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Equilibrium of a competitive firm in the long run.
When choosing the scale of production, producers are guided by the motive of maximizing income. However, the dynamics of income, as one of the decisive factors of profit, largely depends on the market situation, first of all, on the prevailing type of competition. As is known, depending on the competitive environment, markets are divided into the following four groups: the market of pure (perfect) competition, the market of monopolistic competition, the oligopoly market and the pure monopoly market. Therefore, the problem of choosing production volumes and maximizing profits for each market situation should be separately considered.
Signs and conditions of perfect competition
The most important characteristics by which various market models are distinguished are: the number of selling firms in the market; the type of product offered for sale; the ability to control prices on the part of sellers; conditions for additional producers entering and exiting the industry; the method of competition that prevails in that market. For a market of pure (perfect) competition, these signs should be like this:
1. A lot of sellers , competing equally with each other. The concept “very much” does not have quantitative expression. There may be thousands, tens or even hundreds of thousands. The main thing is that the part of each of them on the market is so small that an increase or decrease in the volumes sold by any of them does not in any way affect the market situation at all.
Of course, such conditions are quite rare. However, with a certain convention, this criterion is met by markets for agricultural products in developed countries, exchange trading or sale of foreign currency at exchange offices.
2. Standard products offered for sale. This means that the consumer does not distinguish the product of one seller from the product of another, even if they are actually different. Therefore, he does not care from which seller to purchase the goods.
3. Lack of ability for an individual seller to influence the market price . Of course, the seller is able to offer his products at lower prices than those prevailing on the market. However, this, firstly, will not affect the market price as a whole, since the share of an individual seller in the market is negligible, and secondly, it will contradict the initial assumption of maximizing benefits as the main motive for the behavior of economic entities. Indeed, in the latter case, the seller’s income will decrease compared to the option of selling the goods at the market price. He has no choice but to sell the goods at market prices. Therefore, a seller in perfect competition is often called a “price matcher.”
4. Free entry into and exit from the industry . The market will be competitive only when there are no legislative, technological, financial or other barriers that could prevent the emergence or disappearance of new firms producing a certain product. Particular emphasis should be placed on this feature of perfect competition, since it is at the forefront of explaining the mechanism for adapting the industry to market requirements in the long run.
5. Lack of non-price competition . The basis for non-price competition, as a rule, is product differentiation. Since products in a competitive market are standard, there is no basis for non-price competition.
A comparison of the recalculated characteristics with the existing competitive environment in the real economy shows that pure competition is a unique phenomenon. Today there are almost no areas where all these signs could be found. However, this does not mean that perfect competition does not deserve special analysis. Why?
First, there are several areas (industry markets) where the situation is more similar to pure competition than to any other market model. Secondly, to understand more complex market situations, it is necessary to start the analysis with the simplest options, which include the perfectly competitive market.
In conditions of pure competition, as already noted, a company cannot pursue its own pricing policy. It can only adapt to the prices that this moment have developed in the market. From this we can draw a very important conclusion: no matter how many products a competitive company offers for sale, this will not affect the market price in any way. In other words, unlike market demand the demand curve facing an individual competitive producer is perfectly elastic(Fig. 1).
This difference between market demand and demand in relation to an individual competitive firm once again warns the researcher about the fallacy of the widespread statement: what is true in relation to an individual member of the association is always true in relation to the entire association.
Peculiarities of demand for the product of a competitive company are also manifested through the dynamics of the main indicators that characterize its income, depending on sales volumes.
These indicators include:
P P d D
a) demand curve for b) market demand curve
competitive firm
Rice. 1 Differences between market demand and demand for a competitive firm
1. Gross (total) income (TR) is the total revenue from the sale of the entire volume of products.
2. Average income (AR)- is the gross income per unit of products sold:
3. Marginal Revenue (MR) is the increase in gross income resulting from the sale of one more unit of product:
MR = DTR/DQ. (2)
Graphically, the dependence of the dynamics of the recalculated indicators on production volumes is presented in Fig. 2.
P TR AR=MR=P
Rice. 7.2. Gross, average and marginal revenue of a competitive firm
The gross income of a competitive firm will increase in direct proportion to sales volume. The price per unit of goods, average and marginal income in a competitive market will always be equal to each other.
Finding out common features The competitive market and the peculiarities of the firm’s functioning in it and the formation of its income provide sufficient grounds for developing a model for the firm’s choice of production volumes that provide it with maximum income. This model has its own specifics for short-term and long-term periods. Therefore, we will consider these two situations separately.
Maximizing profits in the long run
The transition to the analysis of a long-term period requires a transition from analyzing the behavior of an individual firm to elucidating their interaction in the process of creating a market supply and forming a market price. This involves introducing some new assumptions:
Table 7.3
Decision-making model for maximizing the benefits of a competitive firm in the short term
1. We assume that the industry’s adaptation to market needs in the long term occurs by attracting new producers to the region or their exit from the industry.
2. We assume that all firms in the industry have the same or very similar cost curves, which makes it possible to talk about a certain average, typical firm.
