Short-run equilibrium refers to the point at which the quantity supplied and quantity demanded are equal in a market, given the existing production capacity and other short-term constraints. This concept is crucial in understanding how firms make output decisions in perfectly competitive markets, how monopolistic competition operates, and how the aggregate demand and aggregate supply model explains economic fluctuations.
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In the short run, a perfectly competitive firm's output decision is based on the principle of profit maximization, where the firm produces the quantity at which marginal revenue equals marginal cost.
For a monopolistically competitive firm, short-run equilibrium occurs where the firm's marginal revenue equals its marginal cost, and the firm is producing a quantity that maximizes its profits given its downward-sloping demand curve.
In the aggregate demand and aggregate supply model, short-run equilibrium is the point where the current price level and the quantity of real GDP demanded intersect the short-run aggregate supply curve, reflecting the current state of the economy.
The short-run aggregate supply curve is upward-sloping, reflecting the fact that firms can only increase output in the short run by increasing the variable inputs, such as labor, which leads to diminishing returns and higher marginal costs.
Shifts in the short-run aggregate supply curve, caused by changes in factors like input prices or productivity, can lead to changes in the short-run equilibrium price level and output level in the economy.
Review Questions
Explain how a perfectly competitive firm determines its short-run equilibrium output level.
A perfectly competitive firm in the short run will produce the quantity of output where its marginal revenue (which is equal to the market price) is equal to its marginal cost. This is the output level that maximizes the firm's profits, as it will not be able to increase its profits by producing more or less. The firm will continue producing up to the point where the additional revenue from selling one more unit (the market price) is equal to the additional cost of producing that unit (the marginal cost).
Describe how the short-run equilibrium is determined in a monopolistically competitive market.
In a monopolistically competitive market, the short-run equilibrium occurs where the firm's marginal revenue equals its marginal cost. Unlike a perfectly competitive firm, a monopolistically competitive firm faces a downward-sloping demand curve, meaning its marginal revenue is less than the market price. The firm will produce the quantity where this equality of marginal revenue and marginal cost is achieved, which maximizes its profits in the short run given its market constraints and demand conditions.
Analyze how changes in the short-run aggregate supply curve affect the short-run equilibrium in the aggregate demand and aggregate supply model.
In the aggregate demand and aggregate supply model, the short-run equilibrium is determined by the intersection of the aggregate demand curve and the short-run aggregate supply curve. If there is a shift in the short-run aggregate supply curve, caused by factors such as changes in input prices or productivity, this will lead to a change in the short-run equilibrium price level and output level. For example, a decrease in short-run aggregate supply will shift the curve to the left, resulting in a higher equilibrium price level and lower equilibrium output level. This demonstrates how short-run supply-side shocks can impact the overall macroeconomic equilibrium in the economy.
The process by which a firm determines the output level that will generate the highest possible profit, given its cost structure and market conditions.