long-run+equilibrium

Long Run Equilibrium Long run equilibrium is based on the concept of free entry and free exit into a marketplace. That is, if there are a certain number of firms producing in a given industry, other firms can enter (if the existing firms are earning a profit) or they can leave the market (if they are not earning an economic profit. The theory contends that if firms are making a profit in the short term, more firms will enter the market. This will lead to increased competition for the firm, which will drive the price down to a point where demand is equal to price which is equal to marginal revenue, meaning that a firm will not earn any long term economic profits. This concept hods true in both perfectly competitive and monopolistically competitive industries where increased competition over time drives the market price down to the marginal cost of production. This is based on society's value for a given product as it encompasses the tastes and preferences of a society.

In a monopolistically competitive industry, increased competition has the effect of driving the deman curve for an individual firm down. The demand curve goes down to the point where it is tangent with the firm's average cost curve. At this point there are not any economic profits, which would make it foolish for another firm to enter.

Consider the market for MP3 players. Now imagine that there is not any brand loyalty or patent protection that would cause barriers to entry. In the short run, a firm like apple can produce a product, consumers demand this product a great deal, and Apple will earn a healthy economic profit. In the long run, other firms will see apple making a profit on their MP3 players and decide that they should enter the market. They will copy the design, features, and production methods that led to Apple's short term gains. In the long run, demand for Apple's MP3 player will decline to a point where it is tangent to their average cost curve, and their long run profits will be equal to their average total cost. This price is still above their marginal cost, but their long run economic profits will equal zero.

Question 1: What will happen if firms in a perfectly competitive industry are losing money in the short term? A. All firms will leave the industry and there will no longer be a market for this product B. Some firms will leave the industry, to the point where price = marginal cost C. Everyone will stay in the industry and continue to lose money

Answer: B. If there are no barriers to entry or exit, some firms will choose to leave the industry, which will benefit the remaining firms. In the long run, they will produce at a level where their price is equal to marginal cost, which is the minimum of average cost.

Question 2: Which of the following statements is true about the long run equilibrium in a perfectly competitive industry? A. Economies of scale have been exhausted B. Their production matches society's value of that good C. Firms left in the industry will earn zero economic profit D. all of the above

Answer: D.