P S D 1 D 3 D 2 P 1 P 3 P 2 QRice. 5. Change in market price under the influence of changes in supply
Let the market price for chairs be set at 147 UAH. (P 1), which allows a typical firm in the industry to earn economic profit. How will entrepreneurs in other industries behave in this case? It would be logical to predict that they will try to refocus their activities on the production of chairs, since it brings not only normal, but also economic profit. As is known, under the influence of an increase in the number of producers, the market supply curve will move to the right, which will lead to a decrease in the equilibrium market price (Fig. 5). Therefore, the entry of new producers into the industry eliminates economic profits.
Ministry of Education and Science of the Russian Federation
Federal Agency for Education
State Educational Institution of Higher Professional Education All-Russian Correspondence Financial and Economic Institute
Department economic theory
TEST
in the discipline "Economic Theory"
using a computer training program
Option No. 18
Teacher: ___________________________________________
Student I course:
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_______________________________________________________
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(personal file no., group no.)
Penza 2010
Work plan
Introduction……………………………………………………………...3
Test theoretical question…………………………………4
Conclusion……………………………………………………………...14
Control test tasks………………………………………………………..15
References……………………………………………………..18
Introduction
The terms “perfect competition” and “perfect market” were introduced into scientific circulation in the second half of the 19th century. Among the authors who first used the concept of a perfect market is W. Jevons. Representatives classical political economy when characterizing market regulation, they relied on the concept of free (unrestricted) competition, focusing on the fact that the action of competition is not subject to restrictions from pre-capitalist regulations that prevented the migration of capital from one industry to another.
Equilibrium of a perfectly competitive firm in the short and long periods
In an industry, a competitive firm can occupy different positions. It depends on what its costs are in relation to the market price of the goods that the company produces. Economic theory considers three general cases of average cost relationships: (AS) firm and market price (R), which determines the position of the company in the industry - whether it receives excess profits, normal profits or the presence of losses (Fig. 1).
Figure 1 – Options for the position of a competitive firm in the industry: a – the firm suffers losses; b) receiving normal profit; c) receiving excess profits
In the first case (Fig. 1, a) we observe an unsuccessful, ineffective company incurring losses: its costs AC too high compared to the price of the product R market, and do not pay off. Such a firm should either modernize production and reduce costs, or leave the industry.
In the second case (Fig. 1, b) the firm achieves equality between average cost and price (AC = P) with production volume Q e, This is what characterizes the equilibrium of a firm in an industry. After all, the average cost function of a firm can be considered as a function of supply, and demand, as we remember, is a function of price R. This achieves equality between supply and demand, i.e. balance. Volume of production Q e in this case is equilibrium. Being in a state of equilibrium, the firm receives only normal profit, including accounting profit, and economic profit (i.e. excess profit) is equal to zero. The presence of normal profits provides the company with a favorable position in the industry.
The lack of economic profit creates an incentive to search for competitive advantages - for example, the introduction of innovations, more advanced technologies, which can further reduce the company's costs per unit of production and temporarily provide excess profits.
The position of a company receiving excess profits in the industry is shown in Fig. 1, V. When producing in volumes from Q 1 before Q 2 the company has excess profit: income received from selling products at a price R, exceeds the firm's costs (AC< Р). It should be noted that the greatest profit is achieved when producing products in volume Q 2 . The size of the maximum profit is marked in Fig. 5.4, V shaded area.
However, it is possible to more accurately determine the moment when the increase in production should be stopped so that profits do not turn into losses, as, for example, when the output volume is at the level of Q 3. To do this, it is necessary to compare marginal costs (MS) firm with a market price, which for a competitive firm is also marginal revenue ( M.R. ). Recall that marginal cost reflects individual production cost each subsequent unit of goods and change faster than average costs. Therefore, the firm achieves maximum profit (at MS = M.R. ) much sooner than average costs equal the price of the product.
The condition for the equality of marginal costs and marginal revenue (MC) = M.R. ) There is production optimization rule.
Compliance with this rule helps the company not only maximize profits, but also minimize losses.
So, a rationally operating company, regardless of its position in the industry (whether it suffers losses, receives normal profits or excess profits), must produce only the optimal volume products. This means that the entrepreneur will always settle on a volume of output at which the cost of producing the last unit of goods (i.e. MS) will coincide with the amount of income from the sale of this last unit (i.e. M.R. ). In other words, the optimal volume of production is determined by achieving equality between marginal costs and marginal revenue (MS= M.R. ) companies. Let's consider this situation in Fig. 2. .
Figure 2 – Position of a competitive firm in the industry: a – determination of the optimal output volume; b – determination of profit (loss) of a company – a perfect competitor
In Fig. 2, and we see that for this company the equality MS – M R achieved upon production and sale of the 10th unit of output. Consequently, 10 units of goods are the optimal production volume, since this volume of output allows you to obtain the maximum amount of profit, i.e. maximize profits. By producing less, say five units, the firm's profit would be incomplete (only the portion of the shaded figure representing profit).
It is necessary to distinguish between the profit from the production and sale of one unit of production (for example, the 4th or 5th) and the total, total profit. When we talk about maximizing profits, we're talking about about the entire profit, i.e. about receiving total profit. Therefore, despite the fact that the maximum positive difference between M.R. and MS gives the production of only the 5th unit of production (Fig. 2, A), We will not stop at this quantity and will continue to produce. We are completely interested in all products, in the production of which MS < M.R. , which brings profit right up to until the MS is leveled and MR. After all, the market price P = MR pays back the production costs of the 7th and even the 9th unit of production, additionally bringing in, albeit small, but still a profit. So why give it up? We should refuse losses, which in our example arise during the production of the 11th unit of production (Fig. 2, A). Starting there, the balance between marginal revenue and marginal cost changes in the opposite direction: MS > M.R. . This is why to maximize profits, i.e. to obtain all the profit, you should stop at the 10th unit of production, at which MS = M.R. . In this case, the possibilities for further increasing profits have been exhausted, as evidenced by this equality.
