session. What if initially a firm's costs differs. For example one firm hires Mensa, hires an employee that is much more gifted. Then initially they think shall be. Or hires a particular office location that turns out to be much more productive than the rival from Densa that doesn't hire such a brilliant employee or doesn't employ, or doesn't hire such a productive office location. Initially that may show up as a profit to Mensa versus Densa. And yet once the employee becomes known that she is more productive, that they've made an especially good hire, the price for that input will get bid up, whether it's an employee or office space. So the firm itself for the long run may not make money, but as the adjustment occurs as we move, there will be the possibility of certain inputs. Making money along the way because they are more productive, than they initially thought what we would be. So, firms cost may differ initially, until the discovery occurs as to which inputs are more productive, or less productive. And then, last point to make, a perfectly competitive industries, the firms themselves, while certain inputs along the way may get above market returns. Firms themselves in the long run will end up with zero profits. It doesn't mean you're not earning revenues, it just means that your revenues just cover your total cost. And these are fundamental not fun industries to be in. classic case in point, Global Crossing which started in 1998 laying transatlantic cable. they invested 750 million, to build their first transatlantic cable. sold off the rights to each voice circuit, so they ended up selling for a total of 2 billion dollars. The firm's market valuation by the stock market, got as high as 32 billion. It was worth in the year 2000 as much as Ford Motor Company, but it was fundamentally turning into a competitive industry. Other companies were also laying Trans Atlantic Cable, and the technology kept improving so each cable could accommodate more voice circuits. The marginal cost of carrying a phone call went closer and closer to zero. And the product was homogeneous. And the investment was literally sunk below the Atlantic. So not withstanding a lot of hype initially, the Global Crossing was this darling firm and going to continue to keep benefiting from greater and greater Internet traffic. Because it ended up finding itself in a, in a very competitive industry. It was one of the firm's losses as competition grew fiercer. And it actually demanded and materialized to the extent people hoped. It lost a lot of money, and it ended up having to declare bankruptcy. So long-run competitive industries are not fun industries to operate in terms of the firms that are beside them. You make revenue, but just barely enough to cover costs.
