Perfect Competition Long Run Factor Mobility
[dropcap style=”inverse”]T[/dropcap]he Short Run Average Cost (SAC) curves that are above the Average Revenue curve (AR), i.e. the two curves to the extreme left and the extreme right are loss makers that will either leave the industry or change plant size in the long run. The three lower Short Run Average Cost (SAC) curves are making supernormal profits. Supernormal profits occur when total revenues exceed total cost (including the compensation of risk undertaken by the entrepreneur). These supernormal profits will attract outer firms into the industry.
Perfect Competition Long Run Equilibrium
In the long run, with the entry of new firms in the industry, the price of the product will go down as a result of the increase in supply of output and also the cost will go up as a result of more intensive competition for factors of production. The firms will continue entering the industry until the price is equal to average cost so that all firms are earning only normal profits.
The short-run cost curves that lie at the lowest point of the long run average cost curve has no incentive to leave the industry.
The firms will continue leaving the industry until the price is equal to average cost so that the companies remaining in the field are making only normal profits. Normal Profits, also known as the break-even or zero economic profit, includes the profit paid to the entrepreneur (included in the total cost, for bringing in scarce resources and taking on risk), and the total cost is equal to total revenue. A firm making normal profits will remain in the industry.
In the Perfect Competition Long Run, the loss-making firms will exit the industry, and new firms will enter the market. Losses are the key to establishing Long Run equilibrium.
In the long run equilibrium, firms enjoy market efficiencies, which leads to scarce resources not being wasted.
Perfect Competition Long-Run Profit Maximization Formula
Where Long Run Marginal Cost (Long Run MC) = Short Run Marginal Cost (SMC) = Marginal Revenue (MR)
1. Productive Efficiency
When the firm produces at the lowest short-run average cost, they can achieve productive efficiency, where price equals minimum average total costs. Therefore, any firm that cannot produce at the minimum Average Total Cost will be forced to leave the industry.
2. Technical Efficiency
Technical Efficiency is when the firm produces the maximum average product. This efficiency is also a consequence of productive efficiency.
3. Allocative/Pareto Efficiency
Allocative/Pareto Efficiency is when the price is equal to marginal cost. The firm achieves the greatest allocative efficiency when there is no other combination of goods and services that would be more desired by society.
Disadvantages of Perfect Competition
1. Firms do not have an incentive to innovate or spend on research and development because other firms can easily copy their products. This disincentive is a characteristic of the perfect competition market.
2. Since they produce the same product, there is less variety.
3. Firms would not enjoy economies of scale if they did then only a few large firms would remain in the industry.