So, the considered rule of equality of marginal costs to marginal income underlies the principle of production optimization, with the help of which it is determined optimal, most profitable, production volume at any price, emerging on the market.
Now we have to find out what it's like position of the firm in the industry at optimal output volume: Will the company incur losses or make a profit? Let us turn to the second part of Fig. 2, b, where the firm - a perfect competitor - is depicted in full: a graph of the average cost function has been added to the MC function AC.
Let us pay attention to what indicators are plotted on the coordinate axes when depicting a company. Not only the market price is plotted on the ordinate axis (vertically) R, equal to marginal revenue under perfect competition, but also all types of costs (AS and MC) in monetary terms. The abscissa axis (horizontal) always shows only the output volume Q .
To determine the amount of profit (or loss), several steps must be taken.
Step one. Using the optimization rule, we determine the volume of output Q opt , the production of which achieves equality MS = M.R. . On the graph this happens at the intersection point of the functions MS and M.R. . By lowering the perpendicular (dashed line) from this point down to the x-axis, we find the required optimal output volume. For this company (Fig. 2, b) equality between MS and M.R. achieved upon production of the 10th unit of output. Therefore, the optimal output volume is 10 units.
Recall that in perfect competition, the firm's marginal revenue coincides with the market price. There are many small firms in the industry, and none of them individually can influence the market price, being a price taker. Therefore, for any volume of output, the firm sells each subsequent unit of output at the same price. Accordingly, the price functions R and marginal income M.R. match ( M.R. = P), which eliminates the need to search for the price of optimal output: it will always be equal to the marginal revenue from the last unit of goods.
Step two. Determine the value of average costs AC when producing goods in the volume Q opt. To do this from the point Q opt , equal to 10 units, draw a perpendicular upward until it intersects with the function AC, and then from the resulting intersection point - perpendicular to the left to the ordinate axis, on which the average cost of production of 10 units of production is plotted A.C. 10 . Now we know what the average cost of producing the optimal output is.
Step three. Finally, we determine the amount of profit (or loss) of the company. We have already found out what the average costs AC of producing goods in the volume Q opt are equal to. It remains to compare them with the price prevailing in the industry, i.e. with market price R.
We see that on the ordinate (vertical) axis the marked costs AC 10 less price (AC< Р). Therefore, the firm makes a profit. To determine the size of the entire profit, we multiply the difference between price and average costs, which is the profit from one unit of production, by the volume of the entire output in the amount of Q opt.
Firm profit = (R - AC) X Q opt .
Of course, we are talking about profit, provided that P > AC. If it turns out that R< АС, This means that the company incurs losses, the amount of which is calculated using the same formula.
In Fig. 2, b the profit margin is shown by the shaded rectangle. Please note that in this case the company received not an accounting profit, but an economic profit, or excess profit, exceeding the opportunity cost.
There is also another way to determine profit(or loss) of the company. Recall that if the firm's sales volume Q op and the market price are known R, then we can calculate the value total income:
TR = P * Q opt .
Knowing the magnitude A C and output volume, you can calculate the value total costs:
TC = ACxQ opt .
Now it is very easy to determine the value using simple subtraction profit or loss companies:
Profit (loss) of the company = TR - TS.
If ( TR - TS)> 0 - the company makes a profit, and if ( TR - TS) < 0 - фирма несет убытки.
So, at the optimal output volume, when MS = M.R. ,. a competitive firm can earn economic profits (excess profits) or incur losses.
Why do you need to determine the optimal output volume? The fact is that if, when producing products, a company follows the rule of production optimization MS = M.R. , then at any (profitable or unprofitable) price prevailing in the industry, it wins.
Optimization benefits is as follows. If the equilibrium price in the industry is higher than the average cost of a perfect competitor, then the firm maximizes profit. If the equilibrium price in the market falls below the firm’s average costs, then the rule MS = M.R. allows the company to minimize its losses - minimize losses.
What is happening to the company in the industry? in the long term?
If the equilibrium price established in the industry market is higher than average costs and firms receive excess profits, then this stimulates the emergence of new firms in the profitable industry. The influx of new firms expands the industry's offer. An increase in the supply of goods on the market leads to a decrease in price. Falling prices “eat up” the excess profits of firms.
Continuing to fall, the market price gradually falls below the average costs of firms in the industry. Losses appear, which drives unprofitable firms out of the industry. Note that those firms that are unable to take measures to reduce costs are leaving the market. Thus, excess supply in the industry is reduced, and in response to this, the price in the market begins to rise again.
So, in the long term industry supply changes. This occurs due to an increase or decrease in the number of market participants. Prices move up and down, each time passing through a level at which P = AC. IN In this situation, firms do not incur losses, but also do not receive excess profits. Such the long-term situation is called equilibrium.
