3 - Long-Run Competitive Equilibrium

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Gustavo Indart

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 Effici
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