Long-run equilibrium

Definition

Long-run equilibrium refers to a state in an economic model where supply and demand are balanced, leading to stable prices and output levels over a prolonged period. In this scenario, firms can enter or exit the market freely, and all resources are fully employed, resulting in zero economic profits for firms in perfectly competitive markets. This condition ensures that no incentives exist for firms to change their level of production or pricing strategies.

5 Must Know Facts For Your Next Test

1. In long-run equilibrium, firms earn zero economic profit because any positive profits attract new entrants, increasing supply until profits are eliminated.
2. Long-run equilibrium can only be achieved when all factors of production are variable, allowing firms to adjust their inputs for optimal efficiency.
3. The concept of long-run equilibrium assumes that all firms operate at their most efficient scale, leading to productive efficiency in the market.
4. In a perfectly competitive market, long-run equilibrium is achieved when the price equals the minimum point on the average total cost curve.
5. When external shocks occur, such as changes in consumer preferences or technological advancements, the long-run equilibrium may shift as firms adapt to new market conditions.

Review Questions

• How does long-run equilibrium differ from short-run equilibrium in terms of firm behavior and market conditions?
  • In long-run equilibrium, firms have adjusted all inputs to achieve the most efficient production level, resulting in zero economic profit. In contrast, short-run equilibrium reflects a temporary state where firms may still be earning positive or negative economic profits due to fixed inputs and constraints. This means that while short-run adjustments may lead to profit maximization based on current market conditions, long-run equilibrium ensures stability and efficiency as firms adapt fully to their environment.
• Discuss how external factors like technological change can impact long-run equilibrium in a competitive market.
  • Technological changes can significantly alter the production processes and cost structures of firms, potentially shifting the long-run supply curve. As firms adopt new technologies that reduce costs or improve efficiency, they may be able to produce more at lower prices. This can lead to an increase in supply, which shifts the long-run equilibrium point. Consequently, prices may decrease and allow for a new level of output in the market, affecting how resources are allocated among competing firms.
• Evaluate the implications of long-run equilibrium on resource allocation and economic welfare in a perfectly competitive market.
  • In a perfectly competitive market, long-run equilibrium leads to optimal resource allocation since firms operate at their most efficient scale. This efficiency means that resources are used where they are most valued, maximizing overall economic welfare. Additionally, because prices reflect the true cost of production at this equilibrium point, consumers benefit from lower prices while firms earn normal profits. The balance between supply and demand ensures that no resources are wasted and that society's needs are met effectively.

Related terms

Perfect Competition:

A market structure characterized by many firms selling identical products, where no single firm can influence the market price.

Short-run Equilibrium: A situation in which a firm maximizes its profits based on existing market conditions, but where long-term adjustments have not yet occurred.

Economic Profit: The difference between total revenue and total costs, including both explicit and implicit costs; zero economic profit indicates a normal return on investment.