In conditions of equilibrium, when the demand price coincides with average costs, the firm produces according to the optimization rule at the level M.R. = MS, t. e. produces the optimal volume of products.
Thus, equilibrium is characterized by the fact that the values of all parameters of the company coincide with each other:
A.C. = P = M.R. = M.C. .
Because M.R. perfect competitor is always equal to the market price R = M.R. , That equilibrium condition for a competitive firm the industry is about equality
AC = P = MS.
The position of a perfect competitor when equilibrium in the industry is achieved is shown in Fig. 3.
Figure 3 – The firm is a perfect competitor in equilibrium
In Fig. 3, the price (market demand) function P for the company’s products passes through the point of intersection of the functions AC And MS. Since under perfect competition the marginal revenue function M.R. firm coincides with the demand function (or price), then the optimal production volume Q opt corresponds to the equality AC= P = M.R. = MS, which characterizes the position of the company in equilibrium conditions(at point E). We see that the firm receives neither economic profit nor loss under the conditions of equilibrium that arises during long-term changes in the industry.
However, what happens to the company itself? in the long term or period? Recall that in the long run (LR - long - run period ) firm's fixed costs F.C. grow when its production potential grows. In the long run, expanding the scale of a firm by using appropriate technology produces economies of scale. The essence of this effect is that the long-term average costs of LAC, having decreased after the introduction of resource-saving technologies, cease to change and remain at a minimum level as output grows. Once economies of scale are exhausted, average costs begin to rise again.
What is the best size for a company? Obviously, one at which short-term average costs reach the minimum level of long-term average costs ( L.A.C. ). Indeed, as a result of long-term changes in the industry, the market price is set at a minimum level LRAC . This is how the firm achieves long-run equilibrium. IN long-run equilibrium conditions the minimum levels of the firm's short-term and long-term average costs are equal not only to each other, but also to the price prevailing in the market. The position of the firm in a state of long-term equilibrium is shown in Fig. 4.
Figure 4 – Position of the company in long-term equilibrium
In the long run, the equilibrium of a competitive firm is characterized by the fact that the optimal volume of production is achieved subject to equality
P = M.C. = A.C. = LRAC .
Under these conditions, the company finds the optimal scale of production capacity, that is, it optimizes the long-term volume of output.
notice, that economic profits in conditions of perfect competition they wear short-term nature. While in a state research institute long-term equilibrium the company receives only normal profit.
In this situation, the firm's average and marginal costs coincide with the equilibrium price in the industry, which has developed when industry-wide demand and supply are equalized.
Conclusion
Competition is a necessary and determining condition for normal functioning market economy. But like any phenomenon
has its pros and cons. TO positive traits can be attributed to: activation of the innovation process, flexible adaptation to demand, high quality products, high labor productivity, minimum costs, implementation of the principle of payment according to the quantity and quality of labor, the possibility of regulation by the state. Negative consequences include “victory” for some and “defeat” for others, differences in operating conditions that lead to dishonest practices, excessive exploitation natural resources, environmental violations, etc.
Competition is a determining condition for maintaining dynamism in the economy, and under conditions of competition, greater national wealth is created at a lower cost of each type of product compared to a monopoly and a planned economy.
Test tasks
1. Which of the following statements are true:
a) each point on the indifference curve means a combination of two goods;
b) each point on the budget line means a combination of two goods;
c) all points on the budget line mean the same level of utility;
Wrong. Budget line ( B.L. ) is a line that graphically displays a set of goods whose acquisition requires the same costs.
d) the slope of the indifference curve characterizes the norm according to which one good can be replaced by another good without changing the level of utility for the consumer.
2. When making decisions about the optimal volume of production, firms first of all evaluate the dynamics:
a) average variable costs;
b) accounting costs;
c) average fixed costs;
D) marginal cost.
This is due to the fact that the optimal volume of production is characterized by the equality of marginal costs and marginal revenue.
Task
The apple market is characterized by the data presented in the table.
1. Build demand and supply graphs
2. Determine the equilibrium price.
3. What will be the situation on the market at a price of 45 rubles.
4. What will be the situation on the market at a price of 60 rubles?
5. If, with an increase in income, demand increased by 10 thousand kg, then what will be the new equilibrium conditions?
We are building a schedule.
As can be seen from the graph, the equilibrium price is 50 rubles, since at this price the quantity of demand is equal to the quantity of supply.
At a price of 45 rubles. demand will exceed supply, and there will be a shortage in the market in the amount of:
Def = D – S = 50 – 20 = 30 thousand kg
At a price of 60 rubles. there will be a surplus on the market of:
S – D = 80 – 20 = 6 thousand kg
If, with an increase in income, demand increases by 10 thousand kg at any price level, the demand curve will shift to the right, to position D¢. In this case, the equilibrium will shift to the right, and the quantity demanded and price will increase.
BIBLIOGRAPHY
1. Kozyrev A.V. Fundamentals of modern economics. Textbook for universities. – M.Finance and Statistics, 2009
2. Course of economic theory/Ed. M.N. Chepurina, E.N. Kiseleva. – Kirov, 2008
3. Economics: Textbook/Ed. prof. A.S. Bulatova. – M.: Economist, 2008
4. Economic theory/Ed. G.P. Zhuravleva. – M.: UNITY, 2008
5. Economic theory/Ed. I.P. Nikolaeva. – M.: Prospekt, 2006
The considered behavior of the company is typical for a short-term period. However, the entrepreneur is interested not only in the immediate result, but also in the prospects for the development of the enterprise. Obviously, in the long run the company also proceeds from the task of maximizing profit.
