The long-run equilibrium in a perfectly competitive market is a stable state where all firms are producing at an efficient scale and earning zero economic profit (i.e., normal profit).1 This equilibrium is achieved through the free entry and exit of firms in the long run.2
Key Characteristics of Long-Run Equilibrium
The long-run equilibrium for a firm in perfect competition is characterized by a specific set of equalities:
This can be broken down into three essential points:
- Zero Economic Profit: The price (3
) must equal the minimum of the Long-Run Average Cost (4
): 5
.6
- Mechanism: If firms were earning economic profit (7
), new firms would be attracted to the market (free entry), increasing market supply and driving the price down until 8
.9 Conversely, if firms were making economic losses (10
), existing firms would exit the market, decreasing supply and driving the price up until 11
.12 The result is a stable market where firms earn just enough to cover all their costs, including a normal return on investment (normal profit).13
- Mechanism: If firms were earning economic profit (7
- Profit Maximization: The firm must be maximizing its profit (or minimizing its loss) by producing where its Marginal Cost (14
) equals the Price (15
): 16
.17
- Since firms in perfect competition are price takers, 18
is also equal to Marginal Revenue (19
) and Average Revenue (20
).21 Therefore, the profit-maximizing condition is 22
.23
- Since firms in perfect competition are price takers, 18
- Productive Efficiency: The firm is producing at the minimum point of its Long-Run Average Cost curve: 24
.25
- When 26
at its minimum point, it ensures that production is occurring at the lowest possible cost per unit, which is the definition of productive efficiency.27
- When 26
Efficiency in Long-Run Equilibrium
The long-run equilibrium in perfect competition is considered highly desirable from a societal perspective because it achieves both major types of economic efficiency:28
- Allocative Efficiency: Achieved because 29.30 This means the value consumers place on the last unit of the good (the price) is exactly equal to the cost of the resources used to produce it (the marginal cost).31 Resources are allocated optimally to satisfy consumer preferences.
- Productive Efficiency: Achieved because the firm produces at the minimum of the
curve, meaning goods are produced at the lowest possible cost
.
