Question

What can you expect from an industry in perfect competition in the long run? What will the price be? What quantity will be produced? What will be the relation between marginal cost, average cost, and price?

Short answer

Answer: In a perfectly competitive industry in the long run, the equilibrium price will be equal to both marginal cost (MC) and average total cost (ATC). Firms will produce at the most efficient scale, minimizing ATC and earning zero economic profits (normal profits). The quantity produced will be determined by the market demand at the market-clearing price.

Step-by-step solution

Perfect Competition Characteristics

In a perfectly competitive market, there are many buyers and sellers, all producing homogeneous products. Additionally, there are no barriers to entry, meaning that firms can easily enter or exit the market. In the long run, all firms face similar costs and have the same access to resources. The objective of firms in this market structure is to maximize their profit.

Long-run Equilibrium

In the long run, the perfectly competitive industry will reach an equilibrium where the market price equals both marginal cost (MC) and average total cost (ATC). This means that firms in this market structure will earn normal profits (zero economic profits) in the long run because they will produce at the most efficient point, where the ATC is minimized.

Determining the Price

In perfect competition, the market demand and supply curves determine the price of the product. In long-run equilibrium, the price equals the minimum point of the average cost curve. The price will be equal to the point where the market demand curve intersects the market supply curve. This is known as the market-clearing price, and it remains constant in the long run because there are no barriers to entry, and firms can freely enter or exit the market.

Quantity Produced

The long-run equilibrium quantity produced depends on the number of firms in the industry because each firm will produce the quantity where their MC = P (or MC curves intersect the market price line) in the long run. The total industry output will be the sum of all the individual firms' outputs. As there is free entry and exit of firms in perfect competition, the quantity produced by the industry adjusts, and it will be equal to the market demand at the market-clearing price.

Relationship between MC, AC, and Price

In the long run equilibrium, 1. Price (P) equals Marginal Cost (MC). This is because firms maximize their profits by producing the quantity where P = MC. 2. Price (P) also equals Average Total Cost (ATC). This occurs because firms earn normal profits (zero economic profits) in the long run, and the price is just enough to cover the firm's total cost per unit. 3. Marginal Cost (MC) curve intersects the Average Total Cost (ATC) curve at the minimum point of ATC. This implies that in the long-run equilibrium, the industry operates at its most efficient scale, which minimizes the ATC as firms adjust their scale and number to reach this point. These equalities show that, in a perfectly competitive industry, the long-run equilibrium price will be equal to both marginal cost and average total cost, resulting in the most efficient production scale and zero economic profits for firms.