The long-term period differs from the short-term period in that, firstly, the manufacturer can increase production capacity (so all costs become variable) and, secondly, the number of firms in the market can change. In conditions of perfect competition, entry and exit of new firms into the market is absolutely free. Therefore, in the long term, the level of profit becomes a regulator of attracting new capital and new firms to the industry.
If the market price established in the industry is higher than the minimum average cost, then the possibility of obtaining economic profit will serve as an incentive for new firms to enter the industry. As a result, industry supply will increase (S → S1), and the price will decrease (P > P 1), as shown in Fig. 8.11. Conversely, if firms suffer losses (at prices below minimum average cost), this will lead to many of them closing and capital flowing out of the industry. As a result, industry supply will decrease (S → S 2), which will lead to an increase in price (P → P 2 ).
The process of entry and exit of firms will stop only when there is no economic profit. A firm making zero profit has no incentive to exit the business, and other firms have no incentive to enter the business. There is no economic profit when price equals minimum average cost. P = ATS type. In this case we are talking about long-term average costs LAC.
Long Run Average Cost LAC (long average costs) are the costs of producing a unit of output in the long run. Every point L.A.C. corresponds to the minimum short-term unit costs ATS for any size of enterprise (volume of output). The nature of the long-term cost curve is associated with the concept of economies of scale, which describes the relationship between the scale of production and the magnitude of costs (economies of scale were discussed in the previous chapter). The minimum long-term costs determines the optimal size of the enterprise. If the price is equal to the minimum long-run unit cost, the firm's long-run profit is zero.
Rice. 8.11. Changes in industry supply
Thus, the condition for the long-term equilibrium of the firm is that the price is equal to the minimum of long-term unit costs RE = = LAC min (Fig. 8.12).
Rice. 8.12. Long-run equilibrium of the firm
Production at minimum average cost means production at the most efficient combination of resources, i.e. firms make the best use of factors of production and technology. This is certainly a positive phenomenon, primarily for the consumer. It means that the consumer receives the maximum volume of output at the lowest price allowed by unit costs.
A firm's long-run supply curve, like its short-run supply curve, is part of its long-run marginal cost curve. L.M.C. located above point E - the minimum long-term unit costs LAC min. The industry supply curve is obtained by summing the long-term supply volumes of individual firms. However, unlike the short-term period, the number of firms in the long-term may change.
So, in the long run in a perfectly competitive market, the price of a product tends to minimize average costs, and this, in turn, means that when long-run industry equilibrium is achieved, the economic profit of each firm will be zero.
At first glance, one may doubt the correctness of this conclusion: after all, individual firms can use unique production factors, such as soils of high fertility, highly qualified specialists, modern technology, allowing you to produce products with less materials and time.
Indeed, the resource costs per unit of output of competing firms may differ, but their economic costs will be the same. The latter is explained by the fact that in conditions of perfect competition in the factor market, a firm will be able to acquire a factor with increased productivity if it pays for it a price that raises the firm’s costs to the general level in the industry. Otherwise, this factor will be purchased by a competitor.
If the firm already has unique resources, then the increased price should be taken into account as an opportunity cost, because at that price the resource could be sold.
What motivates firms to enter an industry if long-run economic profits are zero? It all depends on the possibility of obtaining high short-term profits. The influence of external factors, in particular changes in demand, can provide such an opportunity by changing the situation of short-term equilibrium. Increased demand will bring short-term economic benefits. In the future, the action will develop according to the scenario already described above.
Let's consider the consequences of changes in demand, provided that prices for resources remain unchanged (Fig. 8.13, a), prices for resources increase (Fig. 8.13, b), prices for resources decrease (Fig. 8.13, c).
Rice. 8.13. Industry supply in the long run
If after reaching equilibrium (point E 1) industry demand will increase ( D 1 → D 2), then initially the price will rise from P 1 before P 2. At this price, firms will begin to earn economic profit, which will lead to an increase in supply in the industry both due to the expansion of production in individual firms and due to the arrival of new firms (in the figure this will be reflected by the shift S1 → S2). As a result, the price will again decrease to the level P 1, since the minimum LAC is equal to this value. Equilibrium in the industry will be established at the point E). If demand decreases (D2 > D1). then the price will decrease from P 1 before R 2. At this price, firms will be at a loss, some of them will close and move to other industries. Market supply will decrease (S2 → S 1). Industry equilibrium will be restored at the point E 1 (see Fig. 8.13, a).
Thus, perfect competition has a unique self-regulation mechanism. Its essence is that the industry reacts flexibly to changes in demand. It attracts a volume of resources that increases or decreases supply just enough to compensate for changes in demand, and on this basis ensures the long-term break-even of firms operating in the industry.
If we connect two industry equilibrium points in the long run for various combinations of aggregate demand and aggregate supply (in Fig. 8.13, and these are the points E 1 And E 2), then the industry supply line in the long run is formed - S1. Since we have assumed that factor prices are constant, line S1 runs parallel to the x-axis. This is not always the case. There are industries in which resource prices increase or decrease.
