Long-run equilibrium

Definition

Long-run equilibrium refers to a state in which the supply and demand in a market are balanced, and firms are able to cover their average total costs while earning normal profits. In this state, there are no incentives for firms to enter or exit the market, leading to a stable price level and quantity of goods produced. This concept is crucial in understanding how different market structures operate over time, especially as firms adjust their production and pricing strategies.

5 Must Know Facts For Your Next Test

1. In long-run equilibrium, firms achieve a situation where they produce at the lowest point of their average total cost curve.
2. The entry of new firms in a perfectly competitive market continues until economic profits are eliminated, leading to zero economic profit in the long run.
3. In monopoly markets, long-run equilibrium may result in higher prices and lower quantities produced compared to perfect competition due to lack of competition.
4. Long-run equilibrium does not mean static; it can shift due to changes in consumer preferences, technology, or resource availability.
5. In macroeconomics, long-run equilibrium relates to overall output and employment levels being stable at full capacity utilization.

Review Questions

• How does long-run equilibrium differ between perfect competition and monopoly?
  • In perfect competition, long-run equilibrium is characterized by firms producing at a level where they can cover all their costs and earn normal profits, leading to an efficient allocation of resources. However, in a monopoly setting, long-run equilibrium allows the monopolist to set higher prices and restrict output compared to competitive markets. This means that monopolists can earn positive economic profits over time due to barriers to entry that prevent new firms from entering the market.
• Discuss the impact of market entry and exit on achieving long-run equilibrium in perfectly competitive markets.
  • Market entry and exit play a crucial role in establishing long-run equilibrium in perfectly competitive markets. When firms see economic profits, new entrants are incentivized to join the market, which increases supply and drives down prices until profits normalize. Conversely, if firms incur losses, some will exit the market, reducing supply and allowing remaining firms to raise prices back up to the level where only normal profits are made. This dynamic process ensures that the market moves toward a state of long-run equilibrium.
• Evaluate the implications of shifts in consumer preferences on long-run equilibrium and market stability.
  • Shifts in consumer preferences can significantly impact long-run equilibrium by altering demand for goods and services. If demand increases for a particular product due to changing tastes, firms may experience short-term economic profits that attract new entrants into the market. As more firms enter, supply increases and prices may eventually fall back toward a new equilibrium where firms earn only normal profits. Alternatively, if demand decreases, some firms might exit the market, leading to reduced supply and potentially higher prices until a new long-run equilibrium is established. This illustrates how markets adapt over time while responding to changes in consumer behavior.

Related terms

Normal Profit: The minimum level of profit needed for a company to remain competitive in the market, covering all opportunity costs.

Market Entry and Exit: The processes by which firms enter new markets or exit existing ones based on profitability and market conditions.

Price Elasticity of Demand: A measure of how much the quantity demanded of a good responds to a change in price, indicating consumer sensitivity to price changes.