Long Run Equilibrium: Videos & Practice Problems

In a perfectly competitive market, long-run equilibrium occurs when the price of the product equals the minimum average total cost (ATC). At this point, firms earn zero economic profit, meaning they cover all their costs, including opportunity costs, but do not make extra profit. This equilibrium is achieved because any short-run economic profits attract new firms into the market, increasing supply and driving prices down. Conversely, if firms incur losses, some will exit the market, reducing supply and driving prices up. Thus, the market self-corrects to stabilize at the minimum ATC, ensuring no long-term economic profits or losses.

An increase in demand shifts the demand curve to the right, leading to a higher price and short-run economic profits for firms. These profits attract new firms into the market, increasing the supply. As supply increases, the price begins to fall until it returns to the original equilibrium price, where it equals the minimum average total cost (ATC). At this point, firms earn zero economic profit again. Therefore, despite the initial increase in demand, the market stabilizes at the minimum ATC in the long run, demonstrating the self-correcting nature of competitive markets.

In the long run, firms in a perfectly competitive market earn zero economic profit because of the free entry and exit of firms. When firms earn short-run economic profits, new firms are attracted to the market, increasing supply and driving prices down. Conversely, if firms incur losses, some will exit the market, reducing supply and driving prices up. This process continues until the price stabilizes at the minimum average total cost (ATC), where firms cover all their costs, including opportunity costs, but do not make extra profit. This ensures that in the long run, firms earn zero economic profit.

Shifts in demand and supply affect the short-run equilibrium but not the long-run equilibrium in a perfectly competitive market. An increase in demand raises prices and leads to short-run economic profits, attracting new firms and increasing supply. This increased supply drives prices back down to the minimum average total cost (ATC), restoring long-run equilibrium. Conversely, a decrease in demand lowers prices, causing short-run losses and prompting firms to exit the market, reducing supply and driving prices back up to the minimum ATC. Thus, the market self-corrects to stabilize at the minimum ATC in the long run.

The minimum average total cost (ATC) is crucial in determining long-run equilibrium in a perfectly competitive market. In the long run, the market price stabilizes at the minimum ATC, ensuring that firms earn zero economic profit. This occurs because any deviation from this price, due to shifts in demand or supply, prompts entry or exit of firms, which adjusts the supply and brings the price back to the minimum ATC. Therefore, the minimum ATC acts as a benchmark for the market, ensuring that firms cover all their costs, including opportunity costs, but do not make extra profit in the long run.