Most industries use specific resources, the number of which is limited. Their use determines the ascending nature of costs in this industry. The entry of new firms will lead to an increase in demand for resources, the emergence of their shortage and, as a result, an increase in prices. As each new firm enters the market, scarce resources will become more and more expensive. Therefore, the industry will only be able to produce more products at a higher price. This will cause a shift in the S1 curve (Fig. 8.13, b). Market equilibrium will be established at a new point E 2.
Finally, there are industries in which, as the volume of a resource used increases, its price decreases. In this case, the minimum average cost is also reduced. Under such conditions, an increase in industry demand will cause in the long run not only an increase in supply, but also a decrease in the equilibrium price. Curve S 1 will have a negative slope (Fig. 8.13, c). The new long-term equilibrium will be established at the point E 3.
In any case, in the long run, the industry supply curve will be flatter than the short-run supply curve. This is explained as follows. Firstly, the ability to use all resources in the long term allows you to more actively influence price changes, therefore for each individual firm, and therefore for the industry as a whole, the supply curve will be more elastic. Secondly, the possibility of “new” firms entering the industry and “old” firms leaving the industry allows the industry to respond to changes in market prices to a greater extent than in the short term.
Consequently, output will increase or decrease by a greater amount in the long run than in the short run in response to an increase or decrease in price. In addition, the minimum point of the industry's long-term supply price is higher than the minimum point of the short-term supply price, since all costs are variable and must be recovered.
So, in the long run, under conditions of perfect competition, the following will happen:
a) the equilibrium price will be established at the level of minimum long-term average costs R E = LAC min which will ensure long-term break-even for companies;
b) the supply curve of a competitive industry is a line passing through the break-even points (minimum average costs) for each level of production;
c) with a change in demand for industry products, the equilibrium price may remain unchanged, decrease or increase, depending on how prices for production factors change. The industry supply curve will look like a horizontal straight line (parallel to the x-axis), ascending or descending line.
The long-term period is characterized by the fact that firms in the industry have sufficient time to expand or reduce their production capacity and, more importantly, the industry can be replenished with new firms or, conversely, their number can be reduced, which depends on the price level and profitability of production . If the price is initially at a level higher than average gross costs, this will lead to the entry of new firms into the industry. However, this will soon lead to an increase in output, and to such an extent that the price will drop to the level of average gross costs. And then the danger of incurring losses will cause an outflow of firms from the industry. Then there will be a reverse trend in the movement of prices and production volumes.
The reason for the influx or outflow of firms from an industry is that at the moment when in this industry the price falls and the number of firms decreases, in other industries the owners of firms receive normal or supernormal profits. Free capital flows into this area, which leads to the organization of new companies. An increase or decrease in the number of firms is accompanied by an expansion or limitation of the scale of the industry, which is associated with changes in the ratio of supply and demand for products produced in the industry.
Long-term equilibrium is said to be achieved when three conditions are met:
The firm has no incentive to change production volume, i.e. short-term equilibrium MR = MS is observed;
The company is satisfied with the scale of production, since any change in it will cause an increase in average total costs, i.e. minimum short-term costs equal minimum long-term costs;
There is no incentive for firms to leave or enter an industry. This condition is met only when firms receive normal profits, i.e. when the price is equal to the long-run minimum average total cost.
Generalizing all three conditions, we obtain the equation for the long-term equilibrium of a competitive firm:
P = MR = MC =minATC
A graphical illustration of long-term equilibrium is presented in Fig. 4.6.
Figure 4.6. Equilibrium of a competitive firm in the long run.
The graph shows that at point E all three conditions for long-term equilibrium are met. If the price exceeds minimum average total cost, firms in the industry will earn an economic profit, which will attract competitors to the market. As a result, supply will increase and the price will decrease to the equilibrium level. Conversely, if the price falls below the equilibrium price, firms will earn less than normal profits, which will cause them to leave the industry. Supply will decrease and the price will increase to the equilibrium level.
Therefore, we can conclude that in conditions of perfect competition, economic profit is a temporary phenomenon.
Economists consider markets with perfect competition to be highly efficient because, firstly, production efficiency is achieved here at a price equal to the minimum average total cost, which means producing a product in the least expensive way (the best technology, a minimum of resources, low prices); secondly, there is an efficient distribution of resources, i.e. the creation of goods necessary for consumers at P = MC; and thirdly, due to the free flow of resources, competitive markets have the ability to quickly restore the efficiency of resource use in the event of possible imbalances.
7.3.1. Equilibrium of the firm and industry in the long run
Profit level as a regulator of resource attraction
Entry into and exit from a perfectly competitive market is open to all firms without exception. Therefore, in the long term, the level of profitability becomes a regulator of the resources used in the industry.
If the established level in the industry market prices above the minimum average costs, then the possibility of obtaining economic profits will serve as a kind of incentive for new firms to enter this industry. The absence of barriers to their path will lead to the fact that an increasing share of resources will be allocated to the production of this type of goods.
And, conversely, economic losses will act as a disincentive, scaring off entrepreneurs and reducing the amount of resources used in the industry. After all, if a company intends to leave the industry, then in conditions of perfect competition it will not encounter any barriers on its way. That is, the company in this case will not incur any sunk costs and will find a new use for its assets or sell them without damage to itself. Therefore, it will actually be able to fulfill its desire to move resources to another industry.
economic
The relationship between the level of profitability in a competitive industry and the amount of resources used in it, and therefore the volume of supply, determines
break-even of firms operating in a competitive industry in the long run(or, what is the same thing, their receipt zero economic profit). The mechanism for establishing zero economic profit is shown in Fig. 7.14.
