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6F Long-Run Competitive Equilibrium

6 Pages
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Department
Economics
Course Code
ECO101H1
Professor
Gustavo Indart

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LONG-RUN COMPETITIVE EQUILIBRIUM
Long-Run Cost
There are two ways capital can change in the long-run:
1) Change in the size of individual firms through additional or improved equipment and buildings
or through reduction or depreciation of equipment and buildings
2) Entry into or exit from industry by firm of the same size as existing firms
Economies of Scale (Increasing Returns to Scale): occur when a % increase in all factor inputs
causes a greater % increase in output
Diseconomies of Scale (Decreasing Returns to Scale): occur when a % increase in all factors
causes a smaller % increase in output
Constant Returns to Scale: occurs when a % increase in all factors causes the same %
increase in output
AC decreases with Economies of Scale
AC increases with Diseconomies of Scale
AC does not change with Constant Returns to Scale
Long Run Average Cost
Shows the lowest average cost for each output in the long-run. This defines the size of capital
for the lowest average cost for each output.
Profit Maximization in the long-run implies that firms change capital and labour until they find the
capital with the Short-Run Average Cost function that gives minimum Long-Run Average Cost
for the desired output.
Provided that there is no technological change, the diagram shows that in competitive
conditions, price will fall from Po to P* as new firms enter the industry due to economic profits at
Po for all capitals and above P* for the minimum efficient scale capital. In the long-run, no firm
could obtain the average return on capital unless the firm was the size (capital) that permitted
Minimum Efficient Scale.
The assumption of perfect competition means that we do not need to draw the LRAC function
since we know that its minimum is minimum SRAC of the firm.
Long-Run Competitive Equilibrium
- No change in Capital despite the possibility of Capital Change
- No firms enter/exit the industry
- 0 Economic Profit
- P = min AC
Long Run Supply: the set of price/quantity supplied combinations that give long-run equilibrium
The assumption of perfect competition with entry and exit of optimally sized firms with no
change in the size of firms means that Long-Run Supply is the set of min AC for each output
Constant Costs: assumes that changes in output of the industry do not affect the factor prices of
the industry. We will make this assumption in our discussion of long-run equilibrium.
1) Changes in Demand (ex: Decrease in Demand)

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Description
LONG-RUN COMPETITIVE EQUILIBRIUM Long-Run Cost There are two ways capital can change in the long-run: 1) Change in the size of individual firms through additional or improved equipment and buildings or through reduction or depreciation of equipment and buildings 2) Entry into or exit from industry by firm of the same size as existing firms Economies of Scale (Increasing Returns to Scale): occur when a % increase in all factor inputs causes a greater % increase in output Diseconomies of Scale (Decreasing Returns to Scale): occur when a % increase in all factors causes a smaller % increase in output Constant Returns to Scale: occurs when a % increase in all factors causes the same % increase in output AC decreases with Economies of Scale AC increases with Diseconomies of Scale AC does not change with Constant Returns to Scale Long Run Average Cost Shows the lowest average cost for each output in the long-run. This defines the size of capital for the lowest average cost for each output. Profit Maximization in the long-run implies that firms change capital and labour until they find the capital with the Short-Run Average Cost function that gives minimum Long-Run Average Cost for the desired output. Provided that there is no technological change, the diagram shows that in competitive conditions, price will fall from Po to P* as new firms enter the industry due to economic profits at Po for all capitals and above P* for the minimum efficient scale capital. In the long-run, no firm could obtain the average re
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