Let in a competitive industry (Fig. 7.14 b) initially there is an equilibrium (point O), dictating a certain price level P Q at which the firm (Fig. 7.14 A) in the short term receives zero profit. Let us further assume that the demand for the industry's products unexpectedly increases. The industry demand curve D 0 in this situation will move to position D L , and a new short-term equilibrium will be established in the industry (equilibrium point 0 L , equilibrium supply Q t , equilibrium price R g). New for the company increased level prices will become a source of economic profits (the price lies above the level of average total costs of the ATS).
Economic profits will attract new producers to the industry. The consequence of this will be the formation of a new supply curve S 2, shifted compared to the original one towards higher production volumes. A new, slightly decreased price level P 2 will also be established. If economic profits remain at this price level (as in our figure), then the influx of new firms will continue, and the supply curve will shift even more to the right. In parallel with the influx of new firms into the industry, supply in the industry will increase under the influence of the expansion of production capacity by firms already operating in the industry. Gradually, they will all reach the level of minimum long-term average costs (LATC), i.e., they will reach the optimal enterprise size (see 6.4.2).
Rice. 7.14.
It is obvious that both of these processes will last until the supply curve takes the position S 3, meaning a zero level of profits for firms. And only then will the influx of new firms dry up - there will no longer be an incentive for it.
The same chain of consequences (but in the opposite direction) unfolds in the event of economic losses:
- 1) reduction in demand;
- 2) price drop (short-term period);
- 3) the emergence of economic losses for firms (short-term period);
- 4) outflow of firms and resources from the industry;
- 5) reduction in long-term market supply;
- 6) price increase;
- 7) restoration of break-even (long-term period);
- 8) stopping the outflow of firms and resources from the industry.
Thus, perfect competition has a unique self-regulation mechanism. Its essence is that the industry reacts flexibly to changes in demand. It attracts a volume of resources that increases or decreases supply just enough to compensate for changes in demand. And on this basis it ensures long-term break-even for companies.
long term
equilibrium
To summarize, we can say that the long-term equilibrium established in the industry satisfies three conditions:
- 1) the conditions of short-term equilibrium are met, i.e. short-run marginal cost equals short-run marginal revenue and price (P = MR = MC);
- 2) each of the firms is satisfied with the volumes of used production capacity (short-term average total costs are equal to the lowest possible long-term average costs ATC. = LATC.);
- 3) the company receives zero economic profit, i.e. excess profits are not generated, and therefore there are no firms willing to enter or leave the industry (P = ATC min).
All these three conditions for long-term equilibrium can be represented in the following generalized form:
Long-Run Industry Supply Curve
If you connect all the points of a possible long-term equilibrium, then a long-term supply line of a competitive industry (S L) is formed.
Rice. 7.15. Long term curve
proposals for an industry with constant (a), growing (b) and falling (V) costs
Indeed, the equilibrium points O and 0 3 in Fig. 7.14 actually outlines the position of the long-run supply curve. They show that in the long run, a competitive industry is capable of providing any quantity of supply at the same price P Q . In fact, repeating the above chain of reasoning, it is easy to come to the following conclusion: no matter how demand changes, the volume of supply will react in such a way that ultimately the equilibrium point will return to the level corresponding to the level of zero economic profit for firms operating in the industry.
So, general principle is that The long-run supply curve of a competitive industry is the line passing through the break-even point for each level of production. In Fig. Figure 7.15 shows different manifestations of this pattern.
Fixed Cost Industries
In the specific example we considered (see Fig. 7.14), such a line is a straight line parallel to the abscissa axis and corresponding to the absolute elasticity
of the offer. The latter, however, does not always take place, but only in the so-called industries with fixed costs. That is, in cases where, when expanding the volume of its supply, the industry has the opportunity to purchase the necessary resources at constant prices.
As a rule, this condition is met for industries that are relatively small in size relative to the scale of the entire economy. For example, the increase in the number of gas stations in Russia does not create tension in any of the resource markets that firms enter when building gas stations. Apart from inflation, the creation of reservoirs, the purchase of pumps, the hiring of personnel, etc. the construction of each additional station costs approximately the same amount (the differences can only be associated with its size and design). Consequently, the break-even level, at which the price of gas station services will freeze under the influence of competition, will be the same all the time. We depicted this situation in Fig. 7.15 a, combining on one graph the long-term supply curve of the industry (S L) and the cost curves of a typical firm (ATC 1, ATC 2, ATC 3), corresponding to a given level of industry-wide production.
For a perfectly competitive market, this situation is quite typical. Let us recall trays and shops of various profiles, workshops for the repair and production of various goods, mini-bakeries, confectionery shops, etc. All these types of businesses are small on a national scale, and their expansion is unlikely to affect the prices of purchased resources.
Industries with rising costs
This will not be the case if resources become more and more expensive for each new firm entering the market. This usually happens if the industry's growing demand for a particular resource is so significant that it creates a shortage in the economy as a whole.
This situation is typical for any industries with rising costs in which the prices of the factors used in production rise as the industry expands and the demand for these factors increases.
With an increase in long-term costs, new firms in the industry will reach the level of zero economic profit at a higher price than the old-timers. If we turn again to Fig. 7.14, then we can say that the influx of new firms into the industry will not bring supply to the level of the curve S 3, but will stop earlier, say, in position S 2, at which firms will find themselves in a new (taking into account the rise in price of resources) break-even position. It is clear that the long-term supply curve (S L) in this case will not follow the horizontal trajectory O-0_, but along the ascending curve O-
In a bypassed form, the same is shown in Fig. 7.15 b. As the industry's production volume grows, the break-even point of the firms operating in it will be achieved with a consistent increase in prices (from P to P 3). This will cause the rise of the S L curve.
Costs increase especially quickly if firms in the industry use unique factors of production:
- a) especially gifted highly qualified specialists;
- b) soils of high fertility;
- c) mineral resources that are available only in certain regions, etc.
In such situations, when production expands, rising costs can affect even small industries. After all, unique resources are always available in very limited quantities. Thus, in the history of Russia in the 19th century. similar processes affected, say, the famous malachite crafts (workshops for artistic stone processing), when the fashion for malachite and the resulting increase in output faced the depletion of reserves of this mineral in the Urals. The once cheap (“cheerful”) stone quickly became expensive; even tsars did not neglect making crafts from it, which is perfectly described by P. Bazhov.
Industries with falling costs
Finally, there are industries in which the prices of factors of production decrease as production expands. In this case, the minimum average cost also decreases in the long run. And an increase in industry demand causes, in the long run, a simultaneous increase in supply and a decrease in the equilibrium price.
The long-term supply curve of an industry with falling costs has a negative slope (Figure 7.15 V).
Such an extremely favorable development of events is usually associated with economies of scale in production from suppliers of resources (raw materials, equipment, etc.) for this industry. For example, it is likely that as farms in Russia grow in size and become stronger, their costs will experience long-term declines. The fact is that machines and equipment adapted for farmers are now produced literally piece by piece, and therefore are very expensive. When mass demand appears for them, production will be put on stream and the cost will sharply decrease. Farmers, having felt the reduction in costs (in Fig. 7.15 from ATCj to ATC 3) will themselves begin to reduce the price of their products (falling curve
7.3.2. Perfect competition and economic efficiency
Advantages
perfect
competition
Starting to characterize the positive and negative features of a perfect competition market, let us once again reproduce the condition of long-term equilibrium in a competitive industry and analyze its economic meaning:
- 1. First of all, attention is drawn to the fact that equilibrium is established at the level of long-term and short-term minimum average costs. This clearly indicates that production under conditions of perfect competition is organized in the most technologically efficient manner.
- 2. Equally important is that both the firm and the industry operate without surpluses or deficits. In fact, the demand curve under perfect competition coincides with the marginal revenue curve (D = MR), and the supply curve coincides with the marginal cost curve (S = MC). Therefore, the condition of long-term equilibrium in a competitive industry is actually equivalent to the identity of supply and demand for a given product (since MR = MC, then S = D). Consequently, we can say that perfect competition leads to optimal allocation of resources: the industry involves them in production exactly in the volume that is necessary to cover effective demand.
- 3. Finally, the break-even of firms in the long term (P = LATC min) is also of fundamental importance. This, on the one hand, guarantees the stability of the industry: firms do not incur losses. On the other hand, there are no economic profits, that is, income is not redistributed in favor of this industry from other sectors of the economy.
The combination of these advantages undoubtedly makes perfect competition one of the most effective types of markets. In fact, when economists talk about market self-regulation, automatically bringing the economy to an optimal state- and such a tradition goes back to Adam Smith, we can talk about perfect competition and only about her. Under any type of imperfect competition, long-term equilibrium does not have the listed set of properties: a minimum level of costs, optimal allocation of resources, the absence of deficits and surpluses, the absence of excess profits and losses.
Flaws
perfect
competition
Perfect competition is not without a number of disadvantages.
- 1. Small businesses typical of this type of market often find themselves unable to take advantage of the most effective technique. The fact is that economies of scale in production are often available only to large firms.
- 2. A perfectly competitive market does not stimulate scientific and technological progress. Indeed, small firms usually lack the funds to finance lengthy and expensive research and development activities.
Thus, for all its advantages, the perfectly competitive market should not be an object of idealization. The small size of companies operating in a perfectly competitive market makes it difficult for them to operate in a modern world saturated with large-scale technology and permeated with innovative processes.
Control questions
- 1. What are the conditions and criteria for perfect competition?
- 2. Give examples from Russian reality when the conditions of perfect competition are partially met. How big, in your opinion, is the role of this type of market in the economy of our country?
- 3. What are the fundamental options for the company’s behavior in the short and long term?
- 4. What is the phenomenon of bankruptcy and its role in modern Russia?
- 5. What are the ways for Russian enterprises to reach the break-even point?
- 6. Why is the maximum profit achieved by the company at the point of equality of marginal revenue and costs?
- 7. Describe the supply curve of a competitive firm.
- 8. What role does the absence of barriers play in establishing zero economic profit in the long run in a perfectly competitive market?
- 9. Can perfect competition be considered the most efficient type of market? Give your reasoning.
